Chart of the week - resurgence risk?

Last week I talked about the idea of reacceleration risk, this week I want to focus on the important baggage that this macro scenario will most likely come packing…

Resurgence Risk.

Basically the idea is that much of the disinflation we’ve seen has been a product of deceleration in marginal demand (again, captured by the declining global manufacturing PMI) — therefore, if growth reaccelerates then pricing pressures will resurge.

The key channels for this are…

• Tight Capacity: capacity is still tight, especially labor market capacity — a reacceleration in growth will put pressure here and drive up core inflation.

• Commodity Prices: the way I look at commodities, all indicators show them ripe and primed to rally (technicals, valuations, supply) — a turnaround in the manufacturing PMIs would see commodities rebound, and drive up headline inflation.

• Inventory Cycle: in the background, firms have been running down inventories in response to simply over-ordering post-pandemic as well as softer demand, that’s meant lower backlogs, lower pricing pressures from the supply side.

To be fair, there has been some supply response, and housing (another key component) is quite mixed but expected to be disinflationary as rent growth normalizes, and of course if growth just ticks along and doesn’t reaccelerate enough then inflation pressures may remain contained.

But when I look at the chart below, and think about last week’s chart, firstly I can’t help think about the opportunity in commodities (as an absolute return play, but also as a hedge should inflation resurge as commodities ≈ inflation), but secondly and most of all it makes me think the specter of inflation could return.

This of course will throw a spanner in the works for Fed rate cut expectations — if inflation resurges they will need to maybe even think about the opposite: further rate hikes to stem a prospective resurgence in inflation.

(hmm: kinda reminds me of the pandemic resurgences!)

So this will likely be bad for bonds, and maybe bad for stocks too if inflation comes back too quickly and rates shoot upwards. It probably is a few steps ahead, as you kind of need reacceleration to actually happen first, but also it needs to be significant enough to reheat commodities + capacity.

But as far as credible and impactful macro risk scenarios go, it’s definitely worth keeping on the radar this year.

Key point: Higher growth means higher prices; inflation resurgence.