Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, May 14th, at 2:00 p.m. in London.
The debate over inflation has roared back to center stage this week. After a lower-than-expected reading for new jobs in April, U.S. consumer price inflation saw an increase of 4.2% versus a year ago. That was the largest year-on-year rise in prices since 2008 and even led to some suggestions of so-called "stagflation" - a scenario of weak growth, but rising prices.
As is often the case, big changes in data are a good opportunity to step back and take a breath. Just as the surprising job number likely overstated the problems in the economy, while hinting at some very real underlying challenges, the same is true for prices. This is not the 1970s or 1980s, but prices are rising, and that could create complications for both companies and central banks.
When we think about these high readings of year-over-year inflation, the first thing to keep in mind is what was happening a year ago. The global economy was in shambles, and the prices of many goods plunged as there was simply little demand for airline tickets, hotels and many other items at any price. Comparisons against those unusual circumstances are obviously going to create some distortions.
There are also unusual things going on in the price of commodities. The prices for oil, copper and grain are also up significantly, especially relative to the depressed conditions of a year ago. While higher prices generally bring about more supply, there's a real issue of timing. It takes time to drill an oil well, build a new copper mine, or plant a field.
Interestingly, most commodities trade for both current delivery and delivery at a future date. Future commodity prices are expecting a fall, in some cases quite significantly - a sign that the market does think that this supply response is coming, just not yet.
But these issues of supply and demand are also at play well beyond the commodity market. As vaccinations increase and conditions improve, many consumers may be looking to make up for lost time and spend some of the savings that many have built up over the last year. Yet for certain areas where people may want to spend money, the supply of goods and services hasn't increased. Generally speaking, there aren't more hotel rooms, airline seats, rental cars or restaurants than there were a year ago, yet there may be an unusually high number of people looking to use them. That mismatch could push prices higher. Companies face the same dilemma, as higher input costs could challenge their margins.
It's normal as the economy improves for prices to rise. For central banks, separating how much of these higher prices is normal, versus abnormal, will be the challenge. We think it's most likely that the Federal Reserve, the ECB and the Bank of England will look past these initial price increases. They are, after all, coming from pretty unusual comparisons. And price inflation was unusually low over the last decade, meaning a little catch up may be in order.
But there's another lesson here. In 2010 and 2011, prices also jumped coming out of a recession. Commodities were a big part of that. And fearing inflation, the European Central Bank raised interest rates twice - an action that, with hindsight, looked misplaced. That experience might make central banks everywhere a little bit more hesitant to take action in response to temporarily higher inflation.
In short, expect a growing contrast between headlines of higher inflation, and central banks wanting to stay patient and look past it. That could lead to steeper yield curves, but also some ongoing summer volatility, as everyone waits to see how temporary inflationary pressures really are.
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