The inflation print yesterday was another massive shock.
But what if I told you that DEFLATION should be one of the main concerns right now? It sounds crazy, but stick with me.
Let’s talk about the Bullwhip Effect:
The Bullwhip Effect is a supply-chain term: a small change in consumer demand can lead to increasingly big changes as it trickles through the supply chain stack.
The term comes from the analogy to a whip: a tiny movement of your hand can lead to a big crack of the whip!
Let’s go through an example:
Xavier is a retailer who sells croissants. Btw, I hate how Americans pronounce it - it’s “kruh·saants“ for god’s sake.
Let’s say Xavier usually sells 100 kruh·saants per day.
But one day, he sells 125 of them:
Justin had finally pronounced kruh·saants right and decided to celebrate by going crazy and massively over-ordering.
Xavier mistakes this spike in demand for consistent business growth (looking at you all my “we got PMF” startup friends):
So Xavier requests ingredients for 150 kruh·saants from his distributor Will, who makes the same mistake:
Will anticipates other retailers will increase their orders, so he called his manufacturer Angela and expands his order.
Guess what Angela does next?
Yepp you guessed right: Angela increases her manufacturing run because she now expects more product requests in the future… and the effect trickles through to suppliers.
Here’s an amazing diagram for the toilet paper example (sktechplanations):
At each stage, the forecast for demand has been distorted. There’s a few reasons for such inefficiencies, including:
1. It’s hard to forecast demand
2. We overestimate good news: everyone would like to believe they’re growing more than they are
3. Broken telephone effect
One other important factor: timing.
Retailers can react fast to consumer demand. However, the signal takes time to get to manufacturers and suppliers: they’re operating with a lag.
The more removed you are from the signal (customer demand) the more amplified the effect is.
What happens when the demand for croissants returns to normal? Inventory surplus:
Start: 1 person figuring out how to say kruh·saants.
End: massive croissants overload in the economy.
What does this mean for us today?
The craziness of Q4 2021 + Q1 2022 strongly signaled “huge consumer demand” to all industries:
it's like 1 million Justins showed up to the croissant store and overflooded the shit out of it.
This has trickled down into big raises in supply and inventory all across the board.
As consumer sentiment is heavily shifting, the demand for everything is going to drop drastically.
But it’s already too late: everyone’s already stocked up on inventory to prepare for tons of demand.
Ok, lets go back to the basics:
High supply
Low demand
I’ll let you guess:
Prices go down.
And depending on how much overloading we’ve done on the supply side: prices might go down pretty hard.
So hard, that we might go into deflation…
… we’re about to get whipped.
Many believe that the Fed is well behind the curve… again.
They are still raising rates thinking that demand is still overheating, while they should be preparing for a heavy reversal in the inflation curve.
Our markets are currently forecasting a 50% chance of 4 rate hikes in July (up from <10% earlier this week).
This would be like Angela stacking up on puff pastry right now, even though everyone's been telling her that kruh·saants are not trendy anymore.
https://kalshi.com/events/FED-22JUL
It's hard to know what will happen with inflation, but it's important we keep a close eye on it.
We just released an inflation forecast dashboard to track inflation predictions over the course of the year. https://kalshi.com/forecasts/cpi
