It started with the rise in commodities, especially oil and metals, after Covid in 2020 after a 10-15-year period in which various commodity prices had largely been subdued.
After some ups and downs in 2021, prices began to accelerate around the beginning of the new year. Added to this cyclical upswing are climate events affecting agricultural products; supply disruptions thanks to the pandemic and so on – all of which have contributed to upward pressure on prices.
In the US and some other developed economies, house prices have also been on the run as many government policies to help citizens over the hump of the pandemic resulted in excess liquidity for households, especially as consumption opportunities were limited thanks to the pandemic. This liquidity was used in part for the purchase of real estate. Therefore, many components of the consumption / inflation curve had experienced rising prices in the second half of 2021.
Several central banks estimated that the supply constraint that caused some of this inflation would subside over time and inflation would prove to be temporary. This turned out to be more of a hope for trade than anything else, and inflation continued to pick up.
These trends accelerated with the rising Russia Ukraine tensions early this year, culminating in a full-blown war in late February. Even before the actual war on earth, the prices of a whole lot of raw materials from crude oil and natural gas to aluminum, palladium, nickel, potassium chloride for wheat and edible oils had already risen by 20 to 30% since 1 January.
This has only accelerated since the actual conflict began. In addition, there have been new disruptions in shipping and supply chains as well as in the agricultural production cycles in Ukraine and to some extent Russia, which will result in production shortages.
Let’s look at how this has affected different nations lately, according to inflation figures released for several major economies over the past few days.
INDIA: Inflation is leaking beyond the commodity categories … is likely to affect demand
India’s overall CPI hit 6.95% in March 2021 year-on-year (y / y), which means compared to the same period last year. This is also an increase of 0.96% month-on-month (m / m), ie compared to February 2022. This is the highest since November 2020.
Food and beverages, which account for almost half of the index, increased by 7.5% y / y, thus contributing to more than 60% of the increase in y / y prices, led by double-digit increases in oil and fat ( 18.8% y / y)) and Vegetables (11.6% y / y), which together make up about 9.4% of the index.
This is not surprising given that the UN FAO Global Food Price Index rose 13% m / m in March to a record high amid limited supplies (war between Russia and Ukraine) and adverse weather conditions. As edible oil prices have risen 50-70% above pre-Covid levels, 24% of Indian households have cut back on consumption, while 67% are paying more for it by reducing spending and savings, a survey by LocalCircles shows.
However, inflation has clearly spread beyond the more directly explanatory categories such as edible oils. For example, prices in the clothing and footwear category have increased by 9% year-on-year, and even more services such as health, transport & communication, recreation, etc. have experienced inflation of 7-8% y / y. All this shows that inflation is becoming more entrenched.
This is despite the fact that the high inflation in the wholesale price index (WPI), which has remained or around 13-14% for several months now, has not really translated to the extent of higher consumer price inflation, which producers are still trying to hold on to. repay price increases due to weak demand. However, given the recent runaway rise in commodity prices, they do not have much to choose from and consumer prices are also starting to rise for manufactured products.
As consumers have to pay more for both food and other daily consumer goods, the estimated consumption is and will be postponed.
The effect of fuel prices is also not visible in these figures, as these increases have taken place recently. Fuel prices not only have a direct impact on the household budget, but show up over time in higher prices of most goods and services, as they have a transport component. This effect will be visible from April onwards.
In our view, inflation in India is expected to accelerate over the next few months before beginning to decline once the base effect starts (when the comparable period becomes a period of high inflation in the previous year). This will also affect the demand for a number of goods, in addition to putting an upward pressure on interest rates (already visible) and a downward pressure on the Indian rupee.
United States: Inflation of non-food and fuel begins to decline
US CPI y / y Actual 8.5% (forecast 8.4%, previously 7.9%)
US core CPI (excluding food and fuel) y / y Actually 6.5% (forecast 6.6%, previously 6.4%).
US CPI m / m Actual 1.2% (forecast 1.2%, previously 0.8%)
US core CPI m / m Actual 0.3% (forecast 0.5%, previously 0.5%)
Reaction: U.S. government bonds rose 6-10 bps as the curve became steeper at a softer-than-expected core CPI; The US Dollar Index (DXY), which measures the US dollar against a basket of other currencies that was initially sold off but settled 0.3% higher at 100.3, is close to a 2-year high.
