Known for the candour his widely popular songs exhibited in painting an accurate picture of the society, Hong Kong folk song legend Sam Hui had the runaway inflation vividly captured in his 1979 cover of Bill Haley & His Comets’ Rock Around The Clock: That year, the US’s inflation rate reached 11.3%, and was subsequently topped a year later to hit 13.5%. Mr. Hui’s rendition, entitled Price Hikes Fever, attributed aptly the relentless rise of gas prices despite an ample oil supply to the much-weakened buying power of the Hong Kong dollar by inflation, echoing the views of the late Nobel Prize-winning economist Milton Friedman, who said, “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” One can’t help but admire Mr. Hui for both his musical talents and astute understanding of economics.
Having been largely dormant for the past 40 years, inflation has made a comeback, propelled by global central banks aggressively increasing money supply and government handouts to salvage the world economy, and by the pandemic unleashing chaos throughout the global supply chain that gave rise to a shortage of goods. While the market consensus was that inflation in the US could fall back to 4% in H2 this year, as things stand, we think this projection may be overly optimistic.
Inflation in the US has been powered primarily by the energy and used car markets over the past year – energy prices rose by between 40% and 50%, while a surge in demand for used cars drove prices higher by 37% as the automotive chip shortage had impeded new car production.
As energy and used car prices gradually returned to normal levels, with that of other items remaining stable, it was believed that inflation would start to ebb. However, it’s also worth noting that the US inflation rate has not yet fully reflected the changes in consumer prices, the most important among them being the surge in rental costs and property prices last year.
Within the country’s CPI (Consumer Price Index), shelter makes up the biggest component with a weighting of 32%, and the main constituent of which, owners’ equivalent rent of primary residence, accounts for nearly 80% of the overall rental costs under shelter. To get an estimate of where the rental housing market was at, the US Department of Labor would survey homeowners their estimated rental gains if they were to rent out all of their properties including the homes in which they currently reside. But the biggest problem with estimating rental prices with this method is that owner-occupiers of private properties don’t necessarily keep abreast of the movements in market rental rates, which often leads to a gap between their imputed rents and the prevailing rent rates.
According to the latest figures from a US property data company, home rents in the US rose by 12% last year. Taking into account the increase in rents and the time lag for it to be reflected in accommodation costs, it is obvious that even if energy and vehicle prices soften this year, rising inflation will continue to persist. Compounded by the labour shortages in service industries, the potential pressure to raise wages will add to the operating costs, which will be reflected in consumer prices eventually. As such, we think the likelihood of inflation fading significantly this year appears distant.
Another major contributing factor for inflation to remain strong is consumer spending – despite the Fed beginning to taper asset purchases, the year-on-year growth in consumer spending in December last year, showing no signs of abating, stood at 13.3%. Given the US government’s handouts and a slowdown in service spending over the past two years, household savings have shot up – all in all, a favourable environment for people to loosen their purse strings.
Typically, even when demand is strong, the room for prices to move up significantly is limited if the demand is offset by adequate supply. But the bottlenecks in the global supply chain have hardly improved – in mid-February this year, the transit times for ocean freight shipments traveling from the Far East to Europe and US both taking around 110 days, compared with around 50 and 60 days respectively in mid-2020 – the signs of improvement most investors expected to see have yet to emerge.
To combat inflation, the Fed has started the rate hike in mid-March, but the tricky part is that the US Treasury yield curve has begun to flatten in the past few months. If the Fed continues to increase interest rate, there’s even a possibility that the yield curve would invert. Historically, an inverted yield curve has been one of the most accurate indicators of a recession. And if it does take place, the Fed will be stuck between quashing inflation or rescuing the economy – perhaps Mr. Hui would make his return with a new song about such an economic dilemma then.
This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.
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