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Is inflation transitory or not? Are we seeing a limited rise in the price of goods and services, or is it ratcheting up into a wage-price spiral? Is this phenomenon likely to resolve itself, or do we need tough action from central banks? Although successive reports are increasingly pointing to persistent inflation, the debate around prices continues to rage on markets. On the other hand, the momentum behind the demand that is driving the growth outlook is less controversial. At both the micro and the macro level of the economy, the latest figures are undeniably impressive.
In the US, following on from very strong PMI figures published at the start of the month, with the ISM Services Report in particular hitting a record high, the manufacturing business surveys of the Federal Reserve Banks of New York and Philadelphia came in well ahead of consensus expectations. The new orders element that reflects the level of demand recorded its highest level since March 1973 in Philadelphia! Whilst not quite so strong, retail sales in October still surprised on the upside in the US, with an acceleration in online sales in particular, as was also the case in China. The excellent third quarter NVIDIA results are also worth a mention, and serve as proof that demand for semiconductors is far from drying up.
Can this appetite for consumer goods be sustained? There are some areas of weakness that we should keep an eye on. Chinese consumers dominate global demand, and would certainly cut back on spending were a real estate crisis to materialise – an eventuality that has emerged in the wake of the Evergrande debacle. In the US, the University of Michigan Consumer Sentiment Index indicated that consumers are cautious of spending on durable goods, which they consider too expensive. Continued consumer price rises in the coming months could limit expenditure on this category of goods. Lastly, we cannot rule out a negative impact on consumption from the recent rise in COVID-19 cases in some countries and the measures taken by some governments in response. A case in point is Austria, which is going into lockdown.
Yet the outlook for consumption remains very positive due to a number of factors. Firstly, household savings rates remain high, particularly in the eurozone where they are well ahead of the historical average. Taken in conjunction with the significant optimism highlighted by consumer sentiment surveys, this represents a huge source of future spending. Secondly, the seasonal impact will be favourable, with the approach of the end-of-year holiday period and major promotional events such as Black Friday. And lastly, we are not yet seeing any rotation away from spending on consumer goods, which remains very high. Any move into spending on services could be the first sign that demand is normalising.
It is therefore unlikely that the imbalance between supply and demand underlying inflationary pressure currently will ease as a result of a decline in demand in the short term. Rather, we must pin our hopes on the ability of the supply side to adapt. However, signs of any normalisation in the bottlenecks in supply chains remain few and far between for the moment.
So inflation is here to stay, and the political and monetary authorities can do nothing about it. Inflation is not easy to control, whether rising or falling. The economy is not a simple mechanism. It is an entity with its own momentum and cannot be regulated by a mere turn of the monetary screw. It is a political entity in the fullest sense, and not just an element of monetary policy.
Written on 19 November 2021 by Olivier de Berranger, CIO, LFDE