Inflation is back as the US economy reopens
Steel, lumber, plastic and fuel. Corn, soybeans, sugar and sunflower oil. Houses, cars, diapers and toilet paper. Prices are rising almost everywhere you look.
The post-pandemic recovery is in full swing and the global economy is struggling to keep up. Following a collapse at the start of the pandemic as businesses closed and millions of workers lost jobs, demand has rebounded with a vengeance, spurred by government stimulus and consumers flush with savings.
But companies that idled factories or put workers on furlough during lockdowns are now unable to secure enough raw materials to build the houses, make the cars or assemble the appliances that are suddenly in high demand.
Companies are furiously trying to restock inventories following last year’s global recession, straining supply chains already reeling from the pandemic to breaking point. A shortage of shipping containers and bottlenecks at ports have made matters worse and increased the cost of moving products around the world. Throw in accidents, cyberattacks, extreme weather and the huge disruption caused by the desperate hunt for cleaner sources of energy, and you have a perfect storm.
There’s no telling how long demand will outpace supply, especially as the pandemic continues to rampage through some of the world’s biggest economies. But there have already been shortages of everything from microchips and chicken to chlorine and cheese, and prices are spiking.
The big question is whether shortages and price hikes are temporary byproducts of the pandemic, or if the global economy is changing in ways that could permanently hike the cost of doing business and usher in a new era of inflation. The answer has huge implications for workers, investors, companies and governments.
What is certain is that, for now at least, inflation is back and it’s widespread.
Inflation in countries that belong to the Organization for Economic Cooperation and Development surged in April to the highest level since 2008. Energy price hikes boosted average annual inflation across OECD countries to 3.3%. But prices are rising even when volatile food and energy costs are excluded.
How did we get here?
With US gasoline prices at a seven-year high, it’s easy to forget that oil futures crashed last year. Brent crude, the global benchmark, briefly plunged below $20 a barrel last April, as coronavirus lockdowns cratered demand from airlines, motorists and manufacturers.
Brent has since shot up to over $70 a barrel on a dramatic turnaround in demand. US oil hit $70 a barrel on Sunday for the first time in nearly three years. A similar phenomenon is playing out across a host of commodities, industries and products.
“We’ve never really had anything quite that violent and rapid, both in terms of the change down and the change back up,” said George Calhoun, director of the quantitative finance program at the Stevens Institute of Technology in New Jersey. “It’s clear that [the economic rebound] created a lot of disruptions, not just in supply chains, but in business models.”
Take the auto industry, a prime example of how the events of the past year have upended supply chains, changed consumer behavior and are now fueling price pressures.
The pandemic temporarily shuttered car factories last year, while the recession that followed torpedoed sales. When automakers responded by cutting back vehicle production and thus orders for microchips, semiconductor manufacturers reassigned spare capacity to companies making smartphones, laptops and gaming devices — products in high demand from housebound consumers.
Then, when car sales bounced back faster than expected, manufacturers found themselves at the back of the line for chips. Widespread shortages have forced the likes of Ford (F), Volkswagen (VLKAF), Fiat Chrysler (FCAU) and Nissan (NSANF) to slash production and idle plants in some cases.
That has pushed the price of new cars higher and boosted demand for used vehicles, which are now one of the main sources of inflation in the United States.
Rental car companies, which sold thousands of vehicles early on in the pandemic to shore up their finances, are adding to the crush of demand and holding on to stock that would otherwise have been put up for sale.
At the same time, stimulus checks and low interest rates have made vehicle purchases more accessible to households, many of which want to avoid public transportation and carpooling during the pandemic.
The price of used cars and trucks in the United States jumped 10% over the previous month in April — the biggest increase since 1953, according to the Bureau of Labor Statistics. Prices were up 21% compared with a year earlier, making used cars the primary driver of April’s surge in US consumer prices.
“Demand continues to exceed supply for new vehicles and we expect this to continue through 2021, in part due to the production disruption,” Mike Jackson, the CEO of AutoNation (AN), one of America’s biggest car dealers, said on an earnings call with analysts in April.
