Rabobank: The Choice We Face Is This: Does One Go Long, Or Go Shortages
By Michael Every of Rabobank
Yesterday’s key focus was Fed Chair Jerome Powell’s semi-annual testimony and the Fed’s Beige Book. Many words were spoken and many written, and markets reacted: 10-year US yields went back down to 1.32%, and 30s below 2%, despite soaring US CPI and PPI – the latter up 5.5% y/y excluding food, energy, and the effects of trade; the US Dollar also reversed its post-CPI gains. This underlines the power of words, particularly of “transitory”, which was far more evident in the spoken testimony, from a man who does not run a business, than in the written one drawing on national representatives of those who do.
In the former, there was only a partially culpable mea culpa in Powell saying: “Inflation is well above 2%. The question will be, where does this leave us in 6 months or so, when inflation, as we expect, does move down.” In the Beige Book we instead saw that: “While some contacts felt that pricing pressures were transitory, the majority expected further increases in input costs and selling prices in the coming months.” The word “shortages” also appeared repeatedly.
Of course, the two views above are not mutually exclusive: inflation can be higher for longer and then go back down again due to reversing base effects. Indeed, depending on how narrow the range of drivers of this inflation are, the easier that assumption is to make.
However, it is not all going to be as easy as lumber, where prices are yelling “Timber!”, or used cars, which is rapidly becoming a very used argument. Food prices are about to go up markedly as input hedges roll off; housing prices/rents will filter through ahead at around the same time; and while oil was down yesterday, it is still up 50% YTD, which will hit the price of most everything if sustained. And then there is trade – to also exclude from your thinking if you are a central bank.
We all know a bit about our current supply-chain disruptions, and markets seem to have ‘learned to live with it’ to some degree already. They are telling themselves that these are going to automatically sort themselves out – or at least central banks are telling them that. But are they?
What they don’t want to hear is that the Covid-related disruptions we are experiencing are creating second and third order effects that further destabilize global supply chains, and this process may just be starting: think of throwing a rock into a pond and watching the ripples spread out.
As one specific example, riots in South Africa have seen the major food distribution center for retail stores in the KwaZulu-Natal region looted – and retail shortages are now occurring in the area as food supplies dry up. Worse, riot-related disruption at the Port of Durban has seen global shipping giant Maersk shutting down its depots, warehouses, and cold stores in both Durban and Johannesburg. That means getting new food in could take time, exacerbating things on the ground. Imagine if this kind of action were replicated in any number of global nodes where the Covid- and recession-struck population is angry, frustrated, scared, and increasingly hungry – and that is before food prices go up ahead.
South African ports are also a key stop-off point for trade between Latin America and Asia: if unrest there is not rapidly contained, it could impact shipping and insurance rates between the two, which would push the price of commodities and food even higher than they were already going – and so exacerbate pre-existing socio-economic-logistical fault-lines that can create further supply-chain disruption.
Of course, we hear repeated missives that supply chains are about to be made more “resilient”: but you don’t move from ‘just in time’ to ‘just in case’ just like that – and with just the right amount of inflation. You just don’t. And that’s before ‘just’ politics gets involved.
In the EU, Reuters says “The European Commission on Wednesday proposed adding shipping to the bloc’s carbon market for the first time…Shipping is seen as one of the trickiest sectors to decarbonise, with industry groups citing a lack of commercially viable technologies. With about 90% of world trade transported by sea, global shipping accounts for nearly 3% of the world’s CO2 emissions. Under the EU plan, shipping would be added to the European Union Emissions Trading System (ETS) gradually from 2023 and phased in over a three-year period. Ship owners will have to buy permits under the ETS when their ships pollute or else face possible bans from EU ports.”
In the US, Democrats inserted a Carbon Border Adjustment Mechanism into their proposed $3.5 trillion Infrastructure bill. This does not mean it will pass: but if it does, not only will US demand leap at a time that global supply cannot respond adequately, but certain goods will automatically become much more expensive at US ports/the border because they are carbon-intensive.
I have to reiterate yet again that no matter how high global inflation goes, there is little risk that global wages follow without that supply-chain move from ‘just in time’ to ‘just in case’ –and ‘just for us’– so the threat of a 1970’s-style wage-price spiral remains limited. But aside from long-bond bulls, who is cheered by the thought of that much economic pain raining down on us?
Moreover, even if we *were* to see a 1970’s-style wage-price spiral, at this stage does anyone really believe the political-economy that would be making that ‘Yes, higher wages and local supply chains, please’ decision would allow a central bank to hike rates, or permit bond yields to rise to expose the inflation? Obviously, the far greater risk would be financial repression and negative real returns.
Yet for now the choice we face is this: does one go long, or go shortages? Or, as Bloomberg says, perhaps one just goes home, noting: “Mounting anxieties about inflation risks and the central bank’s likely policy response are taking a toll on the use of US Treasury futures. With uncertainty swirling about which way Treasury yields might ultimately go, some traders are apparently taking their chips off the table and the size of outstanding positions in futures is shrinking.”
Which means higher volatility in the most important global bond benchmark.
Thu, 07/15/2021 – 10:55