La Française: Early signs of inflation

La Française: Early signs of inflation

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Inflation is one of the main sources of concern within the financial market industry right now. There are indeed a lot of uncertainties regarding the transitory nature of these inflationary pressures.

For several months now, signs of inflation have increased in our economies. One of the most distinct signs of pressure emerged from the commodities market, currently displaying significant price increases within raw materials. Since the end of 2019 (i.e. before the start of the crisis associated with the pandemic), iron ore has increased by 69%, copper by 61%, and nickel by 21%, and these increases are not limited to industrial metals but also affect agricultural raw materials with wheat and corn increasing by 17% and 60% respectively.

The Real Estate market is in a way very similar. It has pushed wood prices to extreme levels (+229% since the end of 2019…) and central banks to consider measures to limit loan access in countries such as New Zealand and Canada. The strong demand for goods (offsetting the closure of a large part of services) also caused a break in the semiconductor supply chains, leading once more to inflationary tension on several categories of goods (Electronics, second-hand cars, etc.).

So far, energy has been the only commodity that has not shown a huge increase over the period (+3.73%), this is mainly due to a sharp decline in commercial flight demand since March 2020. 

Implications in the economy

Consequently to these price hikes, production costs are soaring in our economies (US PPI up 9.5% over 12 months, highest since July 2008), which should have repercussions, at least partially, on consumer prices given the current household savings rate.

Since last April, monetary and fiscal policy measures conducted by central banks and governments have been key drivers of this sudden inflation: rate cuts (for central banks still having this possibility) balance sheet size increases and extensive fiscal stimulus not seen since the post WWII era. It is reasonable to expect monetary policies to become more restrictive. However, this should be done gradually to not “damage” the recovery, even if it implies taking the risk of being a little too late.

If we add base effects to all of this, which also have and will continue to have positive effects on inflation in 2021, the conclusion seems evident: if there is no inflation now, then there will never be, as everything seems aligned for inflation to rebound strongly. Is inflation going to be on average at levels not seen for 15 years in the main developed economies? We lean in this direction. 

Is inflation a momentary effect? 

Nonetheless, the most important question today concerns the transitory or non-transitory nature of this inflation. If we listen to the US Federal Reserve’s speech and if we share its interpretations, then yes, this inflation is transitory and it is unrealistic to hope for greater structural inflation as long as the labour market remains so far from full employment.

Indeed, it is very likely that much of the inflation we are currently experiencing is transitory. Second-hand car prices will normalise once supply issues are resolved, base effects will naturally disappear and the US fiscal stimulus may have reached its limits, which will limit the further rise in commodities. On the Real Estate side, the transitory nature of inflation would keep these assets’ rate of return under pressure and support their valuation.