Macro Economic Commentary – July 2021

Author: Ntsekhe Moiloa

There was a time when the Group of Seven — the G7 — represented a club of the seven truly leading economies in the world. For a time, the club became the G8 as it welcomed Russia to the fold on geostrategic grounds. Since Russia’s perceived misbehaviour in the Crimea in 2014, the club reverted to being the G7 but never lost its geopolitical intentions. Through its transformations it has notably not been ready to welcome the next preeminent economy in the world.

As G7 leaders gathered in Cornwall on the English south coast, the focus of attention was the resumption of normal relations with the United States after the tumult that came with the Trump Administration. In the background was a renewed effort to coalesce against the rise of China’s vision for the guiding values of the future world order. Apropos the Cornwall summit communiqué, the G7 affirmed its preference for championing human rights, rule of law, democracy and socially responsible funding. China’s preferences have been less emphatic on all those points.

In the midst of global ambivalence towards China, authorities there continue to play the long game by emphasising an orderly transition of the domestic economy. In contrast to countries like Russia and Turkey, China has had a clearer approach to the management of its domestic economy. The Chinese authorities appear to be focused on financial stability and intend to rein in credit growth despite the braking effect that could have on GDP. Over the recent past, they have increasingly diluted their previous laser focus on GDP growth with a preference for moving up the economic value chain. China is increasingly less interested in being the world’s factory to the detriment of its own air quality, for example. Therefore, the previous reliance we could place on China propping up commodities markets now comes with a caveat. As supply bottlenecks ease, weaker than usual Chinese demand means that factory gate inflation will have one less pillar supporting it.

A contrarian view we have held over the past half year is that global inflation risk is short term rather than long term. If we are correct, investors should seriously consider price dips in inflation-sensitive long duration assets as buying opportunities. In that context we have not reduced exposure to long-dated bonds or to equities in our model portfolios.

The type of inflation that has historically concerned monetary policymakers is demand-driven inflation. Most commonly, demand for goods and services. For these kinds of inflation, interest rate adjustments are an option for affecting their strength in the marketplace, especially when the demand is influenced by the availability of cheap credit. Taming credit-influenced demand can help contain wage increase expectations too.

Inflation that comes about because of supply bottlenecks driving prices higher, is more difficult to manage using a central bank’s spanner box. Yet, higher prices for goods and services can lead to wage-push inflation as workers demand higher wages to compensate for higher living costs. If timber rapidly doubles in price because of supply constraints and hopeful homeowners can no longer afford to build, how is a central bank to help them?

As we survey the sources of recent inflation (especially in the United States), we find that wage inflation in most industries remains normal as opposed to abnormal. This is not inconsistent with observations of wage inflation expanding to more sectors; indeed, it is only that wage increases are not abnormal. The qualification is important to the extent that some investors have been spooked by the fact that wage inflation is gaining breadth in terms of labour market segments. The pending expiration of temporary unemployment benefits that were part of the COVID relief packages is expected to reduce labour shortages in certain industries. Longer term, the Biden Administration’s more lenient attitude toward immigration is expected to add to labour market competitiveness.

The global supply chain for goods is also starting to operate more normally. With that, abnormally high price increases for many key inputs have decelerated, implying that factory gate inflation will soon decrease. Whether lumber, computer chips, steel or soft commodities, prices have come off their year-to-date peaks.

Mobility costs such as vehicle prices, rental costs and air fares drove more than half of the contribution to monthly US core CPI in recent months. News outlets reported that car buyers, as an example, were more willing to pay the advertised price and were often paying above the sticker price recently. Vehicle production has been slowed down by the global shortage of computer chips, affecting supply. Meanwhile on the demand side, some buyers who managed to save while they were working from home under lockdown conditions, have more spending power. Among buyers are also fleet companies that destocked last year and are trying to restock this year. However, we expect this perfect storm to be short-lived.

Of interest, in the United States, buyers are now more willing to buy premium cars. As the effect of stimulus programmes fades away, it will be interesting to see whether the taste for finer things is sustained. We will be curious to see if South African appetites for more expensive cars also return in time. In South Africa, the number of used cars sold relative to new cars is at an all-time high, signalling the extent to which the average car buyer is going to save on their car purchase. Surely the motorcade accompanying former President Zuma to either Nkandla or Johannesburg Central police station cannot consist solely of second-hand Toyota Etios, can it?