Central banks are right to be worried about inflation - there's more coming

Central banks have begun the task of normalising interest rates from historically low levels. The reason? Inflation. After backing away from describing inflation as "transitory", we have now seen the bond market price in an aggressive rate hiking cycle, including a 0.5% increase from the US Federal Reserve in April and a Cash Rate of over 1% in Australia by June.

We think central banks are right to be removing monetary policy stimulus as unemployment rates fall and inflation picks up. It looks like official measures of inflation, including the Producer Prices Index, have not caught up with the current dynamic of supply chain bottlenecks and strong demand. 

For example, intermediate prices (the stuff used to produce final products like lumber and metals) have risen sharply over the past year reflecting higher commodity prices. In contrast, the official measure of semiconductor prices has been relatively well contained by comparison. This partially reflects contractual relationships between producers of final goods (like mobile phones and home appliances) and their suppliers of semiconductor chips.

Companies we speak too are reporting supply chain disruptions across nearly every industry. We know that there is a massive shortage of semiconductors - the so-called "new oil" - for many sectors, including autos and for tech products. As the contracts between intermediate manufacturers of items (like semiconductors) and final goods producers begin to roll-off they will have to be renegotiated, and potentially at much higher prices. The question for investors is whether companies will look to absorb rising price pressures in order to maintain market share, or will they look to pass on rising costs to the end consumer in an environment of low unemployment and rising wages.

With this in mind, the Firetrail S3 Global Opportunities Fund has exposure to a number of global semiconductor companies, including TSMC and Micron Technology. TSMC recently reported that its revenue had grown by 37% year on year in February, so it looks like the official inflation numbers have some catching up to do.