Markets fret as consumers and investors lose faith in central banks keeping a lid on inflation
The price of natural gas is soaring – and both equity and bond markets are again fretting about surging inflation.
The cost of wholesale gas for next-day delivery in the UK today hit an all-time high of £3.55 per therm (one therm is equal to 100 cubic feet of natural gas), a rise of 27%, meaning the price has doubled in a week.
The immediate upshot is that more “challenger” household energy suppliers, who tend to buy their gas on the spot market rather than in advance, are likely to topple over.
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This is not just an issue in the UK.
Natural gas prices are rising across Europe due to a combination of liquefied natural gas cargoes being diverted to Asia to meet growing demand there, lower supplies from Russia and lower output from renewable energy sources such as wind and solar.
The United States is also seeing a surge in natural gas prices.
Stock markets have suffered several bouts of unease this year amid signs that inflation is taking off.
There was a notable sell-off early in May reflecting a rise in the price of commodities such as copper and the cost of shipping, exacerbated in March by the stranding in the Suez Canal of Ever Given, a container ship en route from China.
On that occasion, markets took at face value the insistence of central bankers such as Jay Powell at the US Federal Reserve, Christine Lagarde at the European Central Bank and Andrew Bailey at the Bank of England that the inflation starting to appear was simply “transitory”, a reflection of surging demand as economies re-opened after the pandemic.
The standing of the Ever Given in the Suez Canal exacerbated factors behind a sell-off earlier this year
Investors around the world are now taking the threat more seriously.
For example, in Japan, the world’s fourth largest energy importer, the Nikkei 225 has fallen in each of the last eight sessions, taking it into correction territory.
Similarly, the Dax in Germany is down to a level last seen in May, while the Nasdaq – which is full of tech stocks which tend to move in close correlation to expected movements in interest rates – fell this week to a level last seen in June.
The anxiety about inflation is playing out most markedly in the sovereign debt markets.
The yield on 10-year UK government gilts (the yield on a bond rises as the price falls) has surged from 0.621% at the start of September to 1.15% – a level not seen since May 2019 – today.
In the same period, the yield on 10-year US Treasuries has risen from 1.307% to 1.552%, while yields on Treasuries of other durations have also risen.
Several things have changed since May.
The first and most obvious is that the price of crude oil has continued to grind higher.
The Nasdaq has fallen to levels last seen in June
In May, during the last inflation-inspired stock market squalls, a barrel of Brent Crude traded at between $64-$70 a barrel.
This month, so far, it has traded in a range between $77-83 a barrel.
The main US oil contract, West Texas Intermediate, has seen an even sharper move higher and is now trading at a level last seen in November 2014.
That is starting to feed into inflation expectations – something central bankers everywhere watch warily because it usually tends to feed into higher wage demands.
For example, two weeks ago, the latest survey of inflation expectations carried out by the investment bank Citi and the pollsters YouGov found that the British public is expecting inflation to hit 4.1% over the next year.
It is a similar picture elsewhere.
The latest survey from the University of Michigan, which is closely watched by US policymakers, this week pointed to rising inflation expectations among American consumers.
And a market measurement of inflation expectations among consumers in the eurozone – a part of the world that during the last decade has had to worry more about deflation, or falling prices, than inflation – this week hit its highest level for six years.
The price of crude oil has continued to grind higher
In other words, consumers and investors in the US, the UK and the eurozone appear to be losing faith in the ability of their central banks to keep a lid on the cost of living.
That belief is entirely rational if, for example, you are a British motorist who has spent hours during the last couple of weeks trying to find petrol or, for example, you are an American consumer looking at big increases in the price of your weekly grocery shop.
What is particularly interesting is that a number of so-called “trimmed mean” inflation measures, which strip out the more extreme price changes of items in the inflationary “basket”, suggest the headline rate of inflation in the US is being artificially depressed by big drops in items such as air fares and hotel rooms.
They imply that underlying inflation – that element of inflation that cannot simply be explained away by pandemic-influenced levels of supply and demand – is actually much higher.
The third factor is that some investors are now starting to think seriously about “stagflation” – the ghastly combination of stagnant growth and inflation last seen in the 1970s.
Google searches for the term “stagflation” have in the last week hit their highest level since July 2008, when the global financial crisis was getting under way.
Now, there are several good reasons to argue that we are not in for a re-run of the 1970s, not least the fact that the world is less dependent on oil than it was then and the fact that the trades unions – in Britain at least – are not as powerful as they were then.
But such searches do point to a change of sentiment among not only investors but the wider public.
British motorists have spent hours stuck in petrol queues
There is every reason to think that inflation may well rise in coming weeks and months.
A clutch of UK companies, including the car and aerospace parts supplier Melrose, the bakery chain Greggs, the furniture and floorcoverings retailer ScS and the online fashion retailer Boohoo have all in the last week highlighted labour shortages, supply chain issues and rising input costs.
And that is likely to feed into higher bills for consumers.
