After the decrease experienced during the pandemic shock last year, inflation is expected to rebound in 2021. Commodity prices have been notably impacted, with the global economy’s unexpected halt in 2020 resulting in a massive glut. Internally, social alienation caused a shift in demand as people purchased products rather than services. The recent reopening of much of the global economy has resulted in a significant rise in demand that commodity markets are failing to meet. The magnitude of the disruption is evident, with raw material and input costs rising dramatically over the previous year. Many commodities’ inelastic supply has been unable to keep up with the demand rise.

Commodity price movements can impact headline inflation, but unless commodity prices rise consistently over time, this year’s inflationary tailwinds will turn into headwinds the following year. It is crucial to remember that the OPEC+ agreement in recent years has limited the quantity of oil that nations may pump, so supply can always increase (starting in August, about 400,000 barrels per day). Added to this is a rise in US shale rig counts, which is helping to raise supply and, in our opinion, should reduce pricing pressures in the future. At this stage in the cycle, commodity prices may continue to rise. Inflation is defined as a persistent rise in the broad level of prices, and the current composition of inflation index rises has been dominated by large changes in airfares and used car prices (in the US), which are indicative of relative price shifts (e.g., supply disruptions to new cars pushing up used car prices) rather than inflation. One approach to look at this is to evaluate price breadth and core inflation by excluding volatile categories — this excludes food and energy expenses. Another item to consider is the median measurements or trimmed mean, which reduce the influence of huge outliers (both positive and negative), offering an indicator more in accordance with the concept of a consistent rise in broad prices.

Price inflation can become more persistent if salary increases keep pace with price increases; otherwise, greater inflation acts as a tax on consumption. Another reason to consider is the extra money amassed during the epidemic. The great majority was amassed by richer households and ended up in financial assets such as the stock market or real estate rather than being spent. This is just causing asset price inflation with no influence on wage inflation.

Money supply & fiscal stimulus

The current monetary and fiscal policies are both expansionary and acting in concert, which might lead to price pressures if the supply side does not keep up. However, we must be aware of the debt incurred as a result of the epidemic, which was utilized to sustain present spending. Markets respond to the pace of change in future growth, and the fiscal policy impetus is likely to turn into a fiscal headwind unless governments continue to spend more than they did last year – which is improbable. Furloughs and stimulus checks have boosted discretionary income, which is unlike prior recessionary economic shocks. This, along with unprecedented quantities of central bank quantitative stimulus, has some worried about the prospects for inflation.

The rise in money supply has benefited the government sector, but demand for private sector credit has shifted in the other way, with people utilizing stimulus payments to decrease debt or limit their desire for borrowing:

Chart: Broad money supply (G7+E7) vs credit creation:

The growth in broad money supply is falling sharply, and bank lending (demand for credit) has cratered back to the levels last seen in 2011. This is corroborated by recent data showing that US banks’ excess liquidity is being put to work in securities markets and not being lent to the real economy. As such, it is no surprise that the velocity of circulation of money M2, fell significantly in the first quarter of 2020.

Forces that are worth to be observed:

Debt burdens have risen dramatically since the beginning of the COVID crisis, with government debt reaching 105 percent of global GDP in 2020, up from 88 percent in 2019. To yet, significant fiscal stimulus programs have primarily required borrowing to finance current consumption rather than investing on long-term productive investment. All else being equal, this leads in future principle and interest payments that impact on future spending.

Demographics – while it is commonly stated that the present retiree generation is inflationary since they spend more than they create, research also suggests that the most inflationary group is the young. A lower birth rate indicates fewer young people and less future demand for products and services.

Globalisation and technology — the pandemic has accelerated technological adoption, such as the increase in online retail sales penetration. The increased use of technology and automation reduces workers’ negotiating leverage.

Although supply chain interruptions are predicted to be temporary, the pandemic’s experience may result in a more significant move toward onshoring supply chains and protectionism. Wages are important to monitor, with many businesses emphasizing the difficulty in recruiting staff. There is a chance that we have seen some long-term developments in the labor market that have reduced labor supply. Large fiscal programs and deficits become permanent (rather than transitory) when the political determination to monetize debt and produce inflation gains widespread support in the future.

Global trade

Global trade has recovered sooner and better than projected this year, particularly in value terms (+8.6 percent q/q in Q1 2021 vs. +3.4 percent q/q in volume terms). Price and capacity pressures are to blame.

Chart: Global trade in goods in value, %y/y growth

The global battle for inputs is driving up trade volumes and, more critically, prices. The race results in a more widespread adoption of the just-in-case approach of inventory management, which can lead to a type of micro speculation in which enterprises hurry to buy supplies to hedge against additional price increases. This policy exacerbates the continuing worldwide supply-demand mismatch created by fresh Covid-19 limitations.

Another 35 percent of the increase in trade flow value this year can be attributed to shipping limitations. Vessels are now operating at nearly full capacity, and available containers are rare.

Price and capacity challenges are projected to persist in 2022, despite having peaked in 2021. Lower tariff rates will not compensate for structural changes that will likely keep trade costs high. We predict global trade growth to continue above-average in 2022, at +6.2 percent in volume terms and +8.4 percent in value terms, notwithstanding only a modest stabilization.

Beyond this year, manufacturers will face the top of the demand cycle (around mid-2022), at a time when inventories will be above normal due to the ongoing race for inputs.

Chart: Inventories indices, sector by sector