Global demand for consumer goods has rebounded since the second half of 2020, driven initially by large government stimulus packages and, more recently, by resilient capital expenditures and swift vaccination rollouts in most developed markets. But supply constraints remain.
Some large emerging market manufacturing countries continue to struggle to contain the virus, while sectors such as semiconductors continue to face capacity shortages due to surging demand for automobiles and electronics. Logistical bottlenecks, caused by disruptions to ports, shipping lines and domestic transportation, have lengthened delivery times and further weighed on the supply shortage in some regions. As a result, inventories quickly run out and inflation has spiked in the U.S. and other markets.
However, we expect the supply bottlenecks to ease towards year-end, as production increases, shipping congestion clears, developed market demand for goods declines, and consumers in advanced economies shift spending to services (assuming no further disruptions from the pandemic).
A differentiated supply picture
Overall, Asian production has recovered better than other regions (see Figure 1). In East Asia, where the pandemic has been relatively well-contained and most factories have remained open, industrial production has picked up quickly since the second half of 2020. China’s industrial production had already rebounded and exceeded pre-pandemic levels by last June, and has remained solid since then, supported by strong exports and domestic investment. While global Purchasing Managers’ Index data in May generally showed lengthier delivery times compared with 1Q, Asian economies have fared better.
Figure 1 shows the development of industrial production for Europe, the U.S., Japan, China and EM Asia ex China, indexed to 100 at January 2019. The chart shows that industrial production dropped in China in 1Q 2020 before rebounding a few months later. For all other regions, industrial production fell around April 2020 and has since rebounded. The index shows that as of 30 April, industrial production is strongest in China (at 117.5), followed by EM Asia ex China (at 104), remaining above the index line of 100. The other regions remain below the index line, meaning that industrial production has not caught up to January 2019 levels yet, with Japan at 97.1, Europe at 97 and the U.S. at 92.3.
Semiconductor chip shortages remain a major supply bottleneck for global manufacturing. The recent coronavirus outbreak in Taiwan could prolong the shortage, although the impact so far has been largely on domestic consumption and consumer sentiment rather than industrial activity. While foundry production is mostly automated and not particularly labor-intensive, the pandemic is affecting other parts of the tech supply chain, such as logistics. We continue to expect the chip bottleneck to ease gradually in the second half of 2021, particularly for car companies, yet semiconductor supply will likely remain tight.
Logistical bottlenecks could exacerbate supply-demand imbalances
Ports in Europe and the west coast of the U.S. remain congested. Although crowding eased in the U.S. in late June, delivery of goods could be delayed by a shortage of truck drivers. Congestion has also increased in South China ports due to tighter pandemic controls in response to the coronavirus outbreak that started in late May. Shenzhen’s Yantian port, China’s third-largest, resumed normal operations only at the end of June after having operated below 50% of normal capacity on average for the month. The port accounted for about 6% of China’s foreign container shipments in 2020Footnote so the disruptions could dent China’s June exports, particularly cargo destined for Europe and the U.S. Now that Yantian has resumed normal operations, we expect exports to rebound, which could further exacerbate port congestion in Europe and the U.S. in coming weeks.
Port congestion and strong demand have caused freight rates to soar in recent months and we believe spot rates remain well supported, with an expected strong season ahead in 3Q 2021. While shipping costs generally constitute a tiny portion of the price of final goods, logistical bottlenecks could exacerbate the imbalance between demand and supply and lead to further inflation pressures in destination markets.
Bottlenecks should be alleviated by the end of 2021
Overall, we expect the supply-demand imbalance to ease toward the end of the year after demand for consumer goods peaks in developed markets and service-sector spending – which is less import-intensive – increases (assuming no further disruptions from the pandemic). In addition, production is likely to catch up and adjust to the demand recovery, while logistical bottlenecks should clear in 2022 as capacity ramps up and freight costs should gradually normalize by next year.
Inflation has scope to be elevated in the months ahead and to stay bumpy given some of these bottlenecks and disruptions. However, with production resuming and growth moderating into 2022, we expect inflation in developed markets will peak in coming months and moderate in the second half of 2021.
With strong developed market demand recovery, supply bottlenecks have pushed up commodity prices, benefiting commodity exporters. While the chip shortage and logistical congestion have contributed to a spike in U.S. inflation, the Fed still views inflation as transitory and will likely take a patient approach, compared with potentially faster policy tightening elsewhere. We continue to favor U.S. dollar underweights versus G-10 commodity-related currencies and select emerging market currencies, as noted in our recent Cyclical Outlook, “Inflation Inflection.”
Commodity producers, shipping companies, semiconductor suppliers, and secondhand auto sellers are benefiting from the supply bottlenecks as the prices they charge soar. However, profit margins of some downstream manufacturers will likely suffer.
Global pandemic control and vaccination progress remain key variables. Any deterioration in progress could distort the global supply and demand balance, either through supply chain disruptions or further shipping bottlenecks, resulting in delayed growth recovery or prolonged inflation pressures.
Source: PIMCO, By Carol Liao, China Economist