Marshall Bartlett; Senior Vice President, Portfolio Manager
Transitory Inflation. That phrase has certainly been commonplace to describe the current environment with inflation seemingly stoked by the rapid “re-start” of business and consumer activity. Recall the movie “Jurassic Park” with a young Samuel Jackson saying, “Hold on to your butts!” as he wondered about what might happen as the dinosaur park system shuts down. Similarly today, the unprecedented, forced shutdown of the economy and resulting stimulus has created economic chaos following the pandemic. While the coronavirus could be akin to a tyrannosaurus rex terrorizing the population, inflation persisting for longer than most anticipated is an unwanted byproduct.
Earlier this year, we took the position that inflation would prove to be transitory for a few reasons, including Base Effects, initial price impacts appeared to be contained, the Fed uses various metrics for their analysis, and labor market slack. At the time, each of these items indicated that both individual companies and the economy could naturally absorb expected fluctuations from the economic reopening, even if inflation and inflation expectations may rise for a short-term period.
However, inflation measures have remained “well above” the Federal Reserve’s stated targets in recent months. For example, as of September 2021 the Consumer Price Index on an annual basis has risen to 5.4% and 4.0% on a core level, which excludes food and energy prices. The headline number resembles 2008 and the core level is more than double the Federal Reserve’s stated 2% average annual increase.
Despite this increase, the Federal Reserve has used the term “transitory” for months to describe current inflation dynamics. Originally, transitory from the Fed’s perspective meant inflationary pressures would likely abate in late 2021, once base effects went away. While the timeframe for higher prices was never defined by the Fed, chairman Jay Powell admitted in recent speeches that inflation has been higher and stayed elevated for longer than they predicted.
However, the impacts of supply chain constraints and the spread of the Delta variant have also changed the trajectory of inflationary pressures. The Fed is now expecting the annual inflation rate to be 4.2% by year end, but then moderate back to 2.2% in 2022. Since the 2022 figure will remain above the Fed’s 2% average, it is likely higher levels of inflation than the 2010 expansion will remain for years to come. Considering additional fiscal stimulus is possible, the level and length of time inflation remains a problem could now be significant given current commodity prices, supply chain constraints, and many companies are beginning to blame these constraints for difficulties with their financial performance.
Current commodity prices
While some commodity prices have abated from their pandemic highs, others remain elevated. Lumber prices fall into the first category, after rising from under $400 per unit in the first quarter of 2020 up to over $1,600 per unit in May 2021, it has moved lower in the summer months. However, other commodity prices, such as cotton and oil, have escalated in recent weeks and remain at higher levels. Container prices also have also reached 18-month highs, with only a slight decrease in recent days. These inconsistent trends in various commodities and transportation costs highlight the unpredictable nature of the virus spread, new variants, and different levels of vaccination across the country and world.
Supply Shortages
There are reports of supply shortages throughout the global economy. Delays at ports and other bottlenecks in the system have made it difficult for goods to feed into manufacturing centers, increasing delivery costs for those items. In addition, labor shortages prevail throughout the economy for multiple reasons. First, the additional unemployment benefits approved through fiscal stimulus have created a buffer for those who collected those premiums, so they do not need to return to the workforce as quickly as originally expected. Second, the pandemic caused early retirement for some and working from home remains a necessity for those with children that have not yet returned to school in person. In addition, the migration of individuals from cities into suburbs has reduced the labor pool in those metropolitan areas where they originally lived. Many individuals who were in Leisure & Hospitality jobs in these areas are simply no longer there. Fourth, some workers are hesitant to return to work amidst the spread of the Delta variant of the virus, not wanting to become infected. The result is companies are having difficulty in finding workers, much less those skilled to perform the role they are specifically seeking out.
Shortages in supply have also created higher supply costs than originally expected. During the economic shutdown, individuals shifted their spending from services to goods. Many services were no longer available (movies, dining out, travelling), so spending moved to physical items that individuals could use at home (home improvements, work from home technology). Prices for these durable items, and their inputs, went higher. In addition, with a limited amount of truck drivers who have either retired or are not wanting to return to work, there is limited space and capacity for transporting items. As a result, transportation costs have escalated in recent weeks, as seen by the container freight index shown above. Many companies have tried to raise wages to help entice workers back to the workforce. The 4.6% annual increase in Average Hourly Earnings remains below levels seen at the start of the pandemic, but above levels seen in the previous expansion and above the 50-year average.
So far, much of these wage increases have been in the first quartile of the wage spectrum (lower wage workers). It is important to note that an overall wage increase spiral is not yet imminent, but that could change over time if increases move to other quartiles of the wage spectrum. Companies deciding to significantly raise wages to retain current workers would be a sign of that occurring.
Company Reactions, Implications
In recent earnings reports, more and more companies are citing inflation and related issues as headwinds. For example, recently Levi Strauss mentioned escalating costs as an issue they are dealing with. However, they contract with their cotton suppliers for future delivery months ahead of time, so they are not paying the current high spot prices for cotton for today’s items. In addition, PepsiCo, Inc. mentioned higher commodity costs in their recent earnings announcement, but indicated they will be able to pass on some of those higher costs to consumers. The ability of companies to pass along these costs to consumers (or not) will be closely watched in upcoming earnings reports. If consumers are expected to pay significantly higher prices for products, it could exacerbate inflation expectations and ultimately slow economic growth.
Conclusion
Overall, with higher commodity costs and supply issues already present in the system, it will take longer for inflation to abate than previously thought. Importantly, inflationary pressures may persist longer than markets and the Federal Reserve currently expect. If wage increases become commonplace and spread to other parts of the labor market, inflation may be even harder to deal with once the supply shortages subside and force the Federal Reserve to increase interest rates sooner than they would like. This would cause tighter economic conditions and growth to slow, shortening the length of the expansion. Consumer behavior, which is close to 70% of U.S. GDP will be an important guide as we navigate these issues in the coming months.
Not Investment Advice or an Offer -This information is intended to assist investors. The information does not constitute investment advice or an offer to invest or to provide management services. It is not our intention to state, indicate, or imply in any manner that current or past results are indicative of future results or expectations. As with all investments, there are associated risks and you could lose money investing. Argent Financial Group is the parent company of Argent Trust, Heritage Trust and AmeriTrust.
