Inflation hasn’t peaked, it’s rising. The US consumer price index (CPI) rose 8.6% in the year to May, according to data published by the Bureau of Labor Statistics last Friday. It is the biggest annual increase since December 1981.
Commodity super cycles are converging and, as various other inflationary pressures coalesce, continued high inflation is unavoidable, as I discussed last week. The situation has been exacerbated by Russia’s invasion of Ukraine, which is putting upward pressure on global commodity prices. In addition, China’s strict lockdowns and zero-Covid policy led to industrial shutdowns, supply chain issues and rising consumer costs.
The S&P 500 is officially in a bear market for the first time since the pandemic and, with the Federal Reserve meeting today, a third consecutive rate rise will be voted through in a bid to combat surging inflation. Two rate increases in the previous two Fed sessions had little influence on rising energy and food costs.
Most government officials, with the possible exception of treasury secretary Janet Yellen, may not want to admit it, but global macro data point to stagflation. The World Bank is already warning of 1970s-style stagflation, having slashed its global growth forecasts.
Inflation occurs when aggregate demand exceeds aggregate supply, lifting the prices of goods and services. The various causes and signs of inflation, which I explore below, are complex, but we can learn to recognise them.
Increased money supply
Inflation can occur if the money supply increases faster than output. If a government prints more money, the amount of goods doesn't change, but more money is chasing the same amount of goods.
The US government printed cash at unprecedented rates to stimulate the US economy during the Covid-19 pandemic, and the Fed’s balance sheet – which it has now set about reducing – grew to almost $9tn, as shown below.
The Federal Reserve’s total assets: 30 July 2007 - 8 June 2022
Different forms of inflation
There are two main types of inflation: cost-push and demand-pull. Cost-push inflation is an increase in the price of raw materials. In this scenario, the market has not changed, but costs have gone up. In contrast, demand-pull inflation occurs when consumer demand outstrips supply.
Cost-push inflation refers to prices rising due to increased production costs. It occurs when the cost of raw materials and wages increase.
Economists describe cost-push inflation as a condition when the supply of goods or services is limited. The increased cost of labour or raw materials, for example, leads to decreased supply of these goods. While demand remains constant, commodity prices increase, causing a rise in the overall price level.
Examples of cost-push inflation
A typical example of cost-push inflation can be seen in the energy sector today, with higher oil and natural gas prices.
When global policies, war, or natural disasters drastically reduce the oil supply, gasoline prices rise because demand remains relatively stable even as supply shrinks.
Another current example is the rising price of wheat. This is pushing up the price of bread, among other food products, and is contributing to the rising cost of living. This, in turn, will lead to calls for higher salaries and wages.
Consumer confidence is tied to rising inflation expectations, which propels wage demands. This kind of wage-price spiral is happening now, but wage increases are not keeping pace with inflation.
Demand-pull inflation is the upward pressure on prices that follows a shortage in supply. Economists describe this condition as “too many dollars chasing too few goods”.
It is a simple demand and supply problem. Demand-pull inflation causes prices to go up as businesses try to meet increased demand amid a shortage of supply. This is historically the most common cause of inflation.
Examples of demand-pull inflation
In March 2020, the global economy shut down due to the coronavirus pandemic. As the availability of vaccines increased and the global economy recovered, the pace of vaccinations accelerated, and the global economic recovery moved forward rapidly.
The global economic recovery drove up demand for goods and services that hadn’t been readily available while the world was in lockdown. Inventories had been depleted as consumers demanded more items. This increased demand pulled up prices. Consumers are willing to pay higher prices, creating demand pull-inflation.
Another recent example relates to Ukraine and the grain markets. Supply has reduced, hence prices have gone up.
Inflation during wartime
Wars are inflationary. The chart below shows how US inflation spiked during previous wars. These historical insights might offer clues on the inflation direction in 2022 and 2023.
Russia’s invasion of Ukraine poses a global threat to energy consumption, food security, and mass migration. So-called agflation, when agricultural commodities rise sharply in price, and energy prices are being weaponized. The war is not only a humanitarian tragedy and a geopolitical nightmare; its global economic impact is also profound and, at this stage, incalculable.
To sum up, there are many causes of inflation, and we’ve only touched on a few examples here. Distinguishing between various causes of inflation is a useful skill that can assist traders’ and investors’ outlook and decisions. In my view, inflation will continue because, as discussed above, it will be difficult to reverse inflationary forces in today’s global economy any time soon.
ETF support and resistance levels
S&P 500 (SPY) 380 now pivotal resistance, with 360 next support
Russell 2000 (IWM) 168.90 May low, see if it can hold
Dow (DIA) 306.28 May low, pivotal support at 294
Nasdaq (QQQ) 263 the 200-WMA, with 280.21 resistance
Regional banks (KRE) 56 the 200-WMA
Semiconductors (SMH) 195 some minor support, with 220 resistance
Transportation (IYT) 211.87 the 200-WMA to get back above
Biotechnology (IBB) 105.39 pivotal area
Retail (XRT) 60.62 the important 200-WMA support line