While overall inflation remained high, core inflation, which excluded food and fuel, came under consensus, as Food at Home (1.5% m / m) and energy (+ 11% m / m) were the biggest culprits.
Used cars and trucks, whose prices went through the roof in 2021 due to supply constraints on new vehicles, showed a price drop of 3.8% m / m, which is a good sign.
However, the contribution of housing inflation, which measures housing costs, will remain sticky (+ 0.5% m / m, 5% y / y) due to delayed effects of sky-high rents (see this article for more details) and high weighting (33% ), although mortgage rates jump to 5.1%.
Overall, inflation may remain sticky at levels much higher than 2% (which has important implications for the Fed’s monetary policy and its rate hikes), indicating that we are at or near the top of US inflation, given this price gains in food and energy, which we have seen in the last 1-2 years, are hardly sustainable without destroying demand, and that basic effects may also come to play fast enough.
Elsewhere, according to the NFIB Small Business Survey published today, 31% of business owners identified inflation as their single major problem, the largest share since Q1 1981, and replaced concerns about “work quality” as the number one problem. The study may suggest broader questions regarding the inflation flow capacity, as inflation may not be a problem for companies whose growth / demand is also strong.
UNITED KINGDOM: Both inflation and inflation expectations remain alarmingly high
UK CPI y / y In fact 7% (forecast 6.7%, previously 6.2%) – high for 30 years
UK CPI m / m Actual 1.1% (forecast 0.8%, previously 0.8%)
The UK’s core CPI, net for food and fuel, y / y Actually 5.7% (forecast 5.3%, previously 5.2%).
UK’s core CPI, net for food and fuel, m / m Actual 0.9% (forecast -, previously 0.8%)
The headline and core CPI continue to be higher than expected with the Citi UK Inflation Surprise Index also hovering around its record highs. Motor fuel prices rose by 9.9% from February, the largest increase in 31 years.
The market’s implicit interest rates (meaning inflation expectations), such as those indicated by inflation swaps in the UK, are priced at 9.6% inflation over the next 1 year (Note: In April, a 54% increase in the energy bill is ready, which adds about 1.8 points to the overall rate) and gradually moving lower to an average of 5% over the next 5 years. Long-term inflation expectations as indicated by the 5-year forward 5-year inflation rate have been rising for more than a year and are currently at ~ 4%, ie. double the Bank of England’s target of 2%. The breadth and severity of inflation has actually accelerated to worrying levels (see image below). Major retailers like Tesco have already issued profit warnings based on this.
The table above shows the percentage of items from the inflation calculation categories that fall in each inflation band. Thus, 25% of the categories for which prices are measured experienced an increase of 10% plus inflation.
GERMANY: On the way to historically high inflation
The German overall CPI comes in at 7.3% y / y, the highest since 1981, while the m / m print of 2.5% is the largest since October 1952 – primarily led by food and energy (ex-food / energy is 0 , 6% m / m and 3.4% y / y). Commodity inflation continues to dominate at 4.8% m / m and 12.3% y / y against 0.4% m / m and 2.8% y / y for services. Meanwhile, WPI registers another record high of 22.6% y / y and 6.9% m / m.
Germany has traditionally been a inflation hawk due to the country’s fight with hyperinflation almost 100 years back.
But this time it kept raising interest rates for a long time, but obviously such historic inflation levels have now also put pressure on bond yields in the EU.
Here’s how 10-year government bond yields have moved across the EU from 1 January to date (bps stands for basis points 100 basis points = 1 percentage point)
Germany: + 90bps to 0.79%
France: +107 bps to 1.27%
Spain: +110 bps to 1.72%
Italy: + 120bps to 2.39%
United Kingdom: + 83bps to 1.82%
Poland: +240 bps to 5.90%
Hungary: + 227bps to 6.67%
Czech Republic: +110 bps to 4.10%
Worldwide, inflation will continue to be the most monitored macro variable this year, which in turn will be the key factor driving interest rate movements from central banks from the RBI to the Fed. The price changes are again major determinants of valuations in both equity and fixed income markets. This will be the place to see.
(Harsh Shivlani also contributed to this piece)