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Tuesday, 28 June 2022
Today’s newsletter is from Emily McCormick, a reporter for Yahoo Finance. Follow her on Twitter.
The Federal Reserve is working hard to curb inflation by raising interest rates at the fastest pace in nearly 30 years.
Recently, some analysts have begun to explore the idea that inflation could moderate in the coming months.
But this decline is unlikely to be due to the efforts of the Powell Fed.
It “more and more appears that markets are mistaken” [the] ‘bullwhip’ effect of the supply chain (including food) on secular inflation,” Tom Lee, head of research at Fundstrat, wrote in a note Sunday.
The “bullwhip effect” roughly describes the tendency for companies to over- or underestimate the amount of inventory they need relative to consumer demand, resulting in volatility in orders throughout the supply chain.
In the case of the past year, retailers overestimated, generally over-ordering from wholesalers, who in turn over-ordered from their suppliers, leading in the aggregate to a major mismatch between actual consumer demand and inventory, At hand. The excessive inventory levels at Walmart (WMT), Target (TGT), Gaps (GPS), and other retailers over the past earnings season were recent examples of how this effect played out in real time.
“I don’t believe that companies want a higher inventory permanently. It’s expensive…and carries a huge balance sheet risk,” Lee said. “So companies will want to reduce their inventories as the offer’s visibility improves. The logical implication for me is that prices will come down.”
This may sound suspiciously like the Fed’s debunked argument from last year that inflation would be “transient.” And the data, even earlier this year, disappointed economists looking for a peak, with the May CPI print of 8.6% unexpectedly disappearing what many had expected this year’s rise would be in March.
Story continues
However, prices for metals, commodities, and energy in the supply chain have fallen sharply after recent spikes. West Texas Intermediate crude futures (CL=F) are on track to record their first monthly decline since November, and cotton futures (CT=F) are down from a more than 10-year high in May.
And this decline may come just in time.
As Jim Reid, Deutsche Bank’s chief credit strategy and thematic researcher, illustrates below; the Fed began raising interest rates with inflation significantly higher than its previous walking cycle.
In the past 70 years, the first rate hike occurred on the median when the consumer price index (CPI) reached 2.5%. In contrast, the first rate hike this year came in March, when the CPI rose at an annual clip of 8.5%.
The only rate-raising cycle that resembles the current environment began in August 1980, when the Fed started raising rates with inflation north of 12%.
Chart via Deutsche Bank
“Where this cycle is so different… is that the first rise happened very late in the inflation cycle,” Reid said. “My base case remains that the Fed will find it very difficult to ease policy, especially given that it will become more difficult to drive out inflation.”
And while a new rise in inflation is on the horizon in June, that doesn’t rule out a slowdown in inflation later this year.
“June will undoubtedly see another big jump in the headline index, thanks to the rise in gas prices in recent weeks, but the abrupt decline in wholesale prices…means retail gas prices will fall quite sharply in the coming weeks, Ian Shepherdson, chief economist at Pantheon Macroeconomics, wrote in a note.
“At the same time, pressures on cores are starting to ease, mainly thanks to slower margin wage growth, so we would be surprised if core CPI continues to climb at the recent pace of 0.6% per month.”
Shepherdson said he expects the CPI to rise 1.0% in June but average only 0.3% in the coming months. And this could then give the Fed room to slow the pace of tightening towards the end of this year, he argued, even as it refuses to back down from its aggressive rhetoric for now.
“Policymakers are well aware that the path of inflation, especially core rates, has been largely ingrained for the remainder of this year and will be insensitive to their rate decisions. Monetary policy works with long delays,” Shepherdson said.
“But the Fed has a different constituency than monetary economists; they need to calm the inflation fears of the public, the markets, and politicians. That means they have no choice but to sound as loud as possible because part of their job is to curb inflation expectations.”
Adding: “If inflation falls faster than their base – and the market’s – forecast, all the better.”
What to watch today
Economic calendar
8:30 a.m. ET: Advance Goods Trade Balance, May (-$105.4 billion expected, -$105.9 billion in the prior month, revised to -$106.7 billion)
8:30 a.m. ET: Wholesale stocks, month-over-month, for now, May (2.1% expected, 2.2% over the previous month)
8:30 a.m. ET: Retail inventory, month-over-month, May (1.6% expected, 0.7% over the prior month)
9:00 a.m. ET: FHFA Housing Pricing Index, April (1.6% expected, 1.5% over last month)
9:00 a.m. ET: S&P CoreLogic Case-Shiller 20-City Composite, Month-over-Month, April (1.85% expected, 2.42% over month)
9:00 a.m. ET: S&P CoreLogic Case-Shiller 20-City Composite, Year-over-Year, April (21.20% expected, 21.17% over prior month)
9:00 a.m. ET: S&P CoreLogic Case-Shiller US National House Price Index, Year-over-Year, April (20.55% over the last month)
10:00 a.m. ET: Conference Board Consumer Confidence, June (100 expected, 106.4 in the previous month)
10:00 a.m. ET: Richmond Fed Manufacturing Index, June (-5 desired, -9 last month)
Income
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