The global supply chain crisis isn’t as bad as it looks

If 2021 marks the year of the supply chain crisis, 2022 could easily end up as the year of oversupply
Amid volatile inventory cycles and uncertain demand conditions, central banks must be careful not to upset the markets with gratuitous rate hikes

David Brown

Published: 3:30am, 16 Nov 2021

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While it is often claimed that every dark cloud has a silver lining, it has been hard to put a positive spin on the world as it emerges from the Covid-19 pandemic, beset by supply-side worries and growing doubts about the inflation outlook. But it is time to start looking to the future and thinking more constructively about the post-pandemic world in 2022, with the global economy getting back to business as usual.

Central banks have been accused of sitting on the fence, but patience may prove a virtue in the present circumstances. There’s a good chance of sustainable recovery being achieved, but growth prospects still need nurturing and the last thing the global economy needs is gratuitous, over-reactive interest rate hikes.

Output and prices are both witnessing volatility on the return to normality and central banks have a duty to ensure they don’t add to the instability. If 2021 has marked the year of the supply chain crisis, 2022 could easily end up as the year of oversupply, with inflation expectations moderating quite sharply. Central banks must tread carefully.

Supply-chain constraints have been weighing heavily on the global economic mood but this could change quite dramatically in the coming months. Judging by the positive way that global equity markets are moving, they may already be ahead of the game in anticipating better times.

The next phase of the supply chain crisis could easily be too much of everything as manufacturers respond to the shortages by stepping up production. It’s the logical reaction, and basic economics: supply falls short of what’s needed, prices rise and producers respond by boosting output to cash in.

Instinctively, manufacturers see a market opportunity and step in to fill the gap. While short-term lags are causing temporary supply chain disruptions, these will eventually disappear.

On the demand side, the worry for businesses is not repeating the mistakes of 2021 and overcompensating by maintaining higher inventory levels as a stopgap measure. At some stage, the cost of excessive stockpiling becomes too expensive and ultimately unnecessary, especially once economic conditions pick up.

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Global supply chain crisis bites in US cities as store shelves empty with rising demand

As companies are forced to scale down their order books, underlying demand conditions could be equally unpredictable next year, posing a major challenge for central bank policymakers. Trying to plan interest rate rises in 2022 around volatile inventory cycles, uncertain demand conditions and unclear price trends could be a messy process of trial and error.

It’s no surprise that the US Federal Reserve, the European Central Bank and others are keeping relatively tight-lipped about the prospect of major monetary reversals.

By all means, save Christmas – but don’t blame the global supply chain

Manufacturing capacity constraints, extended delivery times and labour shortages are without doubt causing hiccups in the global supply chain, but maybe policymakers can see some light at the end of the tunnel. US supply-side indicators like the Philadelphia Federal Reserve diffusion index for delivery times and labour market constraints look like they are past their worst.

There may be over 10 million unfilled vacancies in the US right now, but the rapid pace of monthly non-farm payroll gains in recent months underlines that job market constrictions are not quite as bad as portrayed. So far, monthly employment gains have averaged over 500,000 in 2021.

Meanwhile, on the inflation front, global price indicators such as the Baltic Dry Index – a closely-watched benchmark for the cost of moving major raw materials by sea – and world energy prices seem to have passed their peaks in September, suggesting global inflation pressures may be heading lower.

US wage rises might have hit 4.9 per cent year on year in October, but it should be remembered that the phenomenon of the gig economy and zero-hour contracts is still wielding a mighty influence on longer-term wages growth, as the economy continues to emerge from the pandemic.

It still means mixed messages for the markets. World equity markets may be responding more positively to signs of recovery in output and growth, but global bond markets are still being bogged down by nagging inflation concerns. Implied break-even inflation expectations in the US Treasury market are still running at 16-year highs, at 2.73 per cent for 10-year maturities.

If central banks tread carefully and don’t upset the markets with rash interest rate hikes, a soft landing is easily within reach in 2022.

David Brown is the chief executive of New View Economics