US Dollar Deflates Commodity Inflation

Inflation rate is at 29 year highs! The economic recovery from Covid has transitioned from surplus to scarcity of virtually everything. Nobody, including our maligned Fed Chair Jerome Powell, denies the irrefragable truth that we are in cycle of above normal price increases. The real issue is how sticky or ephemral is the inflation trend.

Used car prices are more than 30% higher than a year ago due to Auto manufacturing supplier delays and Government stimulated demand. Record Supply Chain backlogs in computer chips are reducing 2021 production in the Auto industry by an estimated $110 Billion. However, there are indications that sufficient semi-wafer supplies will return before year end along with accelerating  job growth that should make a dent in depleted inventories. Based upon history, this used car price surge should be followed by crashing values down to a new normal in 2023.

Energy and metals have also struggled with production, labor and record delivery delays to customers. However, the base effect price hikes this year should be reversed with a YoY peak price comparison next year. A better supply to demand balance will become apparent as consumption slows from an artificially inflated 2021 peak rate and increasing supplies as extreme labor shortages moderate later in 2022. Climate concerns limiting production growth and growing consumption trends should keep Oil and industrial metals elevated well into 2022, but at a slower rate of appreciation before raw prices actually deflate by 2023. 

As we have illustrated in past recovery cycles, stress of the US Supply Chain is a primary culprit of elevated goods pricing and the growing inflation anxiety. We talked about this Supply Chain factor in the 2017 – 2018 economic upturn. Back then, artificial Government and Central Bank stimulus inducing artificial consumption was miniscule relative to this past year. With the kindness of Uncle Sams helicopter money, excess personal savings remain almost triple normal levels, thus it’s understandable why there is a demand shock and lack of workers that even need a job yet. Due to a temporary labor shortage extreme in 2021, airlines are cancelling 100’s of flights a day, most restaurants can’t serve full capacity and dealer inventories of most goods are stuck at record lows. Our above consensus call in early March for a 10% GDP print for at least a quarter in 2021 has now become almost consensus for Q2 and/or Q3, but reaching these targets is increasingly impeded by a lack of workers. With a record 9.2 Million job openings and subdued employment growth, there is no sign yet of satisfying production demands. As in 2010 and 2017, we expect Supply Chain delays to begin subsiding about 18 months after surging. Perhaps the labor and product shortages will persist a bit longer this time given the outsized artificial consumption created by US and Western Governments, but we still expect Supply Chains and their accompanying pricing pressures to approach a more normal range by the end of 2022. 

The 600% rise in Lumber prices have become the zeitgeist of the Covid commodity inflation boom. The Government stimulus, artificially depressed mortgage rates and a stay at home economy have created a massive demand – supply imbalance in lumber and a plethora of construction inputs. Thanks in part to Lumber prices and cheap mortgages, housing prices have inflated at rates reminiscent of the early 2000’s Housing Bubble. This time, banks and consumers have excellent balance sheets without any speculative buying. Residential building costs are already ameliorating with raw lumber costs falling 50% since the May peak. As artificially depressed borrowing rates rise and labor approaches full employment by mid 2022, home inventory shortages should ease enough to cause raw material costs to fall into the upper end of their historic range by 2023. 

Inflation sensitive precious metals have been in deep corrections for the past 10 months despite a weaker Dollar which supports the disinflationary inflation proxies of the Bond yields and the Dollar. As Emerging Markets tame Covid in the back half of 2021, we would expect the Dollar to work lower while precious metals along and emerging market stocks appreciate sharply.  For now, the inflation contribution factor of precious and even base metals has flattened. 

We acknowledge that inflation is currently rising at a multi decade high rate this year and that most raw and finished goods will remain inflated into 2022. Robust wage hikes in the labor market with long term aging demographics will be even stickier adding to business operating cost inflation. However, the momentum of price hikes should peak this year once full employment rates have arrived and material input costs should exhibit deflationary pressures by the end of next year. The US Dollar’s current strength in 2021 is reflecting some of the disinflationary reversals seen recently in commodities along with falling Bond yields. Some like to point out that the Fed is Buying Bonds to the tune of over $2.6 Billion of US Treasuries per day, yet they have been buying Bonds at a similar rate for the past 15 months when yields were rising. Bond yields will eventually appreciate as the Fed tapers and unemployment falls under 5%, but so far there is no hint of alarming inflation in the eyes of fixed income investors. As long as the Dollar is rising, the Deflation dragon will tame inflation hysteria. Our perspective is that inflation is more than transitory and less than secular. We’ll classify this above normal inflation trend as tolerable and a medium term phenomenon caused by exogenous factors. There is no question about a degree of worrisome inflation short term, but markets are discounting mechanisms of a year or two into the future and at this juncture their perspective is that any inflation spike is relatively short term and will be tamed in 2022.

Investors in the inflation debate should look for a vaccine led Covid recovery in Emerging markets in the 2nd half of 2021. Once South-East Asia and other emerging markets have more vaccines and feel the Covid curve is under control, then investors can buy Emerging market stocks and precious metals more aggressively as the Dollar depreciates.



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