All Things in Moderation

Vital Statistics:

	Last	Change
S&P futures	3987	21.4
Oil (WTI)	60.74	1.62
10 year government bond yield		1.69%
30 year fixed rate mortgage		3.34%

Stocks are up this morning on no real news. Bonds and MBS are up.

With the expiration of the Supplemental Liquidity Ratio issue, perhaps some of the selling pressure in the bond market will abate.

Initial Jobless Claims rose to 719k last week. While the economy has been adding jobs overall, the drip, drip, drip of these high unemployment claims have been a drag on confidence. Separately, outplacement firm Challenger and Gray reported companies announced 30,600 job cuts last month.

Construction spending fell 0.8% in January, according to the Census Bureau. Residential construction spending fell 0.2% MOM, however it was up 21% on a YOY basis. Given the COVID-19 effects on commercial real estate, it isn’t a surprise to see lower spending in areas like office properties and retail.

Things are picking up in the manufacturing sector, with the ISM Purchasing Managers Index rising to 64.7%. This is the highest reading since 1983. New orders and production drove the increase, and it is clear that manufacturing companies are re-building inventories. Bottlenecks in the supply chain remain, and the list of commodities in short supply is pretty extensive. Every commodity is up in price. In fact, the supplier deliveries number, which measures how long it takes suppliers to fill orders, is the highest since 1973, at the end of the OPEC oil embargo.

These sorts of numbers have people thinking about inflation, and it is true that all commodities are up in price. Are we on the cusp of another 1970s inflation repeat? Certainly some of the pieces are there. Massive government spending? Check. Commodities in short supply? Check. Massive monetary stimulus? Yep. Lousy productivity? You bet. These factors are driving the argument that we are about to see inflation return.

Here are some reasons why it isn’t going to return. Most of these supply bottlenecks are COVID-19 related, and therefore are temporary. As manufacturers restock inventories (this is the driver of that ISM number), these bottlenecks will abate. In fact, logistics REIT Prologis thinks the inventory restocking will take years, as manufacturers realized that a “lean and mean” corporate framework makes companies vulnerable to shocks like we saw with COVID. This applies to workers and inventory. Eventually, these commodity supplies will restock, delivery times will decrease, and then final demand will be the driver.

The 1970s inflation issue was driven by energy, particularly oil. The reason why oil stayed so high was because things like fracking weren’t invented yet. High oil prices seeped into almost every other goods price. US factories, which were built during the Industrial Revolution, were aged and inefficient. Capacity Utilization rates were in the high 80% range, so any additional production was expensive. Foreign competition was nascent as Japan was only beginning its rise and China was a Communist country that supplied us nothing.

Inflation is “too much money chasing too few goods” and the “too few goods” part of this is going to prove temporary, IMO. You aren’t going to see inflation until you have massive consumer spending. In the 1970s, the Boomer generation, which knew nothing but 1950s and 1960s prosperity began consuming with a vengeance, which lasted through the 1990s. Today’s Millennials came of age in the Great Recession, and I have to imagine they will be more frugal than their parents.

Final demand is going to be an interesting question. So far, it appears that people are taking their stimulus checks and saving them – meaning they are either paying off debt or putting it in the bank. That is most certainly not inflationary. The labor market isn’t conducive to massive wage inflation either, given that we are a surplus of workers with a low labor force participation rate. It will take time for those folks to get hired.

I suspect the Fed’s forecasts will be about right: we will see an uptick to something like 2.2% this year as supply chain bottlenecks create a temporary bout of inflation. As inventories restock, we go back to the 1.8%-ish PCE reading to which we are accustomed.

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