Inflation: A Tale of Two Canals

Will the supply chain disruptions on opposite sides of the world have the last word on inflation?




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Transcript

Inflation:  A Tale of Two Canals
Season 4: Episode 4

Katz: Welcome to The Real Spiel with Ryan and Kurt. I want to give an inflation update here. You know inflation is a critical economic factor that no one really talked about the 2010s. We've covered it a couple times. It's in every news cycle. We'll probably cover it several more times over the coming year or two hopefully not as persistent perhaps. But a good time we think for an update. We've kind of had this roller coaster ride of CPI going all the way up to 9% back down towards 3% in the span of three years, there's still several factors at play. Unemployment being very low, labor is very tight. GDP in the US and abroad remains decent, but we're still hearing stories about grocery prices elevated and other aspects of inflation being persistent and troublesome. Kurt, do you think inflation is kind of past that spike that we had, and we're going to continue to trend towards the Fed's 2% target, or are there other concerns that you have? 

Nelson: Yeah. Hey, Ryan. Inflation is a really critically important part of investors' portfolios and its impact, and it's the global economy, the maintenance of monetary policy by the Treasury and the Fed. It was really just off everyone's radar a decade ago, I mean, I guess arguably for good reason. I mean, it was just anemic. It was inflation, was below the Fed target of 2%. We had deflation concerns back in the around 2015 period. That's all different now, for sure. We saw inflation and interest rates spike coming out of COVID. And there was a lag, right? When you think about COVID in early 2020, certainly it was the health crisis and how it changed our lives, transformed the workplace. But then about a year later, the supply chain ramifications of it really started to kick in, as well as the mix of demand, goods and services going through a rapid transformational shift where supply couldn't keep up with new demand in certain areas. And the thing that gave was price. So absolutely, the run-up in inflation from close to 1.5% - 2% to 9% was shocking. It was unexpected. And I think this, what I call the immaculate deflation, if you will, or disinflation, this sell-off from 9% to 3% CPI where we are today was also unexpected and fairly sudden as changes in CPI go. Remember, CPI is like a slow -moving thing. It changes by a tenth of a percent typically month -to -month. So, it's not something that we expect to zig and zag around so severely. So where are we now? I do think that absolutely CPI has come on down. It's a data-calculated economic factor for us. It comes out of the government, Department of Labor, and our economic statisticians for the government. That said, forecasting inflation is really hard, and I think we should all be humbled by how we didn't see this inflation shock coming, and we didn't really see the rapid reduction in inflation coming. All that tells me, we will try to predict inflation because it's so important. It's going to affect investors' portfolios maybe more than anything else in the next 12 to 24 months. So, trying to predict it is an important, valiant effort. That said, I think it's going to be really hard. The Fed themselves has said, we do not know where inflation is going to go. What Jay Powell, the chairman of the Fed, said most recently was, we are changing our Fed minutes and our official policy from somewhat tightening to purely neutral, neither easy nor dovish nor hawkish. The market is pricing in five small rate cuts over the course of the next 12 months. The Fed has said, yeah, that's reasonable to predict, but that's only if CPI does continue to slowly moderate closer to our 2% long run target. And the Fed has said they are ready and willing to act to take a more aggressive tightening stance if the data bears that out. So, the Fed themselves have given up trying to use a crystal ball to predict where inflation will be six or 12 months from now, and they're going to be purely data reactive. 

Katz: Absolutely and you touched on this briefly, Kurt, but supply chains were a big story through COVID and that came through in terms of commodity prices and inflation across the board, just delivery of goods with the supply chain bottlenecks. Are we still working through those supply chain issues? Or what other factors can really be a tailwind or headwind for inflation? 

Nelson: Well, one of the things that I don't think most investors thought about was shipping containers and the cost of shipping, but just was sort of assumed, traded at a fair price and it wasn't that volatile and it was true for a long time, but shipping was significantly disrupted during the COVID cycle just a few years ago and it's kind of coming back into the story today for different reasons. We're seeing Global supply through shipping affected by the two pinch points one is the Red Sea and the Suez Canal, a large amount , something like 30 - 40 percent of global shipping moves through that area going from west to east and east to west so that's not just oil or liquefied gas, but it's shipping containers with all kinds of goods where agricultural or containers full of consumer goods produced in China or agricultural products going to China, cars, all these things move by shipping. The conflict in the Middle East has created attacks or instigated attacks on tankers as well as shipping containers in the Red Sea. A lot of that traffic has slowed or stopped. The cost of shipping has gone up astronomically in the last few months as well. If that sticks around, we could see a supply chain shipping effect on inflation, very positive effect on inflation and on prices, which is related but a little different story than what happened during COVID. And on the other side of the planet, on the North America, South America border, we have the Panama Canal, another pinch point for global shipping. And there's no military conflict there, but you have a weather issue. We have the biggest drought in Panama maybe on record. And that's, again, part of this El Nino effect that's hit other commodities and output and prices. But the effects it's having on the Panama Canal is that the interior of the canal, because it stretches for miles and miles, can't draw salt water from the Pacific Atlantic Ocean, and it relies on fresh water. Because of the drought, the shipping traffic through the canal is constrained the volume of traffic is slowed, but also the draft that the ships can afford without running a ground is a lot lower than normal. So, the cargo ships have to be lighter. They can't take as much of their cargo through the canal at a time. So, it's just created an inefficiency. We’ve even seen because of that slowdown; we've seen some of the shipping companies in frustration going around these continents rather than through the Panama Canal. That creates extra cost, and it adds days to their shipping routes. And all of that has a positive effect on price and the price of finished goods.

 Katz: Absolutely, and inflation's incredibly difficult to predict, as you mentioned, and it's hard to say with conviction which direction inflation's going to go. So important to, of course, hedge, you wanted to? 

Nelson: Yeah, one thing I wanted to raise is we have seen this movie once before. Not in our, it's in our lifetimes maybe, depending on when you were born. We certainly not in our memory, but we had this huge inflation bubble in the 70s. And I've gone back and others have gone back and looked at some of the data there. We interestingly saw a rapid two-year spike in inflation and a quick kind of one-to-two-year moderation in inflation at the beginning of the 70s. And if you map what we just experienced on top of what happened back then, it's eerily similar. One might have thought in around ‘72 that it was all over. Thank goodness that inflation spike is over, but it wasn't. Inflation and stagflation was a factor in the US economy, global economy for the entire decade. In fact, inflation began another multi-year run that peaked close to 12%. I certainly don't want to predict that that's going to happen, but I can't say it's never happened before. I think caution would be the watchword I would suggest to investors. 

Katz: I’m sure we’ll have many, or at least a couple more inflation updates as the year goes on. This has been The Real Spiel with Ryan and Kurt. Thank you for listening in. For questions, comments, feedback, please reach out to us at TheRealSpiel@USCFInvestments.com and we'll talk to you soon.