Three Ingredients for a Post-Pandemic Inflation Cocktail
March 15, 2021
In 2002 I was visiting clients with the Chief Economist of Merrill Lynch, David Rosenberg. We had hours of time in the car and David loves to talk. David was very chatty about a subject I knew nothing about, The Baltic Dry Index. This is the first ingredient in our post-pandemic inflation cocktail. It sounds like something from Eastern Europe, but it is actually a shipping and trade index. David is from natural resource rich Canada and discussing the cost of shipping raw products seemed especially interesting to him. The economic relevance is simple. Raw materials needed for manufacturing often must be shipped from elsewhere in the world. The Baltic Dry Index tracks the cost of shipping these raw materials across 22 global shipping routes. Currently, the Index is very high, which indicates global demand is extraordinarily strong.
The second ingredient for our cocktail comes from Los Angeles. I was recently struck by a photo of dozens of container ships waiting to dock and be unloaded at the port in LA. Covid-confined shoppers have ordered their Peloton Bikes but there is no room at the inn. Consumers will have to wait to get their long-ago placed orders. Globally, the container shipping industry is reporting massive dislocations. The shipping industry has become very focused on profitable routes which has created huge imbalances around the world. While some ports like LA are very busy, others have stacks of empty containers but no ships. Pandemic restrictions on workers at ports and drivers of trucks have only added to the problem, since they cannot offload the containers as quickly as needed. These factors have created a perfect environment, provoking increased transportation costs all over the world.
Our final cocktail ingredient is the risk of inadequate investor demand for US treasury debt. The stock market was largely occupied from November through January by the chaos of the election, the transition of government, and an impeachment. That political phase is thankfully now behind us, but a new risk is surfacing. The $1.9 trillion in stimulus spending will need to be financed through the sale of treasury securities. Investors have started to wonder how easily, and at what price (interest rate), this debt will be sold. We got a glimpse of the potential impact recently as the U.S. auctioned off $62 billion of 7-year treasury notes. The auction was met with very poor demand, sending rates upwards and stock market investors into a panic. The Nasdaq sold off heavily in the afternoon following this “bad auction,” and the fear of rising interest rates and inflation left many investors feeling anxious.
Our cocktail has some interesting ingredients. The first two point to strong global demand and the potential for higher prices. The final ingredient points to the market’s uneasiness about a world that may include rising inflation and interest rates. Don’t forget the cherry to top off our new cocktail – the current crop of Wall Street professionals includes many that have never had to trade or invest in a rising rate environment.
Carl Gambrell
