Impending inflation makes the financial market restless

Unrest in financial markets. Inflation will rise, perhaps more than expected. But I think that higher inflation is temporary. Dutch retail sales are heavily in the red, while industry is supporting the German economy. American companies continue to invest.

There is every reason to look to the future with hope. If a large part of the population has been vaccinated, restrictions on public life will be relaxed considerably. At the same time, there is quite a lot of uncertainty that some fear is justified. It is therefore not entirely a surprise that financial markets have shown these fears in recent days.

Uncertainty about the inflation outlook is a major source of concern. I've written before about the likely rise in inflation. Higher inflation rates this year will be driven by a range of factors. First of all, and totally 'harmless', base effects will push the year-on-year inflation rate higher in the coming months as prices fell last year after the outbreak of the pandemic.

Rising oil and commodity prices
Moreover, and less innocently, oil and other commodity prices have risen, which is reflected in the inflation figures. Since raw material prices usually do not continue to rise, this will also stop for a while. A third source of inflation is what I described last week: disruptions in global trade logistics, which have caused freight prices to rise sharply and wide-ranging delivery problems. Which, of course, also lead to price increases.

Producer prices show that inflation is emerging from this angle. If these problems are not solved when the economy reopens and there is a lot of catch-up demand coming to the market, inflation could well rise sharply. But how much is very unclear: we have never experienced a situation like the current one (lockdown with significant build-up of savings).

Powell does not bring peace
Jay Powell, the head of the US Federal Reserve, appeared (virtually) in Congress this week for his semi-annual commentary on economic developments and the Fed's policy. Just as some of his colleagues had done before, Powell tried to reassure the markets. Inflation is still very low and the increase will not be too bad. Such verbal interventions can be effective, but that is by no means a foregone conclusion. They can also make market participants more worried if they think that the central bank is underestimating the risks.

The Fed redefined its strategy last year. It has been said that slightly higher inflation than the target will be tolerated for a certain period of time, because inflation has been below the target for so long. The Fed also said at the time that the target of the lowest possible unemployment rate should be interpreted as 'inclusive'. This means that the policy also looks at the development of unemployment among different ethnic groups.

 The conclusion of this strategic review is that the Fed will intervene less quickly and decisively if inflation rises. With so much uncertainty about the inflation outlook, it makes financial market players even more nervous than calm.

In the end it's all about the wage increase
Whether we ultimately have to deal with structurally higher inflation than in recent years, in my opinion, mainly depends on wage formation. Of course, inflation can and will rise this year. But the factors responsible for this are temporary in nature. What can make the inflation process more permanent is an acceleration in wage growth.

At the moment this is not the case in our own country. The AWVN calculates figures about the wage increase that is contained in correctly concluded collective labor agreements. Last year, that rate of increase declined remarkably quickly and firmly after the pandemic broke out. In January this year there seemed to be some acceleration, but it fell back in February.

Of course, Dutch figures on wage increases are not indicative of the rest of the world, but the same factors probably play a role elsewhere. Wage growth could of course pick up again, but I think this will be disappointing because the economy will be characterized by unused capacity for some time to come. I therefore continue to think that the rise in inflation this year, which may well turn out higher than currently assumed, is not permanent.

Rapid easing of restrictions does not seem likely
According to the government's corona dashboard, 24 injections with the various corona vaccines had been 'set' on February 1.169.302. So there is still a long way to go, but the number is steadily increasing. The tone about it seems to be getting more positive. According to the website Our World in Data (Coronavirus (COVID-19) Vaccinations - Statistics and Research - Our World in Data) we still remain in the rearguard. In the UK, 28% of the population has now been vaccinated, in the US about 20%, in Germany, France, Italy and Belgium about 6%, with us 5%. The pressure on healthcare in our country remains strong, despite the strict lockdown, although regular healthcare is gradually being scaled up again. According to the latest figures from the National Coordination Center for Patients Distribution, 51,3% of IC beds are used by corona-infected people.

Although the government decided to relax the rules this week, a significant further relaxation seems a while away. The effects of the strict lockdown on the economy are now becoming clear. Producer confidence in the manufacturing industry weakened slightly in February: 0,1 from 0.6 in January and a long-term average of 0.2. The industry is clearly still benefiting from the recovery of the global economy.

Dutch retail turnover harmed by strict lockdown
Retail turnover is developing much more negatively. It was 5,9% lower in January than a year ago. When the pandemic hit last year, retail (including online) took a hit, but consumers recovered quickly. The rise in unemployment was limited and consumers changed their consumption patterns. As the opportunities to spend money on services were limited, more was spent on 'things' and the growth rate of retail sales then soared.

The strict lockdown has radically changed that image. This will undoubtedly have negative consequences for the economic growth figures for the first quarter. On the other hand, it must mean that the pace at which people save money has increased further. The chance that there will be a lot of 'shopping' when we get our freedom back has increased further. For some entrepreneurs it is then too late. Spending on clothing in January was 61,5% lower than a year earlier, and that on shoes was 54,2%. That cannot be maintained for long.

The rest of the eurozone is doing marginally better than ours. The major Ifo index measuring German business confidence rose in February (from 90,3 in January to 92,4) largely, unsurprisingly, due to the industry. The future expectations of German industrial entrepreneurs in particular are at their highest level in years.

In Germany, the GDP figures for the fourth quarter have also been revised. Initially, economic growth of 0,1% was reported, but that is now 0,3%. That is clearly better than most other euro countries, again a reflection of the fact that industry is more important to the economy in Germany than in other euro countries.

The Eurozone Economic Sentiment indicator as compiled by the European Commission rose to 93,4 in February from 91,5 in January. For the Netherlands, this indicator actually fell slightly in February. Confidence has clearly recovered from the blow last year, but remains much lower than before the pandemic.

American companies further increase investment
Of the figures released in the US this week, my main focus is on durable goods orders, and in particular on 'shipping of capital goods (excluding defense and aircraft)'. This series gives a good picture of the investment behavior of entrepreneurs. After an initial blow when the pandemic broke out last year, there has been a remarkable recovery.

The figures in January are now 8,2% higher than last January. I continue to draw the conclusion that American companies are adapting their revenue models at a considerable pace with the help of digitization and perhaps also other investments. This in turn offers the necessary hope for the future.

Hans de Jong

Han de Jong is a former chief economist at ABN Amro and now a resident economist at BNR Nieuwsradio, among others. His comments can also be found on Crystalcleareconomics.nl

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