Are Shock US Inflation Numbers A Concern?

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Portfolio managers from Janus Henderson and T. Rowe Price provide their views on the US inflation spike and implications for Australia

Shock Numbers

US April consumer inflation (CPI) data showed a 4.2% annual increase at the headline, the biggest since 2008, up from 2.6% in March. The month on month rise of 0.8% was the biggest since 2009. Economists had forecast 0.2%.

The core rate rose 0.9% month on month, the highest in 26 years, to 3.0% from 1.6%.

US April wholesale inflation (PPI) came in at an annual rate of 6.2%, the highest since 2009. Month on month the PPI rose 0.6% when 0.3% was forecast.

Defining Inflation (US view)

By Andrew Mulliner, global bonds portfolio manager, Janus Henderson

The big beats in US CPI [this week] do tell us a few things about the current economic environment, but one of those things isn’t that there is a change in the secular inflation regime. The magnitude of the beat appears shocking, but needs to be seen in the context of the historic base effects and the unique impact of lock downs and reopening on the data at the moment.

The leading drivers of inflation in Wednesday’s print was used car prices and airline fares, which together illustrate the specific idiosyncrasies of the current environment, with reopening factors (airline fares) coming back very strongly having been exceptionally subdued as a result of the pandemic and supply chain bottlenecks (used cars) causing price pressures in various sectors. Perhaps just as importantly OER (owners’ equivalent rent) was up by 0.2% month on month (the same magnitude of the last months data), suggesting that for now at least the stickier and less volatile/transitory components of inflation remain benign.

Inflation should be expected to rise even further in next month’s print as the base effects from last year peak out as illustrated by the chart below which shows the [year on year] change in the oil price vs US CPI. Somewhat surprisingly, understanding how YoY changes in oil are likely to evolve gives a very good insight into the likely direction of inflation. Of course whilst this year sees a phenomenal positive base effect this falls off sharply into the end of this year and into 2022. 

So what to draw from it all. The Fed’s stance on the transitory nature of inflation at this point of time appears justified. Inflation pressures will likely lift further in the near term, before falling back later in the year. Unfortunately the term ‘inflation’ is often used with little precision and often shorter term changes in price level are described as inflation, but for the term ‘inflation’ to really qualify the changes in price levels must be persistent through time and be broad based.

Unless used car prices continue to surge at their current rate through time and airline fares continue to rise, these ‘inflationary’ factors today will turn into disinflationary factors in the future. Historically, persistent inflation has required a tight labour market and consistent wage gains to support consumption at ever higher price levels. With labour market slack still quite high we think the Fed is appropriately looking through these increases of inflation at this point in time.

Should we see wage gains to come through and persist and the supply chain issues that are lifting input prices to continue beyond the near term, then our relaxed view of the secular inflation outlook will need to be adjusted. For now, we believe the structural drivers of low inflation of the last few decades (technology, demographics and globalisation) remain in place and subsequently the near term price pressures will abate to reveal ongoing low inflation pressures in the years to come. 

For portfolios we think the pricing of certain inflation markets looks increasingly excessive, but we are mindful that the inflation prints have not yet peaked and therefore we may have further to go in the near term. For now we see higher bond yields as an opportunity to add exposure to our funds and ultimately we expect inflation expectations to fall from their current lofty levels in the medium term.

Imbalances Do Not Mean Inflation (Australian view)

By Randal Jenneke, Head of Australian Equities and Portfolio Manager

A sudden shift in consumption away from services like travel, into goods such as electronics and furniture, coupled with global supply chain disruptions, has generated imbalances across many markets from commodities to semi-conductors. Cooper hit an all-time high in April, and iron ore the highest level in a decade (Chart 1). There’s also notable supply/demand imbalance in the property market.

Globally, the semi-conductor shortage has had significant impacts on the auto industry. With the US first quarter earnings season underway, the largest automakers highlighted production constraints due to input shortages (chips), which in turn has eaten into profits. Manufacturing relevant for Australia likely won’t return to pre-covid levels until 2023 (Chart 2). This also means delays for new vehicles and higher prices. For dealerships and marketplaces, including listed Eagers Automotive ((APE)), it means higher margins and a stronger outlook – the stock was our second largest contributor for the month.

One of the key questions going forward is whether these supply constraints will translate into more broad-based price increases.

More importantly, whether that would be enough to spook the central banks into pulling the handbrake on their pervasive monetary stimulus. The RBA actually assessed the implications of supply chain disruptions for local businesses in its May Statement on Monetary Policy. It noted that “issues have generally been mild and/or temporary” with only 10% of businesses experiencing severe supply chain issues. Moreover, the significant increases in freight costs experienced (Chart 3) make up a small portion of total costs and that businesses have adapted to delays by changing order behaviour.

The research is consistent with Governor Lowe’s well-advertised message that inflation is expected to remain subdued over the medium-term and spikes are likely to be transitory. In turn, it supports their critical outlook for monetary policy to stay loose and rates to remain on hold over the coming years, which we believe should continue to be a large positive for domestic businesses and equity valuations.

For active investors like ourselves, we will continue to search for opportunities that arise from potentially profitable market imbalances and longer-term structural trends. Renewables-stoked demand for copper presents as one such secular trend that should persist.

Content included in this article is not by association the view of FNArena (see our disclaimer).

T Rowe Price Disclaimer

This material is being furnished for general informational purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, nor is it intended to serve as the primary basis for an investment decision. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. Investment involves risks. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of May 14, 2021 and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request.

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