Going On Long Yields at Commodity Prices

Let’s hope federal interest rates are off the table when the Federal Reserve starts to taper its quantitative easing program in September.

As I’ve noted, inflation does not hit the consumer until quite late in a supply chain cycle. In most industries, the new-product cycle and existing product cycle are much longer than the value chain. For example, it takes 10 years for an airline to start to earn a profit, then 25 years to lose it; average lifespan of a new-product being sold in the airlines these days is about five years.

The first inkling the consumer has of a new-product cycle in the consumer durable sector comes in the third year after the product is first introduced. This late cycle is fairly easy to predict: As the company introduces more new products, sales in the present production cycle rise (and to some extent so does operating profit).

That helps to explain why consumer prices (CPI) are down slightly after rising for 10 months in a row. While inflation hasn’t hit yet, a weaker U.S. dollar has led the price of imported goods to rise. The price of imported goods should rise 6.6 percent this year, according to Bloomberg.

In the same vein, the first sign the consumer has of the end of new-product cycle in the consumer durables sector usually appears in the second year after new products are introduced. Since clothing (whose prices rise with fabric and are set by the various clothing manufacturers) and shoes (which is mostly produced abroad) are often six to eight years old, there’s a lag on the first hint of the end of the production cycle of new-product materials. Finally, in a prolonged period of rising material costs (which can prove dangerous), the price of existing products (wheat and coal) rises.

The upshot is that price rises associated with inflation in the consumer durable sector usually do not register with consumers until the end of production cycles. It’s hard to imagine people would put up with repeated price increases through the manufacturing and distribution cycles. Consumers would react not just to the end of the production cycle but also to the end of the supply chain.

In this world, if there’s one thing the Fed needs to be sure it doesn’t do, it’s raising interest rates in advance of the end of a new-product cycle. If the Fed manages to slow the production cycle by low-interest rates, the inflation pressure would be more manageable. And no one likes inflation, but raising interest rates doesn’t help.

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