Inflation is peaking, but curb your enthusiasm. Just because it probably won’t get worse doesn’t mean it will noticeably improve anytime soon.
It is poetic justice that this is happening just as Federal Reserve officials are belatedly acknowledging the inflation problem, which was largely their fault.
The four-decade high of a 7.9% year-over-year rise in the consumer price index in February could be surpassed by single or double digits in the coming months, but it is probably near the top. Ditto for the personal consumption deflator, the Federal Reserve’s favored measure of inflation, which rose 5.4% in February from a year earlier.
Signs that inflation may be peaking have been reported by Evercore ISI, including the fact that gasoline futures prices have started to reverse. Additionally, freight rates for shipping and trucking have also started to pull back from their highs, suggesting that a link in the supply chain is beginning to loosen.
Commodity prices have moved off their highs, further highlights Evercore ISI’s weekly note to clients. This supports the observation in this column a month ago that it was time for energy bulls to take some profit. Coincidentally, this column was released just as U.S. crude oil prices momentarily hit $130 a barrel, well above the $101.96 settlement on Tuesday, a drop that qualifies for the conventional definition of a bear market of a 20% decline.
As Evercore ISI reports, “Inflation is likely peaking now, but it is unlikely to slow to near the Fed’s target.” Those targets, as contained in the Federal Open Market Committee’s summary of economic projections released at last month’s meeting, call for the PCE deflator to slow to 4.3% by the end of this year and to 2 .7% in 2023. Inflation was expected to enter this nice soar with the economy continuing its trend growth rate (2.8% this year, 2.2% next year) with low unemployment and stable and interest rates that remain low and well below inflation.
More recently, Fed officials seem to be moving away from this wishful thinking. On Tuesday, Lael Brainard, who is awaiting confirmation as Fed Vice Chairman and has been one of the central bank’s most dovish policymakers, said in a speech: “It is of paramount importance to lower inflation”. To do so, she said the central bank would continue to raise interest rates and shrink its balance sheet, which drains liquidity from the financial system. To underscore the last point, Brainard said this contraction would progress faster than the previous episode in 2017-19.
The irony is that Fed officials are taking inflation more seriously as its most visible manifestations, in energy prices and supply chain issues, wane. But pricing pressures in the larger and more problematic services sector show no signs of easing and could worsen.
According to an analysis by economists at Bank of America, inflation can be divided into three slices: prices that have exceeded their long-term trends, those that have been undervalued and those that have remained on trend.
The overruns were mainly in durable goods which were “turbocharged” by demand fueled by the fiscal stimulus, while supplies were stalled by supply chain issues, which as noted may ease. These items accounted for two percentage points of the 5.4% rise in core PCE over the past 12 months. Undershooters are a decreasing number of prices, mostly prescription drugs depressed by regulatory measures.
Meanwhile, 72% of consumer staples fall into “near-trend” prices that are now accelerating, according to B of A. These are mostly services, meaning they are unlikely to be imported and tend to be labor intensive. These accounted for 3.4 percentage points of the 5.4% rise in the core PCE and could continue to be strong and offset the disinflationary impact of slowing commodity prices.
Images of gas stations and grocery stores, as well as videos of container ships anchored off West Coast ports, make up much of the “B-roll” of television coverage of inflation. Now that these prices may be falling, the less visible costs of services, including rents, will likely continue to rise.
So while inflation readings may not get much worse, don’t expect them to improve anytime soon.
Write to Randall W. Forsyth at [email protected]