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Inflation Risk Outlook: Backlogs Bite

  • The weight of risks is skewed to the upside for inflation as individuals and businesses grow more anxious about higher prices

  • Supply disruptions, rising inflation expectations, and sentiment effects all lead us to reiterate the upside risks

  • Core inflation pressures are also on the cards as capacity tightens

  • Stocks seem generally unphased so far, but risks lie with how policymakers react

You don’t have to search long to find inflation. It’s apparent at the grocery store, on TV, and on Google Trends. Last week, however, the narrative seemed to take a more drastic turn. Many in the “transitory” camp at least dipped a toe into the “permanent” waters.

To wit, the UK 10-year breakeven rate surged to 4.24%, the highest in 25 years. In the US, the 5-year TIPS breakeven yield spiked to 3%. Our flagship Weekly Macro Themes report dived deep into the major puzzle pieces coming together to reiterate the upside risks to the inflation outlook.

Supply Chains Front and Center

Driving the uneasiness surrounding higher prices is undoubtedly the resurgence in supply chain issues. For a time during Q3, it appeared conditions at ports and shipping terminals were improving. Then the second wave of backlogs hit right as consumers geared up for the holiday shopping season. Indeed, everything is not ship-shape as evidenced by the chart below.

Featured Chart: Surging Searches for Supply Chain Disruption & Backlogs

chart of backlog supply disruption indicator

Stocks Taking It in Stride

How traditional economics solves the supply chain horror show will be fascinating to watch. It will take either expansion of capacity (temporary or permanent) or alternatively: softer demand. By way of the equity markets, it seems investors are content with whatever plays out. Equity indices are basically at or near all-time highs despite the onslaught of negative press surrounding business logistics.

Bad Surprises

Ultimately, inflation is what consumers are concerned about. Google Search Trends for terms like “inflation” has jumped to new highs as the global median inflation rate creeps up on 4% (from less than 2% through much of 2020). Moreover, the G10 Inflation Surprise Index is at its highest reading in more than 25 years.

Expectations Are Hot

In terms of inflation expectations, both business and consumer groups are more wary than the market. Consumer and business inflation expectations are some 2 standard deviations higher than long-term average. As time persists with rising prices front of mind, behavior will begin to shift and negotiations/contracts (prices!) will reflect this.

Wage Growth Underscores Permanent Inflation Risks

Powering higher prices is robust wage growth. The labor market remains tight for many developed economies, particularly in the US. Jobs are easy to get and staff are hard to find. As such, the latest NFIB survey reports a record percentage of small businesses expecting to raise worker compensation. It’s also never been more difficult to find workers, according to the NFIB report. Wages are sticky—once they go up, they rarely come back down. Higher pay is a major arrow in the quiver of team “permanent”.

How Will Central Banks React?

The Federal Reserve will have its say. Inflation fears could spark a quicker tightening cycle in developed economies. We already see it across much of the Emerging world. Earlier than expected rate hikes might derail the recovery and thus greatly slow the headline inflation rate. Also, consider that base-effects will be stout next year, helping to slow the rate.

Bottom Line: We continue to see upside risks to global inflation after initiating the view at the start of the year. With a mix of short and medium-term factors at play, we see this key theme of 2021 continuing in importance into 2022.

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