Precautionary stockpiling and its impact on growth

Putnam Fixed Income Team, 01/26/22

  • Companies are buying raw and intermediate goods at a record pace, which we believe will influence economic growth in 2022.
  • A slowdown or a reversal in inventory building is likely to ease price pressures in the global economy.
  • As the Fed and other central banks tighten monetary policy and inflation starts to slow, calls for further rate hikes might abate.

One of the risks we might face this year is excessive inventory building relative to final consumption. Companies seem to be accumulating raw and intermediate goods at an unprecedented pace, expecting strong demand and supply insufficiency. That said, this precautionary stockpiling in some sectors or countries will likely come to an end this year, muddling the underlying growth story.

Electronics and supply chain crises

Many companies are either ordering goods in advance or preparing for future supply bottlenecks. This has kept the “new orders” indicators high while exacerbating transportation, logistics, and other operational issues. While it has not been easy to pinpoint which goods or sectors have driven the buying surge in input materials, several sector and country purchasing managers’ indexes (PMIs) provide insight.

Shortages of some electronic components are well known. However, several global electronics PMIs indicate a varying degree of inventory building across electronics subsectors. Electronic equipment PMIs suggest stocks of finished products are low relative to historical levels. At the same time, stocks of input materials have accelerated, while new orders have slowed since the second quarter of 2021.

Companies are stockpiling inputs even as new orders are falling

(IHS Markit Global Electronics Purchasing Managers’ Index)

New orders decline

Source: IHS Markit, as of December 31, 2021.

Within the electronic computing equipment subsector, the pace of input material stocking has slowed since the summer of 2021. New orders have also decelerated. Meanwhile, electronic consumer equipment orders have fallen since the second quarter of 2021. Still, producers accelerated their purchases of raw and intermediate goods as finished product inventories dropped in the summer.

Similarly, electronic communications equipment new orders have slowed, and stocks of input materials have risen. But, in this subsector, the stocks of finished goods also increased. This subsector is likely to slow before electronic computing and consumer equipment. All subsectors have purchased input materials at a rapid pace even as orders slowed, although the inventories of finished products show greater variation.

Inventory accumulation rates differ among countries

The degree of stockpiling varies across counties. Data from the United Kingdom is illuminating since precautionary stocking is not a new phenomenon in the country. The U.K. has experienced several periods of Brexit‐related uncertainty over the past few years. Ahead of each key Brexit deadline, firms stocked goods, fearing shortages. Once the risk receded, firms destocked, slowing overall production. The uncertainty caused by the Covid-19 pandemic appears to have encouraged British firms — once again — to stockpile production goods. That said, stock building is starting to slow amid a decline in orders and an increase in finished product inventories.

In the eurozone, stocks of input materials have grown at an unprecedented pace, while stocks of finished goods seem to have normalized. New orders have slowed. A further drop in orders (which is likely given the evolving nature of the pandemic in Europe) or a break from purchasing input materials can quickly decelerate activity in the area. The euro area appears to be the most advanced in inventory accumulation and, hence, the most vulnerable to shifts in orders and sentiment.

Japan was reported to be at the epicenter of supply shortages because of the dearth of electronic components needed for auto production. Nevertheless, Japanese firms seem to have accumulated enough inventories both in production goods and finished products. The order growth gradually slowed since the second quarter of 2021, and in December, producers started decelerating the pace of inventory accumulation.

Economic growth and central banks

Growth typically slows when new orders, reflecting final demand, drop. This atypical inventory cycle in a Covid world has been adding to growth uncertainty. Even if supply disruptions do not ease, at some point in 2022, firms will get comfortable with the stocks of goods purchased and will reduce orders of production goods. The associated decline in “new orders” will lower growth temporarily. The good news is that inventory cycles per se do not cause recessions. But a new orders-led slowdown, tighter monetary policy stance, and other volatility may lead to talk about recession.

Inventory building is based on expectations that household consumption will continue to be strong in 2022. A slowdown in final demand can exacerbate the inventory and the associated manufacturing cycles. So far, final demand has been strong but off its highs.

As life continues to normalize, we foresee that growth in final demand will slow. Households might be able to maintain high consumption levels, but if there are expectations for even stronger demand, any decline in spending can exacerbate the impact of precautionary inventory building. A slowdown or a reversal in inventory building will ease price pressures in the global economy. As the Federal Reserve and other central banks tighten monetary policy — and inflation starts to slow — we expect market calls for further tightening to abate.