Record Lead-Times For Materials Signal Firms Are Expecting Persistent Inflation

In May, the Institute of Supply Management (ISM) reported that lead time for production materials jumped to 85 days, up from 79 in April. The May reading is an entire work-day month (21 days) above the level from one year ago and the highest reading since 1979, or when ISM has been using the current methodology to track lead times.

Leadtimes are a valuable indicator of current and future demand. When backlogs rise and get stretched out, firms protect their production schedules by building safety stocks and placing long-dated orders for materials and supplies to meet expected future demand.

The current generation of policymakers probably does not follow lead times, but the old generation did. (Read the 1994 transcripts of the Federal Open Market Committee meetings). Former Federal Reserve Chairman Alan Greenspan religiously tracked lead times, order backlogs, and delayed deliveries (i.e., vendor performance or nowadays called supplier delivery index) as signs of future inflation and inventory building. The latter is an essential part of demand-driven fast growth and inflation cycles since it adds a layer of demand, putting more pressure on prices.

In May, a record low 28% reading for the customer inventories index and a relatively high price index reading of 88% accompanied the record high reading for lead times. The old generation of policymakers would see these data points as evidence of a more general emergence of inflation pressures.

It would be prudent for the current generation of policymakers to scrap their "transitory" price playbook and take out the policy playbook of 1994.

In 1994, with a set of lead time, suppliers index, and price paid data that is not as scary as today, the old generation of policymakers saw the need for substantial monetary restraint to break the inflation cycle and limit the cyclical rise in general inflation. When the monetary tightening cycle was over 12 months later, the old generation raised the nominal and real federal funds rate 300 basis points. Years later, Mr. Greenspan praised his team's decisions as it successfully cut short the inflation cycle.

The current generation is not even thinking about lifting official rates, and even if they decided to so tomorrow, there is a gradual progression of effects on the economy. So if policymakers decided to raise the official rates to pre-pandemic levels of 1.5% over several quarters, the full impact would not be felt for a year or more. Even that would not impose much monetary restraint as it would still leave real interest rates negative.

As such, the current generation of policymakers is running with a policy approach--doing nothing--- that has never even been used to break an inflation cycle. In the past, delays in enacting monetary restraint triggered bad outcomes, so the odds of a successful outcome from a doing nothing policy approach seem very low, probably as low as the federal funds rate (0.06%).