Real story of inflation

Media driving the narrative that inflation is close to its peak

Second order effects

As Howard Marks writes in his book ‘The Most Important Thing’ — it’s not the obvious things that matter. It’s the second and third order effects that cause significant shifts to the ‘expected path’. Predicting such second and third order effects is where the real ‘alpha’ lies.

My thesis is that we can see a huge inflation spike by September-October that can trigger market shocks and a potential liquidity freeze

1. Food crisis

Russia-Ukraine war started in the first week of March. At the time of writing this article, the war appears to be heading for some sort of a stalemate.

Source: IHS Markit
Source: S&P Global Market Intelligence

Over 7 million hectares of farmland that produced corn, barley, sunflower seeds, soybeans every September (spring harvest) will not do so in 2022. It is very unlikely that market has factored in the implications of this shortfall in its 5% inflation estimate.

2. Fertilizer crisis

An even more serious problem is a global shortage of fertilizer (nitrogen, phosphorous and potassium), again thanks to Russian embargo and supply chain disruptions due to Russia Ukraine war. This article on Bloomberg gives a bleak picture of how global crop yields are set to drop because of high fertilizer prices and rampant shortages.

Source: Bloomberg

Massive increase in fertilizer prices coupled with Ukraine crisis means that the September-October harvest will see a sharp reduction. Expect massive food shortages, export controls by individual countries leading to massive price hikes in the last quarter of 2022.

3. Supply chain crisis

While this is happening on the food front, there is another epic event unfolding in China. Thanks to its zero Covid policy, China is witnessing a shutdown in key cities such as Shanghai, Shenzhen, Guangzhou and 70 other cities. Windward, a maritime intelligence and analytics company, in their blog have cited massive congestions at Chinese ports.

Source: Windward AI

Food shortages from Ukraine, global fertilizer shortages & supply chain disruptions, all seem to converge with a devastating lag-effect that will show up somewhere in September-November time window.

Worst case scenario

While I certainly hope we avoid this, I feel there is a non-zero chance that food and supply chain shocks could trigger flashpoints in emerging markets.

Conclusion

I think market is expecting things to go smoothly — this could be a hangover of a 10 year bull run. Sure, there seems to be pain in the market but there is also a feeling that things are largely in control. Never before have we had a hawkish fed, an ongoing war, massive supply chain issues and food crisis of epic proportions hit us together.

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Defipi Guy

Defipi Guy

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Defi investor and researcher. Macro analyst. Believe in first principles thinking. Believe in humility, open-mindedness and long term positive sum games.