Market Insight: What is driving inflation?
- 08 mins 13 secs
Learning: UnstructuredDaniel Booth, Chief Investment Officer at Border to Coast, gives his outlook for inflation, underlying issues in the economy and if he sees a probability for rates to rise.
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Yeah. Mhm, mm. I think the current inflationary outlook, so there's a lot of discussion about whether inflation is transitory or not. Uh I think we're in a phase where we've seen the base effects of inflation pick up. We're now seeing some supply constraints add to that And we're likely to see elevated inflation into 2022. I think the key response function will be how central banks react to higher inflation and what the direction of monetary policy is there after. I think in the near term you've got strong cyclical demand caused by record quantitative easing, Which even today is still at levels that we saw in the global financial crisis of 2008. So albeit that we're producing that and central banks reducing the asset purchases, there still is a lot of excess liquidity in the system. We've also had the largest ever fiscal deficits in a post war period. And those who are going to be the stimulation of those will be lingering on for years to come. Although the UK will tighten their faster than the rest of the developed 12. And then the final thing that's causing the high um cyclical demand is really just record levels of cash from household and corporate balance sheets. So in the us we saw investment grade corporate issue an extra 600 billion bombs in 2020. So we've got those near term factors meaning we've got very strong cyclical demand. And then we've got some longer term structural factors. So unit labor costs are going up And they're typically about 70% of the cost of production because of the combination of a shortage of labor. So aging demographics in the developed world, as well as a desire to reduce inequality and increase minimum wages. We've also got corporate tax rates going up which have passed through to consumers will result in higher prices and we've got SGN carbon costs. We're also going to see rising price pressures there. And then the final thing I'd say is just we have a lot of supply chain pressures Cameed by under investment over the last 10 years. We're seeing issues across multiple industries. And so at the minute we've got moderately strong growth and moderately strong inflation, but we're not had a period that we were in the seventies, we had double digit inflation And that happened after a period of 10 years of rising inflation from the mid-60s onwards. So I think the risk of that, it's not something that's with us today, but depending on the policy responses over the next couple of years will determine the risk of following that route. Yeah, so I think we've got very strong cyclical demand and that's outstripping supply, um and that's causing prices to rise and causing higher inflation and the risk that transitory inflation becomes more permanent and it feeds into a wage price cycle. So if we look at some of the supply chain factors is across multiple industry. So if we look at microchips, for example, an increased demand for consumer electronics over lockdown and the switch from conventional vehicles to electric vehicles which require more microchips, it's just meant the demand there has been high and we don't have the supply yet to meet that Apple is just recently amounts that they're going to reduce production of their iPhone 13 units in the fourth quarter of this year as a result of a lack of microchips. And we've also seen a lot of the new car companies pay back on their new car production, not because there isn't demand, but just because of the shortage of chips for those cars, which has put up with pressure on used car prices for example. But we see this across other industries as well, container shipping rates have gone up between five and 10 times Their former prices over the last 12 to 18 months. And there we've had a just in time supply chain which has been disrupted by a lot of bottlenecks along along the routes. Two others are closed ports and supply chains in china or backlogs in the west. So for example, we've seen a 20-30% increase in the shipping volumes going through Newport Beach, L. A. in the US. Which has caused a big backlog of ships and at one point we had 70 ships waiting outside Elliott called for a birthing place. So we see that those ports are moving to 24 hour cycles to try and meet the increasing demand in the UK Felix stone, we've got a number of containers which have been left on the, on the dark side where they've been delivered to the pool, but we don't have a sufficient number of trackers to transport them throughout the country. So again, causing a knock on impact on containers and not where they're meant to be a specific point in the cycle for trucking. We had a supply shortage in the UK, pre Covid that's been exacerbated by the Brexit and the loss of foreign workers. And we've seen an increase in demand supply not being able to keep up. And that's stressing the supply chains in the UK particularly. And then gas rates. We're seeing upward pressure on energy prices as a result of the strong demand globally. Um Then the UK we've got a particular dynamic um Because we've only got 10% of the gas reserves of Holland or 5% of the gas reserves of Germany Because we closed 70% of a gas storage in 2019. So again, a volatile commodity which generally difficult to store and there's upward price pressures everywhere, but particularly the UK because of the lack of storage. So I think those are supply chain issues that are going to cause multiple years to fix. And that probably keeps inflation bias to the upside over the Yeah, That means that inflation levels will remain elevated into 2022. Yeah, and that will put upward pressure on interest rates and central banks to tighten policy. So I think that will be negative phenomenal problems. And the picture for equities is a little bit more mixed. So they're the higher inflation is feeding through to higher number of learnings. So that's a positive for equity investors but also higher input prices, which puts pressure on margins which is an adverse effect. The net net of those is probably probably a slight benefit for equities in the near term. But I think longer term there is the risk that people will pay lower multiples for future cash flows Um like they did in the 70's. I think there is a longer-term adversaries to to equities, although I would just note that we're in a mid cycle phase as opposed to an end of cycle face. Mm. Yeah. Yeah. So the central banks are already uh either raising interest rates, are reducing the asset purchase programs. We're seeing braids expected to go up from the fourth quarter of this year Until 2022. The Federal Reserve are probably the most accommodative of this global central banks and I think they will be very mindful of the conditions and we'll try to be behind the curve. Another global central banks would probably be tiling a little before them. So I think we are heading into a period of higher rates but from extraordinary low basis. So I think the economy can handle the initial rises in rates. Yeah. Mhm. Yeah