So now everyone is on the band-wagon with inflation going up because of rising commodity costs, which are rising because of QE2, which is the Fed’s undoing of all things good….,or is it?
Woody Brock and David Rosenberg have both just penned great pieces on this topic so I will keep it short.
Headline inflation (CPI) in the UK is now 4%, but at least 75bps is a direct result of VAT going up to 20% from 17.5% according the National Statistics Office and this analysis was done for the month of January. One could argue that the effect is larger now – the CPI indices without taxation (CPI-Y) and with constant taxation are running at or around 2.7%, so the ‘truth’ is somewhere in between the two (2.7% - 3.25%). Is this runaway inflation? No! Is it high considering the recent movements in the oil price which in £ terms went to all-time highs? No, not at all.
One of the other commodities feeding into CPI, which has gone up in spectacular fashion is Cotton. Cotton has risen from around 75c/lb to more than $2/lb before retracing back to $1.78/lb. This has caused major pain for the producers of items made of cotton and for retailers. Hennes & Mauritz reported 30% lower earnings in Q1 as they absorbed the price increase rather than passing it on to their customers.
So far so good. Then I took a look at the futures curve……I don’t recall EVER having seen anything like it: It’s not just in backwardation which means that prices are lower the further out the curve you go – they are a lot lower! May 2012 is 80c lower than May 2011, so while futures prices are not really a ‘prediction’ of where prices will be in the future they are certainly a point at which the manufacturers and retailers can purchase the Cotton they will need for some of their future production.
Of course inflation only ever really becomes a problem when the so-called second round effects take hold and the whole thing becomes a vicious cycle with everything going up and workers are able to ask for higher wages to reflect the higher prices etc.
So if Cotton is a good predictor of future inflation then I’d say we have seen the worst.
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