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Client Update - 14th May 2021

The spectre of inflation was again returned to dampen markets this week as Wednesday’s US Consumer inflation rate jumped to 4.2% in April, compared to consensus expectations of 3.6%. I have written at length about short term inflation expectations given the opening of economies and year on year energy price rises, however the market’s reaction to this figure shows how important inflation will be in 2021. Markets have since been calmed again by US Federal Reserve Governor Waller stating once again that “the factors putting upward pressure on inflation are temporary, and an accommodative monetary policy continues to have an important role to play in supporting the recovery”.

As part of the recovery story, tight supply and increasing demand have led to a surge in commodity prices over the last few months. This is consistent with strong growth, equity outperformance and rising long-term yields. It is also a reason why people are further worried about inflation. It is typical that as demand recovers after a recession, it does so more quickly than supply which, in the case of commodities, is relatively inelastic and the price is quickly pushed up. This early cycle price pressure usually gives way to a normalisation of commodity markets as supply increases, but this process takes time and, in this cycle, it could take longer than usual. As a result, we have been gradually increasing our commodity exposure in our investment portfolios.

In addition to the reopening surge in demand, there is also the structural demand for commodities related to increased investment in communications and digital infrastructure, electrification of transport and investment in renewable energy and smart energy grids. Copper, lithium, nickel, and cobalt are all metals essential for the shift to a lower carbon economy. All have seen significant price increases so far in 2021. No wonder the materials index of the S&P500 has outperformed the market by 8% so far this year.

It is not just basic commodity prices that are rising. Commodities need to be shipped to points of production and consumption. Shipping capacity has not been able to respond quickly to the bounce in demand given that ships were “mothballed” during the depths of the pandemic and because of the delays caused by the Suez Canal shut down early this year. The Baltic Dry Freight index is a composite measure of shipping freight costs widely used as a global trade indicator. It has risen by 139% so far in 2021 and currently stands at its highest level since the global economy emerged from the financial crisis in 2010. The cost of commodities is up, and the cost of transporting commodities is up.

With regards to COVID, we are looking forward to a further relaxation in lockdown measures from Monday, even if we are keeping a careful eye on the spread of the Indian COVID variant. The Governments plans to flex COVID vaccine availability in younger people to target areas where the Indian variant is more prevalent makes sense and I very much hope we can continue to make good progress towards a pleasant summer, even if the weather this week has felt like we are still some way away. Please do have a good weekend.

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