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And previews the challenges that remain in 2021.
The manufacturing sector finished out 2021 on a high note.
On Tuesday, the Institute for Supply Management’s December gauge on manufacturing activity hit its highest level since August 2018, coming in at 60.7, and indicating an increasing rate of expansion in the sector to finish 2020. Any reading above 50 indicates expanding activity in the sector while readings below 50 indicate contraction.
Ian Shepherdson at Pantheon Macroeconomics called this report a “very pleasant surprise.”
The ISM’s report showed that new orders, production, and employment — among other sub-indexes — all expanded at a faster pace in December compared to the prior month. And while respondents to the survey cited COVID protocols and absenteeism among employees as holding back growth, Timothy Fiore, chair of the ISM’s business survey committee, notes there were three positive comments for each cautious comment regarding the sector’s outlook.
But there was one component of the report certainly that made some ears on Wall Street perk up as the perpetual early-cycle concerns about inflation have grown louder in recent weeks. The ISM’s prices paid index jumped sharply in December, to 77.6 from 65.4 in November, indicating an increasing rate of rising prices for inputs among manufacturers.
This marked the highest reading for prices since May 2018.
Shepherdson, for his part, called this reading “less important than it appears,” noting that prices paid are highly influenced by changes in commodity prices. And indeed, between mid-November and mid-December, the price of oil rose about 20%.
But Andrew Hunter, an economist at Capital Economics, argues that the jump in this index exceeds what the rise in commodities prices would imply.
Commodities prices have risen in recent months, but not enough to justify the surge in input prices manufacturers' reported in December, a sign to some economists that inflationary pressures are beginning to really show up as the economic expansion continues. (Source: Capital Economics)
Hunter adds that while commodities played some role in this increase, the sharp jump in prices paid “also suggests that low inventories and ongoing supply disruption will put further upward pressure on domestic core goods prices before long.”
And low inventories combined with rising commodity prices, a falling U.S. dollar, and a domestic economic recovery focused on consumers buying goods certainly points to an inflationary dynamic. At least in some goods and at least for some time.
Of course, from an investment perspective “higher prices for some items for a period of time” isn’t really inflation. Inflation becomes a material part of the investing landscape if or when it is deemed potent enough to result in the Federal Reserve changing its interest rate policy.
A reevaluation that can be prompted either by the Fed itself or the bond market pushing interest rates higher in response to inflationary pressures.
The Fed’s latest interest rate forecasts suggest rate hikes won’t even be considered until 2024. And the central bank’s new average inflation targeting framework suggests the Fed will be even more patient in looking through temporary — or even sustained — periods of core inflation north of 2%.
The investment business has also been through a full generation (or two) of traders since James Carville was complaining about bond vigilantes in the early ‘90s.
And so to begin the year 2021 writing about bond markets pushing around the Federal Reserve over inflation fears is quite anachronistic.
In the end, of course, we all turn into our parents. And each generation since the Volcker Fed has taken its turn worrying about inflation. The financial circle of life.
