Australian Market Strategist, Saxo
Summary: Survey data points to higher inflation driving bond yields upwards, we discuss.
The initial impact of the crisis has been disinflationary, in official price indices at least. Beyond that however, change is afoot, and we see increasing capacity for inflationary pressures to emerge in official measures over the next 12 months, particularly against incoming low base effects, in turn pushing longer-dated bond yields higher.
Supply chain bottlenecks, raw materials prices, food prices, and soaring freight shipping costs all point to inflationary pressures on the supply side that are already here.
A lot of survey data is confirming these significant cost increases. ISM’s January index of prices paid for raw materials is at the highest level since April 2011, pointing to building price pressures in the US manufacturing industry and signalling much higher inflation ahead.
“We are seeing significant cost increases in logistics and raw materials.” (Machinery)
The Prices Index registered 82.1%, up 4.5 percentage points compared to the December reading of 77.6%, signalling headline inflation could rise above 3% in the year ahead. All 18 industries surveyed reported paying increased prices for raw materials in January.
China’s producer price index is another indicator of price pressures creeping through the system. The producer price index rose 0.3% from a year earlier, and 1% from the prior month. Increases in prices across almost the entire commodity complex, from copper, coal and oil to battery metals and rare earths, is buoying factory gate prices and China will soon start exporting those inflationary pressures to the rest of the world.
As commodities continue to inflate, PPI inflation will build, likely feeding through to consumer prices (or margin pressures) outside of China.
That will add more spice to the ongoing rally in commodities. Chinese producer prices turned positive in January having remained stagnant for long. One month’s data does not a trend make. But a strengthening uptrend for factory gate prices in the world’s biggest manufacturer would likely exert pressure on consumer prices in America and elsewhere. China’s PPI has a close relevance with U.S. headline CPI, showing an r*square of 0.75 on the regression over the past three years.
The prices index is soaring higher, corroborating the trend seen in other survey data. Both prices paid and received are each at their highest levels in nearly 10 years.
The global food inflation seen over the past year is here to stay. With the highest corn and soybean prices in 7 years, farmers are being squeezed, particularly those feeding cattle, hogs and poultry. Some reporting that the cost of raising there herds has inflated more than 30%.
Producers like Tyson foods are already increasing prices, which will exert upward price pressure through supply chains in the year ahead.
Price pressures are clearly building. The bond market is responding to these repeated inflationary reads, and will continue to do so, with the 10yr yield continuing to breakout hitting new cycle highs and yield curves steepening.
Coupled with demand side pressures coming from the profound shift toward fiscal primacy – aimed at securing jobs, reinvigorating demand, and fighting inequality - by most Western economies, we have almost a perfect storm for higher inflation. Money printing aimed at demand generation is inherently more inflationary than asset purchases. Money is heading straight to the pockets of those with the highest marginal propensity to spend. Under the banner of this social stability agenda, exacerbated by the pandemics K shaped recovery dynamics, policy makers are willing to take a risk on inflation.