“More important though, interest rates and consumer preference for vehicle ownership versus ride share and public transportation are supporting demand,” he added. “Americans want individual transportation.”
Commodity prices surge
As the pandemic recovery takes hold, the cost of raw materials needed to produce consumer goods and power vast infrastructure spending in China is soaring. US President Joe Biden’s infrastructure proposal would only increase demand if approved by Congress.
Booming investment into green technologies is also adding to strong demand for metals such as aluminum and copper, which are used in electric vehicles. Tesla (TSLA) recently added $2,000 to the price of its Model 3. CEO Elon Musk blamed rising raw materials costs.
Iron ore, copper and steel, used to make cars, houses and electrical appliances, have hit record price levels in recent weeks. The Bloomberg Commodity Spot Index, which tracks price changes across a range of metals and agricultural commodities, has jumped roughly 60% over the past year.
In Shanghai, the price of rebar, a type of steel used to reinforce concrete, has fallen from record levels in May but is still 16% more expensive than at the end of last year.
Rising costs have pushed producer price inflation in China to its highest level in nearly 13 years. The country’s producer price index — which measures the cost of goods sold to businesses — soared 9% in May from a year ago, according to government data released Wednesday.
In the United States, lumber shortages tied to sawmill shutdowns earlier on in the pandemic have spiked prices, adding nearly $36,000 to the price of an average new home, according to an analysis by the National Association of Home Builders Association.
It’s not just the construction sector that’s feeling the heat. The rising costs of resin and pulp, for example, are prompting Procter & Gamble (PG) and Kimberly-Clark (KMB) to increase the prices of household staples such as tampons, diapers and toilet paper.
A growing list of crises on the supply side has exacerbated the commodities crunch. The Suez Canal blockage delayed goods shipments in March. Drought in South America has weighed on corn and sugar output. A deep freeze in Texas and the Colonial Pipeline ransomware attack tightened the market for plastic and fuel, while India’s Covid-19 outbreak disrupted ports and supply chains.
“It’s really been a perfect storm,” said Warren Patterson, head of commodities strategy at ING.
The latest problem: JBS Meat, a major beef and pork producer, suffered a cyberattack that forced the company to shut down plants in North America and Australia last week. Factories have since come back online but the disruption could cause wholesale meat prices to jump, analysts said.
Food prices are already rising due to a surge in demand for agricultural commodities such as corn and soybeans driven by China, where demand for animal feed is soaring as hog herds recover from an African swine fever outbreak, according to Patterson. The government has also been rebuilding depleted domestic corn reserves, he added.
On the supply side, dry weather in Brazil, Thailand and Europe has weighed on crop yields, while Russia, the world’s leading wheat exporter, has implemented an export tax to bolster domestic supplies and cool prices.
Global food prices rose for a twelfth consecutive month in May and at their fastest monthly rate in more than a decade, according to the UN Food and Agriculture Organization. The FAO Food Price Index, which tracks a wide range of products, was nearly 40% higher last month than its level a year ago.
While the cost of raw ingredients accounts for a small portion of the price that consumers pay for goods in supermarkets and restaurants, food companies such as Nestlé (NSRGY) and Unilever (UL) have already announced price increases on certain product lines in response to commodity inflation.
An increase in supply could ease prices gains, particularly because at these levels there is strong incentive for farmers to plant more crops, Patterson said. In other words, the trend could be temporary.
“The move we’ve seen across most commodities is part of the usual recovery, a cyclical uplift,” he added. “As we see the global economy normalize, once we’ve recovered, demand will ease off and I expect prices to. I’m not of the view that we’re in a commodities super cycle.”
Logistics and labor costs climb
Commodities are not the only factor driving prices higher, however.
Logistics and labor costs have also increased and a shortage of workers in some industries could intensify pressure on companies to raise wages even further.
