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Markit PMI survey points to stagflation like scenario for the U.S. economy rather than true reflation

calendar 22/02/2021 - 07:55 UTC

The U.S. bond yield is now surging on the concern of higher inflation and Friday, the Markit PMI survey indicated higher inflationary pressure in the real economy mainly due to supply chain disruption and higher pent-up demand. Flash data shows the Markit US Manufacturing PMI edged down to 58.5 in February from 59.2 in January, right on the expectations. Although expansions in production and new orders softened, rates of growth were still steep overall, as manufacturers noted stronger client demand. New export orders also rose further.

Nevertheless, supply chain disruption remained apparent, as suppliers’ delivery times lengthened to the greatest extent ever. Key raw material and component shortages, alongside transportation delays, were often cited as factors behind worsening vendor performance. Longer lead times also led to declines in stocks of purchases and finished goods. As a result, cost burdens were pushed higher. The rate of input cost inflation was the sharpest since April 2011 and output inflation the fastest pace since July 2008. The rate of job creation was the quickest since December 2017, while output expectations improved and were the highest since November 2020.

The Markit US Services PMI expanded by 58.9 in Feb, from 58.3 in Jan and above market expectations of 57.6 and at the strongest expansion (m/m) in the service sector since Mar’15, as new business growth picked up to a three-month high despite a decline in new export orders. Meanwhile, employment rose only marginally, amid COVID restrictions protocols. Pressure on capacity was evident nonetheless, as backlogs of work rose modestly.

On the price front, cost burdens increased by the most since data collection began in October 2009, while output charge inflation was the second-highest on record. Finally, ongoing COVID-19 restrictions led to hesitancy regarding the year-ahead outlook, as service providers registered softer output expectations.

Finally, the Markit US Composite PMI edged up to 58.8 in Feb, from 58.7 sequentially (Jan) as service sector output expanded by the most in almost three years, while manufacturing production growth moderated, but remained among the highest seen over the past decade. Firms raised their selling prices at the sharpest rate on record due to the partial pass-through of higher costs to clients. Finally, business confidence remained upbeat and among the highest seen over the past two years, albeit down from recent highs.

Markit said:

Price gauges hit record highs as businesses report the fastest growth for almost six years. Substantial price increases for inputs such as PPE led to the fastest rise in cost burdens since data collection began in October 2009. That said, more encouraging demand conditions allowed firms to pass on a greater proportion of the cost increase to clients through a marked rise in selling prices. The rate of charge inflation was the second-fastest on record (behind only November 2020).

Service sector growth hit the fastest since March 2015, with firms often reporting higher activity as virus-related restrictions were partially eased and inflows of new business picked up, notably among domestic customers. Exports of services fell, largely reflecting ongoing restrictions on travel and tourism.

The slower manufacturing growth was often blamed on extreme weather and existing widespread supply shortages. Supplier delays hit a record high during the month. Input costs across manufacturing and services soared higher as demand outstripped supply, rising at by far the steepest rate since comparable data were first available in 2009.

Despite headwinds of COVID-19, extreme weather, and record supply chain delays, US businesses reported the fastest output growth for almost six years in February. The data add to signs that the economy is enjoying a strong opening quarter to 2021, buoyed by additional stimulus and the partial reopening of the economy as virus-related restrictions were eased on average across the country.

Business sentiment remains buoyant, boosted by hopes of further stimulus and the vaccine roll-out, but it’s disappointing to see this not yet translate into stronger job growth. Many service sector firms, in particular, remain reluctant to hire, cautious about adding to overheads.

A concern is that firm’s costs have surged higher, driving selling prices for goods and services up at a survey record pace and hinting at a further increase in inflation.

Overall, Markit is concerned about possible higher inflation, not accompanied by higher employment/wages and higher growth for the U.S. economy at present; i.e. it’s like stagflation, not an ideal reflation.

US Markit Composite PMI

US Core CPI (Prices)

U.S. Wages ($/h)

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At a glance in the last decade, the U.S. wage increased from around $20.5/h to $25.1/h; i.e. by almost +22.5%. And the U.S. Core CPI increased from around 220 to 270; i.e. by around +22.7%. Thus in the long term, the real wage growth is almost nil/negative wrt to core inflation. If we consider the headline CPI index for the same period of around 10-years, the real U.S. wage growth would be around +1.5%; i.e. almost nothing/negligible. But if we consider the last year, the real wage growth is around +3.7%.

