Pomona Wealth Market Comment October 2021 - Inflation, Disinflation - A world gone crazy?
The German electorate has spoken. Unfortunately, the German electorate mumbled and gave an inconclusive electoral result. The SPD (social democrats) won the largest share of the vote, but the result was closer than opinion polls had suggested. Politics now moves from the ballot box to the political backrooms as the different parties negotiate possible coalition combinations. Negotiations after the last general election in Germany took months to form a government. The markets are not therefore necessarily going to react strongly to this situation. This just increases uncertainty in the economy and takes time away from legislators debating legislation that might be economically constructive.
The UK is giving the global economy an interesting lesson in demand and supply. Last week, there were reports of supply chain disruption for gasoline. This led to a surge in demand with sales rising 180%. Of course, the supply chain, by definition, managed to increase supply by 180%. This further argues against massive disruptions, however, as in some areas demand overwhelmed supply, some gas stations have had to close or ration supply. In a couple of weeks, demand will go from being strongly above normal to being below normal as people use the fuel they have stockpiled in their vehicles.
This situation offers parallels to global consumer demand now especially durable consumer durable goods. There has been a big surge in demand which has been met by a dramatic surge in supply. But the demand has overwhelmed supply for now. However, demand will fall back probably next year, and the supply and demand relationship will correct. Just a few weeks ago, builders were fretting about the surge in lumber prices which have now fallen back to pre-corona levels.
These price movements explain why central banks are rushing to taper their bond buying programs. The European central bank has already announced a tiny taper with ECB President Lagarde even going so far to try to pretend that the taper did not exist. The US Federal Reserve is hinting at a turbo taper with Fed Chairman Powell strongly suggesting a November start date with a conclusion of the tapering process in mid-2022. There is some justification for the difference in the pace. The demand for cash is falling faster in the US than in Europe as the US consumer is spending their saving stockpile faster than is the European consumer. Lower savings means lower liquidity demand and lower liquidity supply is required.
Why the rush to conclude the taper in mid-2022? One of the reasons may be that the Fed can see disinflation forces on the horizon. In the first half of next year inflation base effects are likely to push down the headline Consumer Price Index (CPI). Some of the goods and services that have been experiencing inflation rates of 50% or even 100% this year may very well prove outright deflationary next year. The Fed again noted the transitory nature of current inflation. If deflation were to be more than a statistical base effect and became persistent, the German electorate may have proven prescient in giving the SPD the lead in the elections. After all, Mr. Scholz, its candidate to succeed Mrs. Merkel as Chancellor, is Vice-chancellor in the current administration and in his role as finance minister has dispensed with the constitutionally enshrined German fiscal prudence and has spent lavishly to support the economy.
Switzerland, October 1st, 2021