High U.S. inflation may finally be near its peak as global growth slows and oil and other commodity prices plummet. The focus is now shifting to the speed and distance of its retreat.
Welcome to the second round of the duel narrative battle over the cost of living.
“We’re going to see inflation come down,” said Jeffrey Rosenberg, senior portfolio manager for systematic multi-strategy. blackstone Inc. “But to what level?”
In the first round last year, Team Transitory, effectively captained by Fed Chairman Jerome Powell, was defeated as inflation soared and proved more stubborn than expected. Now, it’s betting that price pressures will drop significantly without doing too much damage to the economy or a strong labor market.
On the other hand, some analysts who warned about the price climb last year warned that Powell & Co. may once again be too optimistic. Inflation could prove sticky, they warned, and a contraction in the economy and massive job losses could be needed to bring it down significantly.
“We can’t get out of this hyperinflation without a recession,” said Lawrence Summers, a former Treasury secretary and paid Bloomberg TV contributor who last year was an outspoken critic of Fed inflation call. “We should expect unemployment to be 6% or above in a few years.”
By contrast, Fed policymakers in June expected the unemployment rate to rise to 4.1% in 2024 — slightly above what they see as the maximum employment level — as inflation decelerates to near its 2% target. The latest jobs report on Friday showed the unemployment rate slipped to 3.5% last month, the lowest level since 1969, as payrolls increased by 528,000.
The consumer price index report for July, due on Wednesday, is likely to contain factors to support both teams. The median forecast in a Bloomberg survey showed the CPI likely to rise 8.7% from a year earlier, down from a four-year high of 9.1% in June, thanks in large part to a slump in gasoline prices. But after excluding food and energy costs, annual inflation is expected to rise to 6.1% from 5.9%.
One big uncertainty in the inflation outlook: energy prices, still subject to geopolitical vagaries, from the Ukraine war to a combustible Middle East.
“It would be absurd to think that we won’t get a shock that will have an impact on energy markets and uncertainty,” said Randall Kroszner, a former Fed governor and a professor at the University of Chicago.
Here are some of the forces driving and pulling inflation in the coming months:
Commodity prices fall
In part in response to falling global demand, prices for everything from oil to copper to wheat have plummeted. It also helps ease cost pressures: slowly unraveling chaotic supply chains.
Excluding food and energy costs, the PCE price index will rise by less than 2% year-on-year in mid-2023, from 4.8% currently. UBS AG Chief U.S. Economist Jonathan Pingle. The PCE metric is the inflation measure used by the Fed in its forecasts, and it targets 2% inflation over time.
“We expect a fair amount of deflation in commodities,” Pingle said.
Skyrocketing rents have played a major role in soaring consumer price inflation in 2022, and are likely to continue for some time.
But the super-fast rise is peaking, which should show up in next year’s CPI.
High demand for work-from-home living arrangements is easing as Covid-19 concerns subside. Soaring inflation itself is prompting renters to stick with the deal, choose more affordable neighborhoods and bring in roommates to save money, according to real estate rental platform Zumper.
“As consumers continue to tighten their wallets, the stratospheric price increases we’ve seen through much of the pandemic are likely to moderate,” said Zumper CEO Anthemos Georgiades.
This may be the biggest reason why inflation may be more entrenched than optimists expect. Labor costs are by far the biggest expense for many businesses, especially in the service sector.
With the job market still tight — 1.8 vacancies for every unemployed person — companies are forced to pay fees to get the talent they need. To maintain profits, businesses need to pass on the increased labor costs to consumers at higher prices.
Former White House chief economist Jason Furman wrote in an Aug. 2 article for Project Syndicate that inflation “drives wages, which in turn drives prices.” The Harvard professor estimated underlying inflation to be at least 4 percent, and believes it is more likely to rise rather than fall from there.
Price pressure widens
While the inflation surge was initially limited to a few areas such as used and new cars, it is now spreading across the economy, including areas such as health care where prices don’t typically change frequently.
Vincent Reinhart, chief economist at Dreyfus and Mellon and a former Fed official, said that once such so-called sticky prices accelerate, they tend to keep rising at that pace.
Reinhart sees the economy slipping into recession by the end of the year, with unemployment rising to around 6 percent, but ultimately putting inflation, the Fed’s favorite price gauge, above 3 percent.
Anna Huang, chief U.S. economist at Bloomberg Economics, agrees that despite a mild recession in the U.S., inflation will not fall below 3 percent next year.
In the battle over the inflation narrative, there is one big difference between the first and second rounds.
Powell and his colleagues no longer expect inflation to fall on its own. They are fighting it aggressively, raising interest rates to slow the economy and bring price gains back to their 2 percent target.
Cleveland Fed President Loretta Mester at the Aug. 2 webinar.
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