Petrol prices are already at their highest level for eight years.
The increase in the energy price cap this week will result in higher household energy bills for 15 million UK households.
And recent rises in the price of a number of agricultural commodities in recent weeks mean that food price increases are looming.
Further eating away at the ability of consumers to spend will be next year’s increases in national insurance.
In London, meanwhile, nearly 350,000 households and businesses are about to fall foul of Mayor Sadiq Khan’s extension of his ultra low emissions zone, obliging them to either replace their vehicle at vast expense or pay a £12.50 daily fine – again carrying the same effect as inflation.
In short, there are a lot of reasons why consumers and businesses alike have good reason to believe that current levels of inflation are not just transitory, but more deep-seated.
The Bank of England – along with its counterparts around the world – has its work cut out to persuade them otherwise.
If you ever fly to Washington DC, look out of the window as you land at Dulles Airport – and you might snatch a glimpse of the single biggest story in economics right now.
There below you, you will see scattered around the fields and woods of the local area a set of vast warehouses that might to the untrained eye look like supermarkets or distribution centres. But no: these are in fact data centres – the biggest concentration of data centres anywhere in the world.
For this area surrounding Dulles Airport has more of these buildings, housing computer servers that do the calculations to train and run artificial intelligence (AI), than anywhere else. And since AI accounts for the vast majority of economic growth in the US so far this year, that makes this place an enormous deal.
Down at ground level you can see the hallmarks as you drive around what is known as “data centre alley”. There are enormous power lines everywhere – a reminder that running these plants is an incredibly energy-intensive task.
This tiny area alone, Loudoun County, consumes roughly 4.9 gigawatts of power – more than the entire consumption of Denmark. That number has already tripled in the past six years, and is due to be catapulted ever higher in the coming years.
Inside ‘data centre alley’
We know as much because we have gained rare access into the heart of “data centre alley”, into two sites run by Digital Realty, one of the biggest datacentre companies in the world. It runs servers that power nearly all the major AI and cloud services in the world. If you send a request to one of those models or search engines there’s a good chance you’ve unknowingly used their machines yourself.
Inside a site run by Digital Realty
Their Digital Dulles site, under construction right now, is due to consume up to a gigawatt in power all told, with six substations to help provide that power. Indeed, it consumes about the same amount of power as a large nuclear power plant.
Walking through the site, a series of large warehouses, some already equipped with rows and rows of backup generators, there to ensure the silicon chips whirring away inside never lose power, is a striking experience – a reminder of the physical underpinnings of the AI age. For all that this technology feels weightless, it has enormous physical demands. It entails the construction of these massive concrete buildings, each of which needs enormous amounts of power and water to keep the servers cool.
Sky’s Ed Conway at the data centre
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We were given access inside one of the company’s existing server centres – behind multiple security cordons into rooms only accessible with fingerprint identification. And there we saw the infrastructure necessary to keep those AI chips running. We saw an Nvidia DGX H100 running away, in a server rack capable of sucking in more power than a small village. We saw the cooling pipes running in and out of the building, as well as the ones which feed coolant into the GPUs (graphic processing units) themselves.
Such things underline that to the extent that AI has brainpower, it is provided not out of thin air, but via very physical amenities and infrastructure. And the availability of that infrastructure is one of the main limiting factors for this economic boom in the coming years.
According to economist Jason Furman, once you subtract AI and related technologies, the US economy barely grew at all in the first half of this year. So much is riding on this. But there are some who question whether the US is going to be able to construct power plants quickly enough to fuel this boom.
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For years, American power consumption remained more or less flat. That has changed rapidly in the past couple of years. Now, AI companies have made grand promises about future computing power, but that depends on being able to plug those chips into the grid.
Last week the International Monetary Fund’s chief economist, Pierre-Olivier Gourinchas, warned AI could indeed be a financial bubble.
He said: “There are echoes in the current tech investment surge of the dot-com boom of the late 1990s. It was the internet then… it is AI now. We’re seeing surging valuations, booming investment and strong consumption on the back of solid capital gains. The risk is that with stronger investment and consumption, a tighter monetary policy will be needed to contain price pressures. This is what happened in the late 1990s.”
‘The terrifying thing is…’
For those inside the AI world, this also feels like uncharted territory.
Helen Toner, executive director of Georgetown’s Center for Security and Emerging Technology, and formerly on the OpenAI board, said: “The terrifying thing is: no one knows how much further AI is going to go, and no one really knows how much economic growth is going to come out of it.
“The trends have certainly been that the AI systems we are developing get more and more sophisticated over time, and I don’t see signs of that stopping. I think they’ll keep getting more advanced. But the question of how much productivity growth will that create? How will that compare to the absolutely gobsmacking investments that are being made today?”
Whether it’s a new industrial revolution or a bubble – or both – there’s no denying AI is a massive economic story with massive implications.
For energy. For materials. For jobs. We just don’t know how massive yet.
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