The Drewry World Container Index (WCI) more than doubled over the past four weeks: this will begin to push up goods prices. Global reinsurers have begun inserting cancellation provisions into policies to protect against a full-scale Middle East conflict. Tesla, Volvo have paused production in Europe due to a shortage of components. Air freight costs have jumped too.
Climate change is adding to household insurance costs (storms, fires, etc.). Reinsurers, focussed on climate risk, have pushed up premium increases for home insurers. Insurance premiums have surged for EVs too, due to more advanced technology and a shortage of specialist technicians.
Supply shocks may only have relative price effects, i.e., they may not be inflationary in the aggregate, if underlying demand is weak. But this is simply not the case in the US. Adjusted for timing shifts, the CBO estimated that the federal budget deficit in Q4 was: “$553 billion, $94 billion more than the shortfall for the same period in fiscal year 2023.”
This is a world of more volatile inflation. All else equal, this should push up term premia. Negative supply shocks are inflationary if underlying demand is strong. The widening of the federal budget deficit increases the chances that relative price changes feed through to broader inflationary pressures. The Fed risks a policy mistake if it begins an easing cycle now. In summary, if the Fed cuts aggressively into a fiscal deficit that is widening and a labour market that is getting tighter, combined with higher freight rates, there is every chance that inflation will reaccelerate, forcing the Fed to backtrack.
