Is Inflation Finally Easing?
The Labor Department once again showed a rising yearly inflation rate with the release of the consumer price index for March 2022. U.S. inflation rose to 8.5% from March 2021 to March 2022, representing the country’s highest 12-month inflation since 1981. The CPI for March 2022 alone was 1.2%, the highest monthly inflation observed in the U.S. since September 2005. The increased inflation rate has led to much public dismay about the current state of the economy and the performance of the Biden Whitehouse.
The same reason for the drastic monthly inflation in September 2005 can also explain the excessive increase in March 2022 -- chiefly due to a surge in gasoline prices. Rising gasoline prices aren’t usually a sign of progress, but in this case, they may represent a north star of inflation slowly receding throughout the American economy. Yes, the U.S. had its worst monthly inflation in nearly 20 years, but that was primarily due to a drastic increase in energy costs due to the outbreak of the war in Ukraine. Energy prices jumped 11%, while gasoline prices increased 18.3%, which offset other disinflationary markers for the CPI.
The Good News
Many of the culprits responsible for the high inflation for the past year are finally cooling off. Used cars and trucks received a lot of attention for drastic price increases after the reopening of the economy. 12-month inflation peaked at a 45.3% increase in June 2021 and decreased to 35.3% in March 2022. At -3.8%, the month of March represented the most considerable monthly deflation in the used car sector throughout the pandemic, including the period when many were locked down and not buying transportation.
The 12-month percent change receives the majority of media attention, and in the case of used vehicles, we should expect the year-over-year change to start rapidly declining. Even if used cars suddenly began increasing in price again, the measure will begin losing some of the highest inflated months like April and May 2021, when inflation in the sector was nearing double digits. Essentially, we should see base effects begin to lower in year-over-year inflation.
We see similar results observed in many durable goods. The pandemic resulted in a mass restriction of spending on services, leading to increased spending on products. The CPI of durables to services has been rapidly declining for decades in the U.S., only to be reverted during the pandemic. Just now, we may see the beginning of another reversal in this trend as the prices of goods level and price of services increase.
The core CPI, or the CPI less food and energy, appears to be finally slowing down. The 1-month inflation rate was the lowest in March 22 since September of last year. Base effects are keeping the 12-month change elevated for now. However, April, May, and June 2021 are the next three months on the chopping block for the 12-month change, and each month also represents the highest annual inflation rate in core CPI in two decades. In other words, expect each month forward to show lower 12-month inflation in Core CPI as the base effects of high inflation in April-June 21 come off the books.
The Bad News
While core CPI is finally relenting, headline CPI is still at monthly levels unobserved since 2005. A 1.2% increase in inflation in March gets you pretty close to the Fed target of 2% for an entire year. Extrapolated out for 12 months would result in the highest annual inflation in the U.S. since the 1940s, surpassing the dreaded 1970s stagflation crisis.
Supply chains may finally be untangling, and disposable income may be dissipating. We are witnessing a significant correction in prices in a wide range of goods from automobiles, GPUs, and microchips that surged in costs during the pandemic. Unfortunately, we do not see any decline in the two measures excluded from core CPI – food and energy.
CPI for food was 1% in March 2022, matching the previous month and the highest since April 2020. Food inflation seems to be increasing with no signs of slowing. Regarding base effects, it will be difficult for the 12-month CPI for food to decrease due to the relatively low inflation observed in food in the months that are soon to exit the measure. For food to negatively impact the 12-month CPI report, it would have to show as lower than .4% -- possible, but not a figure we have seen in over a year.
The war in Ukraine may already have an effect on commodity prices, and many experts expect the trend to continue. In March, global food prices increased to a new record, with costs soaring 13%. Ukraine was responsible for the sixth-highest exports of wheat in 2021. Due to the war, the U.N. expects 20-30% of crops to remain unharvested in the 2022 growing season. The impact of a global wheat shortage is far more problematic for E.U. and Asia than for the U.S., but we live in a global economy. Black Sea wheat is generally much cheaper than ours, which pushes the international cost of the commodity up. By all means, I would expect the annual CPI for food to increase further in the next few months.
That gets us to energy, which has quickly become the single most significant driver of headline inflation. The increases in energy prices in 2021 can largely be attributed to the reopening of the economy – energy crashed hard during the COVID pandemic in 2020, and prices returned to some normalcy. Unfortunately, prices never really stabilized and only continued to ascend pre-pandemic levels. Consumer demand returned without the same amount of supply due to supply chain crises and “capital discipline” on behalf of energy corporations unwilling to invest in growth due to fear of energy prices plummeting.
It is impossible to separate the ongoing effects of constrained energy supply via capital discipline and the invasion of Ukraine. February 2022 exhibited significant energy price increases but less so than many months of 2021. March 2022 had the highest single-month inflation in the sector in over a decade. Either way, the U.S. is combating the supply shock by releasing barrels from its strategic petroleum reserve and encouraging companies to invest further in growing supply. Biden has even called on Congress to make oil companies pay fees on wells from unused leases.
As a result of those changes, which are also happening on various levels in many countries around the world such as Europe, many forecasters believe energy costs to begin declining in the next few months. Already, we have seen Brent crude oil drop from a high of $118/barrel to under $100 on April 26. The U.S. Energy Information Association predicted the price to decline to $90 by the end of 2022. The somewhat rapid decline in oil prices over the past two weeks can largely be attributed to an oil demand shock in China due to surging coronavirus cases. Expect a lot of variation in this sector throughout the year, but the U.S. may have already seen its peak monthly energy inflation.
Final Thoughts
Inflation is one of the most enormous problems facing the U.S. economy and, subsequently, the incumbent Democrats’ chances at re-election in the 2022 midterms and beyond. It does seem like core CPI minus energy, and food is finally stabilizing, and I would predict May’s CPI release to show the first decline in 12-month % change in over a year – chiefly due to base effects. Base effects do not favor the 12-month % change for energy or food declining, and for that reason, we can also predict that 12-month inflation will again rise next month in those sectors. We will also likely see some immediate decline in monthly inflation in energy and, thus, subsequently, food.