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October 26, 2021 08:42 AM

Keeping an eye on inflation, supply chains and the Fed

Bill Wood
Economics Editor
Plastics News Economics Editor
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    The Consumer Price Index for all items escalated by 5.4 percent in the 12 months that ended in September, well above the 2 percent level the Fed uses as a long-term target, but the Fed seems willing to let the economy "run hot" for the short term.

    As the fourth quarter gets underway, the U.S. economy continues to struggle with supply chain issues. As a result, we are also struggling with rising prices and a wavering certainty about the meaning of the word "transitory."

    Resin prices are much higher than they were last year at this time, due to the sharp run up in the price of energy products. And the prices for other commodities are also well above the levels of a year ago. I do not yet feel the situation is urgent, but if they continue, these trends represent significant risks to the current recovery in both the plastics industry and the overall economy.

    More specifically, I believe these trends represent three risks to the outlook that must be acknowledged. First, rising energy prices are similar to a tax on consumers and businesses. Every dollar spent on energy products is a dollar not spent on other goods and services. The heating season is just around the corner, and very soon prices for heating fuels will join gasoline as a frequent and "top of mind" consumer purchase. If prices continue to rise, confidence levels will weaken.

    Second, higher resin prices are putting downward pressure on profit margins for many processors. Demand for most plastics products is still strong, but the prices are rising faster than demand growth. Increasingly, processors are in the position of either swallowing the higher costs or else risk losing business by trying to pass the price increases through to customers.

    And third, these broad-based price hikes combined with a corresponding rise in wages may yet be indicative of a bout of inflation that is less transitory and more threatening than policymakers are currently expecting.

    I do not have enough space here to describe adequately all of the ways in which high inflation damages an economy, but they are both numerous and severe.

    Inflation is highly corrosive to economic growth, and if it gets out of control, the antidote is higher interest rates. In a world in which negative interest rates are common, any increase in interest — either by the Fed or the credit markets — will not be pleasant. As I said, I do not think the situation at this time is urgent. But the risks of higher inflation have escalated in recent months.

    The main reason for this is that nobody seems to have a clear picture of how and when the burgeoning problems with this nation's supply chain will be resolved. We all want to believe the current bottlenecks will eventually be resolved, which would render the bulk of the current price increases "transitory." But as always, we have to consider for an alternate hypothesis. In other words, any more unforeseen disruptions and I may start to get anxious.

    So my forecast from nine months ago for moderate increases in resin prices in 2021 was on the low side. Or maybe I was just too early. As the chart indicates, the increase in crude oil and resin prices started as the economy emerged from the shutdown in the second quarter of 2020, and as 2021 got started, the curves were accelerating higher.

    I acknowledged this acceleration in the column I wrote last February. At that time, I believed the sharp rise in prices was due to supply imbalances caused by the shutdown. I thought there would be some lingering effects of these imbalances but that the supply chain would be able to adjust as this year progressed.

    At that time, my forecast for crude oil prices, represented by the dashed line on the chart, called for a moderate increase throughout this year to a level of about $70 per barrel by the fourth quarter. This would have corresponded with a moderate increase in my Resins Price Index to a level of just under a dollar per pound during the same time.

    As you can see on the chart, the price for crude oil has already hit $80 per barrel this month, and my Resins Price Index is tagging $1.15 per pound. To add some context to these trends, the average price of crude oil was up 76 percent in the third quarter, which just ended when compared with the third quarter in 2020.

    The latest reading for my Resins Price Index was just about double (up 100 percent) what it was in the third quarter of last year. And the jump in the price of natural gas last quarter was also in the range of 100 percent when compared with the same period a year ago.

    These recent spikes in the data notwithstanding, I will again post a forecast calling for a deceleration in the upward slope of the curves going forward. This means I expect only moderate price gains, if any, for the remainder of the fourth quarter. And I expect prices for both crude oil and most commodity resins to decline in 2022.

    This forecast is based on the premise that, at these levels, there is burgeoning pressure to increase supply and get it to the market. Some of the leading indicators for this data currently suggest that this is happening; therefore, both of these curves should peak soon. But if I hear about another kink in the supply chain, I am more than willing to adjust my forecast and include additional upside risk for these curves in the next few months.

    And while I currently believe that what I have just described will likely turn out to be another example of a typical cycle in the prices for commodities, I am acutely focused on the overall inflation data for the U.S. economy to provide additional guidance.

    According to the Bureau of Labor Statistics, the Consumer Price Index for all items escalated by 5.4 percent in the 12 months that ended in September. This is well above the 2 percent level the Fed uses as a long-term target, and it is a level that makes me increasingly uneasy.

    In an effort to meet their objective of optimal levels of employment in the U.S., the policymakers at the Federal Reserve Board have clearly communicated their intention of tolerating the rate of inflation to "run hot" as the economy recovers from the severe recession from last year. They are willing to put up with a higher level of inflation if it means that everybody who wants a job can find one.

    Inflation is certainly running hot, but I do not think they anticipated a rate in excess of 5 percent for the past year. And I am far from certain that anybody knows how the trends in the labor market are going to unfold.

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