When “Transitory” Becomes a “Swear Word”
Transitory—adj. 1. of brief duration: temporary. 2. tending to pass away: not persistent.
And there, in a nutshell, is the market's current quandary around rising prices courtesy of Merriam-Webster's Dictionary. It may be as good a guide as any to the fierce inflation debate today and the right investment strategy over the next year.
Atlanta Fed President Raphael Bostic shared his own frustrations with the sloppy use of the word in a speech last week, sitting next to a “swear jar” into which he deposited a dollar every time he uttered it. This year’s price spikes, clogged ports, and labor shortages, he rightly noted, hardly feel anything like “brief duration.”
But “tending to pass away” still looks pretty accurate if you look hard at the pressures driving prices higher now and what seems most likely to unfold over the next year. For investors struggling to price in the future, that’s probably the more useful definition, even if it’s important to keep an eye on the risks.
Those of us who work in finance usually think markets mostly clear as money, stocks, and bonds move instantly and globally from buyer to seller. Obviously, moving the right crankshaft to the right assembly line in time for the right engine is a far trickier flow to restore once it has been disrupted. It also takes time to move the right short-order cook to the right diner.
Yet most markets don’t fail forever, and it’s hard to see anything on the current list of inflation drivers looking anywhere near as strong in six months.
Revenge consumption: This spring, vaccinated consumers in the United States and Europe emerged from lockdowns with a frenzy of catch-up spending. No reason to expect that next year.
Generous government payments: Most have already expired, leaving households to moderate their spending and return to work.
Lingering pandemic fears: Labor shortages persist as some workers still worry about infections or explore different post-pandemic careers, but vaccinations and immunity will soon alleviate most concerns and depleted savings will nudge them back to a job.
Surging orders: Supply managers started the year uncertain about the recovery, then scrambled to catch up with spiking summer demand and now face a mad rush of pre-holiday hoarding. If the rise and fall of used car prices is any proxy, supply will close the gap with demand.
Tight inventories: Shipping delays have sent firms scrounging to stock up and even build a cushion if they can. This has fueled sharply higher prices of goods and transportation capacity for anyone who has “guaranteed” products or deliveries to their customers. But these will not last either.
Lingering lockdowns: COVID cases in China have famously snarled port activity, and severe weather made the problem worse. There’s no reason to expect either will persist next year, and there are some signs that it’s already improving.
Logistical tangles: President Biden’s announcement this week that the Port of Los Angeles would shift to 24-hour operations and states would issue more trucking licenses won’t solve the problem right away. Still, stabilizing prices of container and dry cargo capacity suggest market pressures are getting better rather than worse.
Shipping Costs Level Off
Source: Bloomberg. As of October 15, 2021.
Energy price spikes: Oil and gas have surged amid cold weather, poorly integrated markets, and OPEC supply discipline. There are plenty of scenarios in which any of these could persist or get worse, but are they really the most likely?
Commodity prices: Yes, lumber prices are soaring! No, wait a minute, not any more….
The only thing that will drive persistent inflation is when rising prices become embedded into expectations. We really don’t understand much about how or when this can happen. Indeed, the bellwether University of Michigan price expectations survey only launched after the great inflation of the 1970s. And that was a period of much stronger unionization and industrial strife, which contributed to a spiral of higher wages and prices.
If there is even a whiff that we now face more than a post-crisis step-up in prices, then markets will sour quickly. The Fed’s plans to gradually withdraw liquidity will turn into painful tightening and unexpected rate hikes. Asset prices will fall.
For now, though, we have not seen any signs of expectations becoming unanchored. Consumers naturally anticipate higher prices in the near term as they absorb what they see at the supermarket or in real estate news. But longer-term forecasts have barely budged since before the pandemic.
Atlanta Fed’s Bostic ultimately opts for the word “episodic” to describe current price dynamics, which seems to allow for a series of potential price swings in coming months. This leads him to predict better growth, higher inflation, and a sooner Fed rate hike. But even that “hawkish” view falls short of a continuing surge that seems to cloud the current economic debate.
The recent data may look confusing, but the story arc for investors remains clear. Growth is slowing, but still strong. Prices are adjusting to wild dynamics, but hardly spiraling out of control. Use whatever word you want.