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September 30, 2021

What's causing inflation right now?

It's not just soaring energy prices that are to blame.
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In-house blogger
Guest blogger
Julius Probst
Application Specialist
All opinions expressed in this content are those of the contributor(s) and do not reflect the views of Macrobond Financial AB.
All written and electronic communication from Macrobond Financial AB is for information or marketing purposes and does not qualify as substantive research.

Rising commodity prices, higher trading costs and supply chain disruptions are all adding to inflationary pressures.

Surging commodity prices earlier this year led to renewed talk of another commodity super-cycle, similar to the one that occurred in the early 2000s. Back then, it was largely driven by China’s economic boom. As the heat map below shows, precious metal prices surged at the beginning of this year. While the boom has started to cool, a strong global economic recovery will keep prices elevated.

Historically, there is a relatively strong inverse correlation between real interest rates and the price of gold, which is unsurprising since a lower discount rate increases the fundamental value of financial assets. However, that correlation reversed recently. Record high CPI inflation figures have lowered the real interest rate to minus 4%, while the gold price has fallen – a sign that gold is not always a great inflation hedge.

Copper prices rose on the back of renewed demand as the global economy recovery continues.

Copper is strongly correlated with global industrial production and output because of its widespread use in industrial production. However, falling copper later this year could be an early indicator that the global recovery might get derailed again by the coronavirus.

We also saw a spectacular surge in lumber prices this summer due to temporary supply side shortages, which affected the US construction industry. After the price almost tripled within a couple of months, it has now fallen again by over 70%.

This is a common dynamic in commodity markets: a temporary shortage leads to higher prices. This will then lead to a large increase in supply as production ramps up. As a result, suppliers subsequently sit on excess inventories, pushing the price back down again – a phenomenon known as the bullwhip effect.

As this chart shows, the real price of lumber (deflated by the US CPI) shows signs of mean-reversion and is now just slightly above its long-run average.

With climate change intensifying, we can expect extreme weather events to occur more frequently. This is causing disruptions in agricultural production worldwide and leading to higher prices for agricultural and food commodities in general. New research suggests that advanced economies may suffer as much as, or even more than developing countries from rising food prices.

Oil prices are now exceeding USD80 per barrel for the first time since 2014.

As US shale became the world’s margin producer, oil prices were range-bound between USD40and USD70. When oil prices rise too much, US capacity goes up and the number of rig counts increases. Higher supply then puts downward pressure on prices.

Meanwhile, when prices fall too much, some US producers suspend operations, as they did in2020, simply because shale production is only profitable at a price of USD45 to USD65 per barrel.

Now both oil and natural gas prices are surging, leading to renewed talks of a 1970s-style energy crisis, as we can see from spot prices below. The UK is particularly affected because the truck driver shortage is also causing additional supply chain disruptions.

Just as concerning is the continued supply-side disruptions resulting from the global pandemic, such as a major Chinese port shutting down due to a zero-Covid policy.

Shipping indices have more than quadrupled since the beginning of the year. These higher trading costs will translate into higher prices for goods.  The shipping industry took a big hit during Corona when a large part of the world went into lockdown. With a now booming global economy, the shipping industry is suddenly facing rapidly accelerating demand while capacity is constrained, which is leading to surging freight rates.

The Baltic Dry, a shipping index for dry bulk transport vessels, has also soared higher than at any point since the global financial crisis. The capsize index, which is tracking coal and iron ore cargos, has hit its highest level in 13 years. This is to show that the global economy is facing ongoing shipping constraints across the board as the global recovery accelerates.

Finally, the IHS PMI suppliers’ delivery time index shows that the pandemic has caused some supply-side disruptions across industries, with delivery times increasing across all major economies.

The US, in particularly, is facing rapidly rising demand combined with supply-side constraints, which should lead to temporary inflationary pressures.

There are three factors that have led to the recent surge in inflation.

First, while the commodity price boom has stalled when it comes to metals, rising commodity food prices and energy prices continue unabated, and have been one of the main contributors to eurozone inflation in recent months.

Second, shipping costs are surging.

And third, supply chain disruptions continue to affect all major economies with rapidly worsening delivery times. While these are all temporary factors, they will contribute to inflation in the coming quarters.

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