With inflation surging and the Fed in the midst of a crisis of confidence, Fed Governor Randal Quarles (a voting FOMC member) said on Oct. 20 that there are now “significant upside risks” to inflation and that “there is evidence in the past couple of months that a broader range of prices are beginning to increase at moderate rates.”
“If those dynamics should lead this ‘transitory’ inflation to continue too long, it could affect the planning of households and businesses and unanchor their inflation expectations,” he said. “This could spark a wage-price spiral that would not settle down even when the logistical bottlenecks and supply chain kinks have eased.”
More importantly, though:
Source: Reuters
As a result, while a November taper announcement is likely a done deal, Quarles reassured that “I do not see the [Fed] as behind the curve” and “I am confident that the monetary policy tools at our disposal can bring inflation down toward our 2% goal.”
However, while investors still underestimate the hawkish implications of a completed taper “by the middle of next year,” the Fed still underestimates its inflationary problem. To explain, Fed Governor Christopher Waller (another voting FOMC member) said the following about inflation on Oct. 19:
Source: Reuters
Well, while Quarles remains confident that the Fed’s tools “can bring inflation down toward our 2% goal,” unless the Fed turns the dial up a few more notches, its current hawkish stance isn’t nearly hawkish enough.
For example, the Commodity Producer Price Index (PPI) is a reliable leading indicator of the following month’s headline Consumer Price Index (CPI). And if the former stays flat for the next three months (which is unlikely) – referencing releases in November 2021, December 2021 and January 2022 – the readings will still imply year-over-year (YoY) percentage increases in the headline CPI in the 4.75% to 5.50% range.
Furthermore, this is an extremely conservative forecast since the commodity PPI has increased month-over-month (MoM) for the last 17 months. Thus, it’s more likely that the headline CPI rises above 6% YoY than it falls below 4% YoY.
Supporting this thesis, gasoline and crude oil futures prices have increased by 21.08% and 19.60% in the last month.
Please see below:
Source: Barchart.com
Likewise, cotton, lumber and coffee futures prices have increased by 24.39%, 14.41% and 12.57% in the last month.
Source: Barchart.com
Furthermore, nearly all dairy and meat futures prices have increased in the last month:
Source: Barchart.com
As a result, does it seem like the commodity PPI will decline MoM anytime soon?
To that point, Procter & Gamble (NYSE:PG) released its first-quarter earnings on Oct. 19. CFO Andre Schulten said during the company’s Q1 earnings call:
“Input costs have continued to rise since we gave our initial outlook for the year in late July. Based on current spot prices, we now estimate a $2.1 billion after-tax commodity cost headwind in fiscal 2022. Freight costs have also continued to increase. We now expect freight and transportation costs to be an incremental $200 million after-tax headwind in fiscal '22.”
More importantly, though:
Source: P&G/The Motley Fool
Singing a similar tune, American Plastic Toys – which has manufactured toys in the U.S. since 1962 – expects abnormally high inflation to persist well into 2022. CEO John Gessert told CNBC on Oct. 18:
“It’s not going to be transitory.... I can’t imagine going back to the people that have stuck with us and saying, ‘OK, we’re going to take $1 out of your hourly wage.’ I just don’t see wage inflation retreating anytime soon.”
And what about commodity inflation?
“You have to go back to retailers and offer them an item that used to retail for $20 or $25 and it’s now retailing for $30 or $35, maybe even $40, depending on their margin requirements,” said Gessert.
Straight Talkers
Also making headlines, Danone – the world’s largest yogurt maker – projects that milk, packaging and transportation inflation will worsen in 2022:
“Like just about everyone across the sector and beyond, we see inflationary pressures across the board,” said CFO Juergen Esser. “What started as increased inflation on material costs evolved into widespread constraints impacting our supply chain in many parts of the world…. We expect 2022 at least at the same level as 2021, and maybe even higher. We need to get prepared for more supply-chain disruptions and challenges.”
For context, Danone experienced input-cost inflation of 7% in the first half of 2021 and expects that to increase to 9% in the back half of 2021.
Continuing the theme, Canadian National Railway (NYSE:CNI) – a North American transportation and logistics company that transports more than C$250 billion worth of goods annually across Canada and mid-America – released its third-quarter earnings on Oct. 19:
And with CN’s labor costs up by 12% YoY (“mostly driven by increased wages”) and fuel costs up by 40% (“driven by a nearly 50% increase in price”), how is the management dealing with the inflationary pressures?
Source: CN/The Motley Fool
For context, the “railway cost inflation” that CN’s management is referencing pertains to the Association of American Railroads’ (AAR (NYSE:AIR)) All-Inclusive Index (which excludes fuel). In the latest quarterly release (on Sep. 16), AAR data showed that “railway cost inflation” increased by 0.81% quarter-over-quarter (QoQ) and by 7.4% YoY. Thus, if CN is pricing “ahead” of that (plus the additional fuel costs) in 2022, the Fed’s 2022 inflation target is likely wishful thinking.
Finally, to hear it straight from the horse’s mouth, the Fed released its latest Beige Book on Oct. 20. The report revealed:
“The majority of Districts reported robust wage growth. Firms reported increasing starting wages to attract talent and increasing wages for existing workers to retain them. Many also offered signing and retention bonuses, flexible work schedules, or increased vacation time to incentivize workers to remain in their positions.”
More importantly, though:
“Most Districts reported significantly elevated prices, fueled by rising demand for goods and raw materials. Reports of input cost increases were widespread across industry sectors, driven by product scarcity resulting from supply chain bottlenecks. Price pressures also arose from increased transportation and labor constraints as well as commodity shortages.
“Prices of steel, electronic components, and freight costs rose markedly this period. Many firms raised selling prices indicating a greater ability to pass along cost increases to customers amid strong demand. Expectations for future price growth varied with some expecting price to remain high or increase further while others expected prices to moderate over the next 12 months.”
The bottom line? While the deflationists have receded into the background and the Fed is hoping that 2022 will be kinder to its “transitory” narrative, inflation is still accelerating. And while the death of QE should help calm some of the fervor, an accelerated taper that concludes “by the middle of next year” is extremely bullish for the USD Index. Moreover, with the Fed still materially behind the inflation curve, hawkish whispers of further tightening should hit the wire in the coming months.
In conclusion, the PMs rallied on Oct. 20 as misguided narratives have helped underwrite their recent optimism. And while the USD Index seems like the odd man out in investors’ latest game of musical chairs, the greenback’s fundamentals are actually stronger now than they were in September (during the rally). As a result, the tables will likely turn over the next few months, and the PMs’ optimism should reverse sharply as the colder weather approaches.