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Mounting cost pressures for commodities to drive goods price inflation in next six months
Commodity markets remain buoyant. Notwithstanding a retreat in late January, prices as measured by our Materials Price Index have advanced nearly 8% since mid-December and by almost 36% since early November. A solid rebound in manufacturing, a weaker US dollar, generous government stimulus, and investor buying are all providing demand-side support.
Persistent disruptions in supply chains are also creating supply-side bottlenecks and roiling markets. Markets are replete with examples of industries roiled by the pandemic: steel sheet is on allocation in the US, semiconductor shortages are hampering auto production, drops in South American mine production have sent copper inventories to their lowest level in 10-years, a lack of containers has reduced ocean going shipping capacity while high absenteeism remains a problem throughout manufacturing.
These supply-side problems are highlighted most prominently in the IHS Markit Purchasing Manager Indexes (PMI) for backlogs and delivery times. December data showed delivery times rising alarmingly again after spiking in early 2020. This is a testament to continuing problems in meeting orders. Rising backlogs are another manifestation of the same problem. Together, backlogs and delivery times indicate how stretched and even fragile supply chains have become.
To date, the surge in commodity prices has been largely absorbed in company profit margins. This said, there are clear signs that building cost pressures are beginning to push downstream, with a burst of goods price inflation over the next six months now unavoidable.
Whether or not commodity markets show the kind of prolonged strength last seen between 2010 and 2014 will depend on two factors: how quickly supply-side bottlenecks are resolved this year and the character of demand once the pandemic begins to subside. In most industries, available capacity looks sufficient to meet anticipated demand growth through 2021 or even 2022.
The question remains, will capacity utilization rates improve or will supply chain problems persist? Our sense is that, just as demand will slowly build during the year, so too will problems on the supply-side be slowly resolved.
Pent-up demand may also prove to be weaker than expected, at least for goods. It is true that personal savings are well above historical averages in the advanced economies and even in important emerging markets, such as mainland China. But goods demand has been pulled forward, supported by stimulus and the fact that service consumption - travel, entertainment, dining out - has been suppressed because of COVID-19 mandated restrictions. It is possible that a return to more 'normal' consumption patterns once the pandemic recedes will not be accompanied by a burst of growth in goods markets. It is also possible the scarring in labor markets, with a rise in the number of long-term unemployed, means that saving rates fall back to historic levels only slowly.
Where does this leave commodity markets? It is true that the run-up in commodity prices has been stronger and lasted longer than we expected six months ago. This upstream pressure in supply chains is now guaranteed to push into intermediate materials and even final goods prices in early 2021.
Still, we believe this burst of goods price inflation will prove temporary with stresses beginning to ease after mid-year on the assumption that problems on the supply-side are slowly sorted out. A better balance in markets may also prompt some investor selling as positive momentum ebbs. Commodity prices may not only stop rising, but they may see modest corrections by spring or summer. Our expectation is that our Material Price Index, after increasing almost 50% between the July of 2020 and March of 2021, will then retreat by as much as 10% by year end.
Commodity Price Outlook
For individual commodities, the declines will be even more dramatic. US lumber prices, currently near $850 per thousand board feet are project to drop under $500 by year-end. Hot rolled steel sheet in Europe is projected to fall from an average price of over 800 euros per metric ton in the first quarter to 600 euros by the fourth quarter. North Asian ethylene prices, currently above $920 per metric ton are project to fall below $850 per metric ton late this year.
Watch delivery times and backlogs over the next six months. They will provide a clear signal of any shift as vendor performance improves. Even a hint that conditions are returning to normal in supply chains is likely to trigger price corrections in several markets given how exposed prices appear to be now.
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The JPMorgan Global Manufacturing PMI, compiled by IHS Markit from its proprietary business surveys, held steady at… https://t.co/d1OGcPvYa4