The Great Economic Rebound and Inflation Debate

Please note this blog post was published over 12 months ago and so may not include the most up-to-date information, for example where regulation around investing has changed.

The Great Economic Rebound and Inflation Debate

We are currently witnessing one of the quickest recoveries on record. Across multiple data points good news is in evidence.

Economic activity is moving back to pre-pandemic levels albeit requiring significant levels of assistance from governments and central banks. Realistically, it will take longer to move to self-sustaining growth, but confidence is growing.

Below, we discuss some of the notable trends already well underway. We start with the current backdrop of improving activity, look at the price effects on businesses and finish with some conclusions.


12 months ago, the first quarter of 2020 marked a sudden stop in global economic activity as we entered the COVID-19 pandemic.

Fast forward to the first quarter of 2021 and the COVID-19 situation has changed significantly. We now have the successful rollout of vaccinations, alongside astonishing levels of fiscal and monetary support.

Consequently, year on year growth (yoy) rates in economic data are extremely high, in some cases record breaking. Here is a sample of what we are seeing yoy globally:

  • April exports from China increased 3%
  • March retail sales in Italy increased 6%
  • March retail sales in the United States increased 7%
  • April British Retail Consortium reported retail sales increased 5%

With strong demand resuming, prices are firming. This is most apparent in areas experiencing supply shortages or bottlenecks. Demand and supply imbalances across the real economy are undoubtedly having an impact and pushing market inflation expectations higher.

We can measure inflation expectations using the break-even inflation rate. The break-even rate is derived from the difference in yields between standard (nominal) bonds and inflation-linked (real) government bonds. You can see from Chart 1 that expectations for inflation are rising in both the US and the UK.

Chart 1: US and UK 5 Year Inflation Break-Even Rates

Source: Bloomberg Finance LP, May 2021

We can also see that amid the Pandemic inflation expectations fell sharply. Now that recovery is underway, they are rising back to where they were pre-pandemic.

The bigger question for companies and asset markets, is will this upward trend be sustained or as forecast by Central Bankers, will inflation expectations simply fall back?

According to the US Federal Reserve bank prices are at a short-term peak and exacerbated by comparisons against the price lows of last year.

In our opinion, the latest US inflation reading does contain evidence supporting the idea that price hikes right now are probably transitory. In April US Inflation increased 4.2% year on year, in comparison to 2.6% the previous month. This big jump was driven by energy costs which increased 25% year on year, but from a very depressed level. The rebound in oil prices is clearly a factor pushing the CPI up and should begin to fall away as we pass through the anniversary of the low point a year ago.

The inflation spike is demonstrated clearly in chart 2 below:

Chart 2: US Consumer Price Index (CPI)

Source: Bloomberg Finance LP, May 2021

Another reason why central banks believe prices will subside is contained within month-on-month comparisons.

At a headline level consumer prices rose in April at the fastest pace in more than a decade, increasing 0.8%. The high month on month figure is driven by specific sectors; car and truck prices increased 10%, airfares 10.2%, hotels/motels room rates by 8.8% and car and truck rentals 16.2%. In each of these areas demand is exceeding supply, but such imbalances are typically self-correcting. Thus, in the months ahead price rises should ease.

One additional unknown is what will happen to wages. Anecdotally there is some limited evidence that companies are having to push through significant wage increases to attract labour, especially where workers are more at risk from COVID-19 or there are skill shortages. But it is too early to say if higher than average wage growth is a trend

Despite all of the unknowns about inflation one thing is certain, inflation-related news will continue to attract a lot of attention.

The Corporate Sector

The most comprehensive dataset available for what is happening to company profits sits in the United States. US companies report results quarterly giving an up to date reading of what is happening.

The most recent data from FactSet, one of our research providers, indicate several interesting trends:

  • Sales and profits are massively exceeding analysts’ forecasts.
  • First quarter 2021 profits are 4% higher year on year.
  • Companies input costs are rising with some price rises passed on to consumers.
  • Appliance manufacturers and car companies are grappling with semiconductor shortages causing end prices to rise.
  • Commodity prices are on a tear and this is having a sizeable impact on consumer goods companies.

The bull market in commodity prices is relevant because of the way it impacts corporate profit margins. Companies with pricing power can pass on the higher input costs, and even add on a little more. Whereas weak companies must absorb the costs, squeezing margins. Rising commodity prices are also an indicator of rising demand.

The following chart illustrates how a basket of diversified commodity prices has changed over the past 12 months.

Chart 3: Commodity Price Basket

Source: Bloomberg Finance LP, May 2021

Prices are now higher than they were pre-pandemic. Why? Infrastructure spending is emerging as a big theme and expected to drive higher demand for commodities like copper. At the same time climate change carbon policies are expected to constrain supply with mining companies not being encouraged to invest capital. Investors are betting on further hikes in commodity prices and some are predicting a new commodity supercycle!

Here and now, we know of several companies, including Nestle, Proctor & Gamble and Unilever passing on energy and soft commodity-related price increases to consumers. If this gathers pace, we will all see higher prices in the shops.

Graeme Pitkethly, Unilever’s Chief Financial Officer commented, ‘we are seeing some of the highest commodity price inflation that we’ve seen in a decade’, (Source – Financial Times, understandable in the context of the rapid price recovery shown above.

Concluding Thoughts

One of the fastest recoveries on record is weighing on inflation expectations.

Inflation will be a front and centre issue for markets and policymakers for this year and beyond.

Company results for the first quarter of 2021 have been bolstered by recovery from the pandemic induced effects last year, but they are facing higher input cost pressures.

Commodity price rises are impacting many companies, with some suggesting price increases for us in the shops.

Global Markets