As manufacturing grows, so does inflation: What’s next?

Recently, concerns about a resurgence of inflation in the US have raised fears that the Federal Reserve might delay cutting interest rates. Consequently, the stock market has retreated. But why is there a resurgence of inflation?

Long-awaited manufacturing recovery after prolonged de-inventory action

The U.S. manufacturing sector expanded in March, as indicated by the Manufacturing PMI, which reached 50.3—an increase of 2.5 points from February's figure of 47.8. In April, the PMI slightly declined to 49.9. This expansion in March marked the first instance of growth in the sector in 16 months. The accompanying chart highlights the cyclical nature of the PMI, suggesting that we are currently in a rising phase.

The recovery in manufacturing is notably positive due to persistently low customer inventories, signaling a strong demand for stock replenishment. This trend is likely to sustain the sector’s growth for several months. Additionally, this revival is boosting demand for commodities, thereby exerting inflationary pressures. In Q1 of 2024, inflation began to rebound, and such momentum is expected to continue into Q2 of 2024. This economic trajectory could only be disrupted by a financial crisis, potentially plunging the economy into turmoil and deflation.

Globally, the recovery in manufacturing PMI is not limited to the US; the EU, UK, and Japan have also seen their manufacturing PMI stabilised over the past year. With a wide range of countries experiencing manufacturing recovery simultaneously, there has been a sudden surge in demand for commodities, leading to price hikes. This trend is particularly evident in the case of copper.

A deficiency in copper will likely lead to higher prices

AI, electric vehicles (EVs), decarbonisation, and other macro trends within the manufacturing sector are driving an increased demand for copper. According to McKinsey & Company, global demand is projected to rise to 36.6 million metric tonnes by 2031, up from the current level of 25 million metric tonnes. Furthermore, researchers anticipate a shortfall in global copper supply by 2031, with a projected deficit of 6.5 million metric tonnes.

Compounding this issue, the global capacity for mining and recycling copper is not keeping pace with demand. Recently, major Chinese copper smelters agreed to cut production due to shortages in the supply of raw materials (Source: businessinsider).

The combination of escalating demand and dwindling supply may cause a surge in copper prices, posing challenges for manufacturing costs, particularly within sectors heavily dependent on copper.

Investment strategies based on PMI and market trends

During periods when the ISM PMI is recovering, the S&P 500 rarely experiences a major downtrend. Given the current rebound in manufacturing, this presents a favourable time to explore trading prospects within the S&P 500.?

Technical analysis of S&P 500

Since October 2023, the S&P 500 has been rallying, reaching a temporary peak in late March. It has since pulled back. Recently, the 20-day moving average crossed below the 60-day moving average, signalling that a correction is underway. The next support levels to monitor are at the 0.382 and 0.5 Fibonacci retracements, which correspond to 4829 and 4691, respectively. Meanwhile, the 50-day moving average will act as resistance. Unless the S&P 500 can close above this average within the next few days, we can potentially expect the correction to continue.

In addition to the S&P 500, copper and copper mining stocks are another sector worth considering.

Written by: Bruce Yam?

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