Inflation Revving Up
Earnings season is getting underway, and thus far Costco (COST), Federal Express (FDX), and Nike (NKE) have warned that inflation is real and is bound to hit consumers as the holidays approach. Costco, Federal Express, and Nike are seeing rising shipping costs and supply chain disruptions that persist and should continue through the upcoming holiday season. In particular, the cost to ship containers overseas has skyrocketed over the past few months. These rising inflation expectations and the realization of these inflationary pressured could cause the Federal Reserve to change policy course sooner rather than later. It’s going to be a tug-a-war between inflation, employment, Washington wrangling, and the delta variant backdrop. CPI reports will become more significant as these readings are used to identify periods of inflation. The recent CPI readings result in a much stronger influence on the Federal Reserve’s monetary policies hence the recent taper guidance.
Real World Inflationary Commentary
Supply chain disruptions, specifically in the shipping channels, have led to rising freight costs that have escalated shipping costs dramatically. The cost to ship containers overseas has soared in recent months. A standard 40-foot container from Shanghai to New York costs about $2,000 a year and a half ago pre-pandemic. Now, it runs some $16,000, per Bank of America.
Costco CFO Richard Galanti called freight costs “permanent inflationary items” and said those increases combine with things that are “somewhat permanent” to drive up pressure. They include freight and higher labor costs, rising demand for transportation and products, shortages in computer chips, oils, and chemicals, and higher commodity prices.
Quantifying the situation, he said inflation is likely to run between 3.5% and 4.5% broadly for Costco. He noted that paper products had seen cost increases of 4% to 8%, and he cited shortages of plastic and pet products that are driving up prices from 5% to 11%.
Nike CFO Matthew Friend made references to second-half price increases as well as “stronger than expected full-price realization” and “additional transportation, logistics, and airfreight costs to move inventory in this dynamic environment.” “There’s only so much you can pass on to the consumer,” he said. “What most retailers are doing is looking across their [profit and loss statements], and they’re looking to improve performance and to optimize efficiency. That means really focusing on their supply chain.”
FedEx announced that it would hike shipping rates by 5.9% for domestic services and 7.9% for other offerings. The company said it is being hit by labor shortages and “costs associated with the challenging operating environment.”
“The labor market is tight, and in certain parts of the country, we’ve had to make some market-rate adjustments to react to the demands of the market,” per United Parcel Service (UPS) CEO Carol Tome. UPS has also has been hit by supply chain issues. “I’m afraid this is going to last for a while. These issues have been a long time coming, and it’s going to take all of us working together to clear those blockages,” Tome said.
The Federal Reserve Inflationary Commentary
The Federal Reserve indicated that the central bank is likely to begin withdrawing some of its stimulatory monetary policies before the end of 2021. Although interest rate hikes are likely off in the distance, the economy has reached a point where it no longer needs as much monetary policy support. This pivot in monetary policy by the Federal Reserve sets the stage for the initial reduction in asset purchases and downstream interest rate hikes. As this pivot unfolds, risk appetite towards equities hangs in the balance. The speed at which rate increases hit the markets will be in part contingent upon inflation, employment, and of course, the pandemic backdrop. Inevitably, rates will rise and likely have a negative impact on equities.
A string of robust Consumer Price Index (CPI) readings spooked the markets as a harbinger for the inevitable rise in interest rates. Although rising rates may introduce some systemic risk, the financial cohort is poised to go higher. Moreover, the confluence of rising rates, post-pandemic economic rebound, financially strong balance sheets, a robust housing market, and the easy passage of annual stress tests will be tailwinds for the big banks.
Future Rates Hikes
Jerome Powell stated, “The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test,” He added that while inflation is solidly around the Fed’s 2% target rate, “we have much ground to cover to reach maximum employment,” which is the second prong of the central bank’s dual mandate and necessary before rate hikes happen.
The Fed looks at employment and inflation as benchmarks for when it will start tightening. Powell said that the “test has been met” for inflation while there “has also been clear progress toward maximum employment.” He said he and his fellow officials agreed at the July Federal Open Market Committee meeting that “it could be appropriate to start reducing the pace of asset purchases this year.”
The Fed is committed to full and inclusive employment even if it means allowing inflation to run hot for a while. “Today, with substantial slack remaining in the labor market and the pandemic continuing, such a mistake could be particularly harmful.” “We know that extended periods of unemployment can mean lasting harm to workers and to the productive capacity of the economy.”
Powell noted that the delta variant of Covid “presents a near-term risk” to getting back to full employment. Still, he insisted that “the prospects are good for continued progress toward maximum employment.” “Inflation at these levels is, of course, a cause for concern. But that concern is tempered by a number of factors that suggest that these elevated readings are likely to prove temporary,” he said.
Consumer Price Index (CPI)
The Consumer Price Index (CPI) readings will become even more important and directly impact market movements and overall sentiment. These CPI reports are becoming more significant as these readings are used to identify periods of inflation. More robust the CPI readings will translate into a stronger influence on the Federal Reserve’s monetary policies and downstream interest rate hikes. The Federal Reserve is reaching an inflection point to where they will need to curtail their stimulative easy monetary policies as inflation, unemployment, and overall economy continue to improve. As a result, their long-term monetary policy of low-interest rates and bond purchases will inevitably need to pivot to a scenario of higher rates to tame inflation. As a result, investors can expect increased volatility as these critically important CPI reports continue to be released through the remainder of 2021. Additionally, any notion of higher rates may spur investors to reduce exposure to equities.
Real-world inflation is now precipitating company earnings reports, like Costco (COST), Federal Express (FDX), and Nike (NKE). These companies specifically pointed to supply chain disruptions, labor costs, and shipping costs. The Federal Reserve also said that tapering is now in the cards between now and the end of 2021. It’s going to be a tug-a-war between inflation, employment, Washington wrangling, and the delta variant backdrop. CPI reports will become more significant as these readings are used to identify periods of inflation. The recent CPI readings result in a much stronger influence on the Federal Reserve’s monetary policies hence the taper guidance. Investors speculate on when, not if the Federal Reserve will curtail their stimulative easy monetary as inflation, unemployment, and the overall economy continues to improve. Inevitably, low-interest rates will not be here indefinitely, and bond purchases will need to subside, thus pivoting to a scenario of higher rates in the intermediate term. As investors grapple with the prospect of downstream rate increases, pockets of vulnerabilities throughout the market will be exposed when rate hikes are deemed on the horizon. As real inflation enters the fray, these frothy markets will come under pressure, as evidenced by the volatile month of September. This could possibly continue to disrupt the market and introduce some systemic risk in the process. Investors can expect increased volatility as a function of key economic data, specifically the CPI readings and more real inflationary data.
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