Head of Global Economics
BofA Global Research
The long and short of supply
The August Consumer Price Index (CPI) report showed a slowing in core CPI inflation to just a 0.10% month-over-month clip. Used cars, airline fares, and lodging were major drags after contributing to positive inflation surprises from March to July this year, suggesting the end of goods shortages and reopening price pressures. That said, goods categories such as households furnishings & supplies, apparel, and recreation actually posted stronger month-over-month gains in August compared to July. Additionally, there were broad-based increases across major services categories, underpinned by signs of labor constraints and resilient wage growth. In short, shortage-related pressures may be here for a while longer, though they may show up in different forms than the recent past.
The pandemic has disrupted the global supply chain from start to finish. Port congestion has steadily gotten worse since the July 4 holiday amid the worsening spread of the Delta variant. Data from Clarksons show that an incremental 5-6% of the world’s fleet is stuck in port congestion caused by COVID. Businesses continue to report that their companies and suppliers are struggling with record-long supply lead times, continued shortages of raw materials and other supply chain logistics. In the latest August ISM manufacturing survey, the backlog of orders and supply delivery time components remained elevated at 68.2 and 69.9 respectively. From our read of the data: the supply chain challenges have only worsened of late.
Labor supply has yet to fully recover since the beginning of the pandemic. The labor force participation rate is below 62%, more than a percentage point lower than pre-pandemic levels and the lowest since January 1977. Some older workers likely retired during the pandemic, but a majority of workers are on the sidelines due to pandemic-related reasons and should return over time. With so many workers sitting out, businesses are facing an unprecedented labor shortage with job openings at all-time highs. There are currently more job openings than unemployed workers in the labor market: as of July 2021, there were 10.9mn job openings compared to 8.7mn unemployed workers. These labor shortages have disrupted business activity. The Census Bureau's Small Business Pulse Survey show labor shortages impacting operating capacity across industries, most prevalent in the accommodation and food services industry.
Continued supply-side constraints pose upside for inflation, though downside risk for growth. The big test comes as we move past the Delta wave—we will see how long it takes to loosen up the supply side of the economy. At the same time, once we are past Delta, reopening pressures can return and generate further bouts of price strength. Though we are likely past the peak of transitory inflation, we believe the inflation data could be in for some choppiness over the next year, with transitory inflation emerging in some months and transitory disinflation in others. The extent and timing of the cooling or reversal of transitory inflation will likely be a function of how quickly the supply-side constraints are resolved. Consumers have experienced large price increases to many products and services, and the longer it takes to resolve supply-side issues, the more likely that transitory inflation proves persistent as the psychology around inflation changes.
It is critical for the Fed to determine if this is a temporary or more sustained supply shock. If the former, the policy prescription is to keep policy accommodative and the business cycle ongoing to allow supply to catch up to surging demand. But if the supply shock is more permanent, the Fed risks stocking imbalances and inflation. In the meantime, the Fed will continue to carefully monitor inflation expectations.
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