The market is concerned that this real wage growth may translate into higher inflation. But as long as higher inflation is accompanied by higher economic growth, higher employment, and higher wages, there should not be any significant cause of worries. And the Fed is ready to allow the U.S. economy to run a little hotter after years of the Goldilocks scenario (not too hot/cold) and its inflation (core PCE) misses.

The U.S. has now around 9M unemployed people due to COVID (nominal 11M, less 2M normal run rate) and most of that is related to the consumer-facing service industry (travel & tourism, leisure & entertainment, offline educations/schools & colleges etc). Unless the U.S. completes its mass-vaccination process (COVID) and attains visible herd immunity/flattening of the COVID curve, the public will not get the required confidence and it’s not possible for full/normal reopening of the country/society/economy. The underlying scarring factor continues to haunt the economic and employment recovery (pre-COVID levels).

As the U.S. is expected to achieve herd immunity against COVID by mid-2022, the Fed may signal QE tapering from Dec’22 and gradual rate hikes from Dec’23 (starting from +0.25% a year like during 2015-18). The Fed has to keep U.S. borrowing costs at ultralow levels for the government as-well-as for the whole world to fund the deluge of COVID fiscal stimulus.

But at the same time, Fed has to ensure Goldilocks nature of the U.S. economy in the long run (not too cold or hot) even after allowing inflation to run hot (core CPI above 2%) for some time. The U.S. unemployment levels may not dip below 4% before 2024-25 and now Fed will give greater priority to maximum employment rather than temporarily high inflation, which is a byproduct of some structural issues rather than monetary policies.

As the U.S. is expected to complete its mass-vaccinations (COVID) by Dec’21-Mar’22, the much-awaited national herd immunity is expected to grow by June’22; i.e. by H1-2022, the U.S. COVID curve should be completely flattened. Thus Fed may start its QE tapering by Dec’22 and may also go for gradual hikes from Dec’23. To avoid any knee-jerk reaction, Fed may start telegraphing the market about its policy normalization plan by June’22 after the expected flattening of the U.S. COVID curve.

But the big question is now whether Fed will allow the U.S. 10Y bond yield to surge over +1.50%, which may cause another taper tantrum like in 2013s for risk assets (equities) as-well-as cause higher borrowing costs for the U.S. government to fund COVID fiscal stimulus to rebuild the economy.

Although huge monetary and fiscal stimulus may cause higher inflation theoretically in the DMs (U.S.-Europe), that’s not the case practically, thanks to the export of deflation by China and other South Asian/American exporters. This was the fact during 2008 GFC despite QQE and will be the same in 2020 COVID led the greatest financial crisis. Cheap exports due to devalued currency and lower labor costs by EMs (including China) to DMs will not cause any abnormal inflation despite unprecedented pandemic monetary and fiscal stimulus.

The U.S. Core CPI may jump by +1.75% in Feb and if this trend continues, it may scale around +2.25% by Dec’21- supported by devalued USD, especially against Chinese Yuan, higher tariffs (high imported inflation), supply chain disruption, and higher commodity prices. In that scenario, the U.S. core PCE, Fed’s inflation targeting tool may also hover around +2.00%, just below Fed’s symmetrical target of above +2.50% for a sustainable period (say 2-4 years to make up prior undershooting).

The Fed is changing its inflation and the maximum employment goal post, realizing the ground reality that it has to ensure ultralow borrowing costs for the U.S. government to fund COVID stimulus. The Fed has to also ensure price stability and Goldilocks nature of the U.S. economy to avoid stagflation-like scenarios (lower GDP growth, higher inflation, and higher unemployment). The Fed also has to stay above the inflation curve, not behind.

The U.S. as-well-as European inflation will be elevated to some extent in the next couple of years, but the Fed and ECB have already shifted their price stability strategy, accounting for the transient factors. The market is already discounting such a temporary scenario of slightly elevated inflation.

Bottom line:

Biden admin has to go for a big CARES Acts (3 & 4) up to Dec’21-Mar/June’22 for a total $4T (?) and infra/green stimulus for another $4T by Dec’21-Mar’22 to get lower borrowing costs. The U.S. has to keep its net interest/revenue around 10-15% for a sustainable perpetual debt. And if Biden admin unleashes a huge fiscal stimulus for around $6T (CARES Acts 3 & 4 for around $2T and infra stimulus for around $4T), totaling almost $10T (50% of GDP). In the long term, U.S. inflation may be elevated structurally if the U.S. indeed goes for domestic manufacturing policy (thrust on ‘Make in America’ policy) rather than cheaper import from Asian and South American countries.



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