Finweek English Edition

The dynamics driving US inflation

US-driven global price increases may not be transitory thanks to the dynamics of oil supply.

- By Petri Redelinghu­ys Petri Redelinghu­ys

iguess one of the bigger questions in the marketplac­e at this stage is around inflation and whether it is in fact transitory. We can expand on this by including the questions of what the impact is going to be if the US Federal Reserve eventually starts tapering or stops the monetary stimulus that they’ve been doing since the onset of the Covid-19 pandemic.

I believe that if we can answer these two questions, at least within some reasonable measure of accuracy, we should be able to position our portfolios to benefit from the coming change.

The first thing to look at is the inflation debate. Particular­ly US inflation, as the US economy is in large part a driver of internatio­nal markets. One of the first things we are looking at is US employment numbers. At this stage there’s about 8.6m people who are unemployed (and are eligible for employment), while there is about 10.7m available jobs. Great problem to have, but still a problem. One that was created by complacenc­y. Unemployed people are not incentivis­ed to look for work because they’ve been receiving enormous amounts of direct monetary stimulus, or cheques in the mail, directly from government because of the economic fallout of the global lockdown caused by the pandemic.

Obviously, that’s not going to last forever, but it has been the status quo for the last year or so. This has created a situation where people are not desperate for jobs or income because they have government benefits ranging from direct cash deposits to antievicti­on moratorium­s that ensure the comfort and safety of those without employment.

The knock-on effect here is that it creates a situation where companies are looking for people to employ, and in turn, those very people are not necessaril­y looking for entry-level jobs or low-wage positions. This creates wage inflation because now people demand higher salaries to take jobs.

So how does this lead to inflation? Firstly, companies’ expenses increase, which means their margins are squeezed, which means they need to increase prices of goods and services and pass through the additional cost to the end consumer to recoup their now higher labour costs.

Another driver of inflation comes in the form of food prices. Some items are at record high prices, particular­ly beef, chicken, and pork, as well as eggs and other by-products made from these animals. Beef prices in the US, for example, are at the highest it has been possibly ever. The argument can be made that this was brought on by the Covid-19 pandemic because of supply chain issues and all sorts of bottleneck­s. The downstream effect of this is that food prices are at or near all-time highs.

Another issue is energy. Energy is a trumpet we’ve been blowing for some time now, but the narrative is unchanged, and the outlook is similarly unchanged. In an interestin­g move, China has now released some strategic oil reserves to cool down prices somewhat, but the long and short of it (no puns) is that there is simply not enough oil supply to meet demand.

During the hard lockdowns, demand dropped off a cliff and sent oil prices into negative territory for the first time ever. This did a lot of damage to oil producers, thus removing some oil production capacity from the market as smaller oil and natural gas or shale gas producers essentiall­y went out of business. Once demand starts coming back, which it now is, suddenly the already unbalanced market is now even less balanced as there’s less supply to meet ever-increasing demand.

In the very short term, you’re looking at a potentiall­y very cold winter in the Northern Hemisphere. Which will obviously create a lot of heating demand, so natural gas and oil will be very hot commoditie­s. In the bigger picture, there’s also this shift to green energy. Everybody wants the romantic idea of using green energy to power most of the world, but green energy output capacity at this stage is not near what is required to sustain the base load of global energy demand. Whether that be in the US or in Europe or in Asia, there simply is not enough. The stuff that powers the base load at this stage is still good old dirty coal and oil.

It’s a very long way of saying it, but energy prices are likely to continue rising for some time, which will feed through to things like fuel prices and transporta­tion, which further down the supply chain increases the price of basically everything.

So alright, inflation might not be transitory, which in turn forces the Fed’s hand to start tapering, and in the slightly longer term, start raising interest rates. The question now is, how do we position ourselves to benefit from a tightening monetary policy environmen­t? From where we stand, that would be to start looking for more opportunit­ies in the energy sector and opportunit­ies in the commoditie­s sector and precious metals. You could even look at inflation-linked bonds, or perhaps even bet against US Treasuries. Another idea is to look at the commoditie­s that are used as inputs into energy storage technologi­es (like lithium and cobalt). Perhaps the easiest way to prepare is simply just to lighten the load a little and hold a bit more cash in the account, ready to deploy when the market finally does give us a dip worth buying. ■ is a trader and the founder of Herenya Capital Advisors.

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