“When it comes to the economy we’re building, rising wages aren’t a bug; they’re a feature,” Biden said in a speech during a recent visit to Cleveland, Ohio.
Labor shortages, which have also become a problem in Europe, are partly related to the speed at which economies reopened and are likely to normalize once welfare payments dry up, stimulus checks have been spent and workers in sectors such as hospitality and travel feel more confident that businesses won’t be forced to shut again, said Andrew Kenningham, chief Europe economist at Capital Economics.
When it comes to the economy we're building, rising wages aren't a bug; they're a feature."
US President Joe Biden
But that’s little consolation to companies trying to get products out the door. For Whirlpool (WHR), which makes washing machines, fridges and ovens, the rising cost of commodities, labor and logistics has led to several rounds of price increases.
“That’s the only way to mitigate significant cost inflation,” CEO Marc Bitzer said in an interview with Bloomberg Television last month. “There is talk or hope that this is a temporary blip. We see it elevated for a sustained period,” he added.
Supply chain constraints have forced the company to make products based on the goods it has available rather than on customer orders. “That is anything but efficient or normal but that’s how you have to run it right now,” Bitzer said. “The supply chain is pretty much upside down.”
In Germany, the industrial heart of Europe, supply chain disruptions exacerbated by the Suez Canal blockage offer one possible explanation for an unexpected drop in industrial orders in April, according to Carsten Brzeski, head of research at ING.
A growing list of companies around the world have flagged higher supply chain costs — from engine manufacturer Cummins (CMI) to exercise equipment maker Peloton (PTON) — partly driven by soaring shipping charges, which have made it much more expensive to move goods. If demand remains elevated, more firms may opt to pass these costs on to customers.
The Logistics Managers’ Index, a US economic indicator, attests to rising cost pressures in supply chains. The monthly gauge asks corporate supply chiefs where they see future expenses relating to inventory, transportation and warehousing.
In May, respondents predicted that over the next 12 months costs across all three categories would experience their highest increase in the nearly 5-year history of the index.
The end of easy choices
With price hikes apparent on store shelves and in official data, inflation expectations among businesses and consumers are rising, according to various surveys. That in itself poses a challenge. If businesses and consumers think that higher prices are here to stay, they may change their behaviors in ways that cause price pressures to persist.
For example, workers might demand higher wages, forcing companies to increase the price of their goods and placing additional upward pressure on salaries.
At least for now, central bankers are of the view that price hikes will prove transient and are unlikely to lead to persistently higher inflation — even as some economists including former US Treasury Secretary Larry Summers and former Bank of England governor Mervyn King sound the alarm.
“Neglecting inflation leaves global economies sitting on a time bomb,” Deutsche Bank economists warned in a research note this week. If central banks wait too long to raise interest rates they will be forced into “abrupt” policy changes, causing significant disruption to markets and the economy, they argued.
Neglecting inflation leaves global economies sitting on a time bomb."
Deutsche Bank economists
Yet Federal Reserve officials remain sanguine. “Although continued vigilance is warranted, the inflation and employment data thus far appear to reflect a temporary misalignment of supply and demand that should fade over time as the demand surge normalizes, reopening is completed, and supply adapts to the post-pandemic new normal,” Lael Brainard, a Federal Reserve governor said in a speech last week.
Policymakers in the United States and Europe are “looking through” upward pressure on prices and “basing monetary policy decisions on where they think inflation will be in two years’ time rather than in the next six to 12 months,” said Kenningham of Capital Economics.
Still, whereas a year ago concerns centered on deflation, the risks now are “much more balanced and possibly tilted to the upside in some cases,” Kenningham told CNN Business.
“The risks of inflation rising on a sustained basis are much higher in the United States than in Europe,” he added, pointing to far more generous financial support for US households, which has propped up income and helped boost savings to levels not seen in more than 70 years.
“In brief,” wrote the Deutsche Bank economists, “the easy policy decisions of the disinflationary 1980-2020 period appear to be behind us.”
— Charles Riley, Laura He, and Chris Isidore contributed reporting.
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