Will Inflation Ever End?
Today’s CPI inflation print of +8.6% spooked investors across the market.
However, the year-over-year growth rate of the U.S. CPI may experience a minor fall back at the end of 2022. This is because it is unlikely that the gap between supply and demand will be eliminated any time soon.
Demand Side
Consumption and demand for goods and services is projected to constantly increase in the following months. Goods consumption comprised 36% of total consumption after the pandemic, rising from 30% prior to its onset; no evidence suggests that this number would decrease.
Recently, many big retailers, including Target and Walmart, announced that their profit is expected to drop due to high inventory levels of outdoor furniture, electronics. Nowadays, customers’ buying behavior has shifted from electronics and outdoor furniture to services and necessities such as food and fuel. Such buying patterns indicate that demand for necessities has become the largest part of general consumption. Prices of necessities are hence unlikely to decrease in the short run while the price of hotels, airline tickets, car rental services and other services are likely to increase.
Supply Side
Labor shortage is still a remarkable problem, likely to exert pressure on supply chains.
According to data from March, the labor force participation rate for those aged 24-25 in the US is close to the levels before the pandemic. But the levels of those whose age is 55 and older remains significantly lower than before. A study conducted by the US Bureau of Labor Statistics shows that only 15% of retired citizens would go back to work. Considering the sustained prevalence of Covid-19, this number is likely to be even lower than 15%.
Energy and food prices have a large impact on residents’ inflation expectations. Both energy and food are necessities and account for a high proportion of residents’ consumption. Crude oil and food price increases played a crucial role in starting the “Great Stagflation” in the 1970s. We can look at the 1973 food crisis and oil embargo, for example, widely considered to be one of the main causes of inflation and economic recession in 1974.
Since 2022, both international oil and food prices have seen large increases due to the Russia-Ukraine incident. Because of sanctions by some EU countries, Russian crude oil and oil product exports would reduce by 1-2 million barrels per day, bringing a risk premium of $20-30 per barrel.
On the grain side, Russia and Ukraine together account for 29% of global wheat exports. Sanctions on Russia grain exports would put upward pressure on prices. In addition, Russian gas exports will be restricted, driving gas prices up. Natural gas plays a central role in fertilizer production, and higher gas prices will also affect food prices in the medium term.
One bright spot is lumber. where prices seem to be dropping.
The impact of money becomes limited. The Fed has already raised interest rates for the first time in March. However, according to the Fed’s economic forecast table, the federal interest rate may rise to about 2% by the end of 2022, and core PCE inflation may fall back to about 4%; thus the actual federal interest rate is only about -2%.
Historically, demand requires at least a positive interest rate to have a contractionary effect on narrowing. Even in 1994, when the Federal Reserve guided the economy to a soft landing, real interest rates rose from 0% to 3%. In addition, the impact of rising interest rates has a delay on curbing inflation, so it is likely that inflation will last until the end of this year.
