Persistent Inflation And Supply Chain Recovery

AT A GLANCE

• Early signs point to both goods demand and manufacturing activity beginning to wane

• The Federal Reserve has made it clear that their goal is to reduce the demand imbalance through short-end rate hikes and quantitative tightening on the long end

On June 10, the U.S. Consumer Price Index printed an alarming 8.6% and sent interest rate futures markets into a chaotic repricing of Federal Reserve expectations. At that time, Fed Fund futures had been pricing in 50-basis point rate hikes at each of the next two Fed meetings. 

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But in the hours that followed the CPI release, estimates changed to two 75-basis point hikes. The highest inflation reading in 40 years has fueled an ongoing debate as to what is causing this and what is the best path forward. 

In its most simple terms, inflation is rising prices due to aggregate demand outstripping supply. Monetarists will argue that inflation is always caused by increases in the money supply and that the 40% increase in M2 over the last two years should bear most of the blame. Meanwhile, other analysts will point to issues on the supply side.

“Supply chains take a very long time to heal,” said Cameron Dawson, chief investment officer at NewEdge Wealth. “A small disruption just starts to cascade and has this snowball effect. That’s what we saw during the pandemic and lockdowns and the surge in demand for goods that came out of that.”

Of course, the surge in demand was, at least in part, due to the extraordinary monetary and fiscal policies implemented by the Federal Reserve and the federal government to lessen the pandemic’s negative economic impact. 

Despite disagreements on the current causes of inflation, the Federal Reserve has made it clear that their goal is to reduce the demand imbalance through short-end rate hikes and quantitative tightening on the long end. But there are some signs that the supply chain is in the process of healing on its own. Dawson believes that we are starting to see early signs that both goods demand and manufacturing activity are starting to wane, as the New York Empire Fed and Philly Fed both pointed to much slower manufacturing activity, as well as improvement in supplier delivery times.

“We are also seeing it in the trucking data, where truck demand is starting to fall,” Dawson said. “That’s indicative of some health coming back into supply chains where now there’s not as much scarcity and urgency, so some of the pricing can come out of things like durable goods.”

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