Investors better wake up to the growing risk of stagflation. The coming weeks promise to deliver the verdict on how they should be positioned.
By all metrics, inflation is heating up. But it’s not clear the same can said for underlying economic activity.
According to producers, input costs have risen for six of the past eight months. And it’s not just big companies that are feeling pressure. One in four small businesses say they plan to raise prices, a 10-year high, according to the National Federation of Independent Business. Inflation’s persistence will finally begin to trickle through to consumers.
David Rosenberg, chief economist at the wealth management company Gluskin Sheff, recently quipped that investors “better say a prayer for Jay Powell,” the Federal Reserve chair. The deniers will dismiss the suggestion. But Rosenberg is serious, citing the core consumer price index’s March leap to 2.1 percent, a level that breaches the Fed’s 2 percent inflation target.
"There is going to be a price to be paid for last year’s string of wireless-induced 0.1 percent prints which are falling out of the year-over-year math,” Rosenberg explained, referring to the collapse in wireless services that skewed inflation lower in 2017.“I see 50/50 odds of a 3 percent core inflation by year end.”
That would certainly grab the Fed’s attention and -- critically for investors -- keep the central bank in a tightening mode through the end of the year and into 2019. Notably, no single Federal Open Market Committee member voiced concern about the risk of inflation that is too low, the first time this has occurred since the Fed began making public the views of participants in 2011.
The weak dollar and trade rumblings aren’t helping matters. Import prices excluding energy are rising at the fastest rate in more than six years. Peter Boockvar, the chief investment officer at Bleakley Advisory Group, has expressed growing concerns that the rhetoric will begin to exact a price of its own. “While tariffs may never be implemented, prices and behavior have already changed as buyers lock in their supply ahead of any disruptions,” he wrote in a recent report.
Evidence of “panic buying” -- that is, buying in anticipation of potential price hikes that could occur as a result of tariffs -- arrived with the first releases of regional April manufacturing surveys. The Philadelphia Fed has been releasing a gauge of factory activity in its district for longer than any other regional bank. Economists and analysts lean on these releases as a rich source of historic data.
In April, Delivery Time -- defined as how stretched vendors are in getting input products to manufacturers -- jumped to the highest level since record-keeping began in May 1968.
As with any commodity, the less the supply, the higher the price that can be commanded. In formulaic fashion, Prices Paid rose to the highest in seven years. But here’s the clincher -- Prices Received increased to the highest in almost a decade.
It’s one thing if manufacturers are absorbing higher costs, but it’s much more pertinent to Fed policy if these higher costs are passed along to end users. Nonetheless, the ability to maintain pricing power is clearly weighing on manufacturers. The Philly Fed’s six-month outlook for future business activity slid to the lowest since July 2017, while planned capital expenditures also fell to a June 2017 low.
The New York Fed’s regional survey also raised red flags. Delivery Times remained near their highest levels in seven years while New Orders, Backlogs and Employment all declined. The survey showed an even gloomier outlook for the future. The six-month business activity outlook dove to 18.8 from 44.1, the weakest since February 2016. Though one month can never make a trend, the depth of the plunge is bound to have raised eyebrows given that prior moves of its magnitude tend to coincide with recession.
As Rosenberg observed, the difference between the current crash in expectations and the last episode is that this time there is no “deep-dive in oil prices, no sharp Emerging Markets slump and there is no Chinese devaluation.” For points of comparison, the 26-point move lower is worse than anything seen during the 2008-09 financial crisis and on par only with the one that followed Sept. 11.
The Fed’s own nationwide survey of business activity, the Beige Book, prepared and released two weeks before the Federal Open Market Committee meets, corroborated the anxiety creeping into the regional surveys.
According to the Beige Book, “Outlooks remained positive, but contacts in various sectors including manufacturing, agriculture, and transportation expressed concern about the newly imposed and/or proposed tariffs.” At the same time, “There were scattered reports of companies successfully passing through price increases to customers in manufacturing, information technology, transportation and construction. Businesses generally anticipate further price increases in the months ahead, particularly for steel and building materials.”
Rosenberg may have a point when he suggests that prayers might be in order for Fed Chairman Powell. Rising prices and collapsing confidence could portend that both inflation and slowing growth are looming, a sure recipe for stagflation.
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