Little sign of relief in supply chain problems

In Europe, compounding existing problems sourcing semiconductors, and steep rises in energy costs, auto makers now face a shortage of magnesium – a material critical to aluminium used in car production – due to energy rationing in China (where 95% of Europe’s consumption is sourced). This could cause further stoppages at car manufacturers before the end of the year if left unresolved. In the US, industry is somewhat more insulated from these specific problems, with energy price rises not nearly as steep as we see in Europe, and a magnesium shortage unlikely given that the US has its own production source. However, the US is facing more homegrown problems, with continued above-normal demand for goods and a shortage of materials and workers to produce and transport those goods. According to the Beige Book published on Wednesday, and a special survey by the New York Fed yesterday, these problems appear to be worsening: 80% of service providers and 95% of manufacturers report supply-side problems, with more than half of respondents saying that these problems worsened over the past month, and almost none reporting an improvement.

Disruptions are inflationary…

The most obvious and near-term consequence of supply chain disruptions at present is inflation, at least in goods. Strong consumer demand has given manufacturers increasing confidence to pass on higher costs, and this was also a finding in the Fed’s Beige Book. This process likely still has some way to go in the goods sector, although we are unconvinced that services sector inflation will follow to anywhere near the same extent. Demand for services continues to lag that in goods, particularly in the US but also in Europe. While we expect a continued recovery in services consumption, we do not expect the same above-trend demand that we have seen for goods. As such, demand-side pressures for services should remain contained. This should ensure that major central banks do not overreact to recent rises in inflation (although the Bank of England looks set to be an outlier in this regard).

…but also contractionary

Even for goods, there are signs that higher prices will ultimately trigger falls in demand. In the US, Michigan consumer sentiment remains near the post-pandemic lows, with recent weakness driven by consumer aversion to recent price hikes, particularly for cars. Thus, to some extent the problem is likely to provide its own solution, insofar that weaker demand eases pressure on supply chains. At the same time, production cuts and stoppages also have knock-on effects in reducing demand for labour: some 10% of companies in the NY Fed survey said they had responded to supply chain challenges by reducing headcount or number of hours worked. This could therefore have knock-on effects on the labour market and on incomes, although this effect at present appears to be dwarfed by strong labour demand elsewhere in the economy.

The supply side will also recover… eventually

A combination of pandemic restrictions, shifting patterns of demand, and distortions from government support and energy policies have caused more longer-lasting disruption to the supply-side than expected. But with vaccination rates approaching herd immunity levels in most advanced and major EM economies, and government support unwinding, these effects will eventually dissipate. For instance, in shipping, we already see some signs of easing, with freight tariffs from Shanghai to LA falling back 14% over the past month. In the labour market, we are still to see the effects on labour supply of the gradual withdrawal of wage subsidies in Europe, and of the expiry benefit top-ups and schools reopening in the US. Reduced migration is something that has hampered labour supply in both the US and Europe, and so the recent easing in travel restrictions should help here. Responses to these policy changes is taking longer than expected, but they are still likely to happen. In the meantime, disruptions are putting a dampener on the recovery, raising downside risks to growth, even as upside risks to inflation have risen.