When will the Federal Reserve stop raising rates? To end the rate hike, inflation must subside. But when will inflation decline? As it seems, the Fed is just crossing the stream by feeling the stones. Otherwise, Fed’s rate hikes wouldn’t lag so much behind inflation.
As to whether inflation will continue to rise, we have no crystal ball. But in analyzing the data, we can look for some clues.
In 2012, the Fed announced that it would use the Personal Consumption Expenditures (PCE) Price Index as an indicator for inflation, rather than the Consumer Price Index (CPI). In the past thirty years, the two indexes have generally reflected a similar trend. Except inflationary pressures reflected by the PCE are slightly lower than that by the CPI, while the CPI provided more figures. In the following, we will use PCE and CPI interchangeably.
CPI analyzes three aspects. The first is the price elasticity of demand (mostly commodities, so it’s often referred to as commodity price). The second is shelter (rent), and the third is sticky prices (primarily services, so it’s often referred to as service fees).
As it appears, commodity prices have already reached a peak and are declining, but rent and service fees continue to climb. With 2/3 of the indexes for CPI continuing to increase, the odds of a decline in CPI are low. When might it peak? We’ll need to analyze shifts in three factors.
Let’s start with commodity prices. This includes food, energy, and other consumer goods.
Food is the largest item in commodity prices. Looking at data from the last thirty years, CPI for food usually lags behind the Food and Agriculture Organization (FAO) of the UN’s Food Price Index by about 9 to 12 months. The YoY increase of the FAO Food Price Index fell from 40% in April to 28% in October, so we can infer that there is a chance that the increase in food prices will start to slow down by the end of this year or the start of next year.
The second component of commodity prices is energy, in which oil price is a dominant factor. Although crude oil prices have fallen by around 30% from the intra-year high in June, it’s too early to say that oil prices have peaked. On the supply side, the space for the US to tame oil prices by reducing the Strategic Petroleum Reserve (SPR) is decreasing. Also, oil production is expected to reduce due to the decline in capital expenditures of oil companies in the past few years. On the demand side, it’s getting increasingly clear that China may exit from its stringent COVID-Zero controls. The consequent Chinese economic recovery will boost global crude oil demand, which will also support oil prices.
The last component of commodity prices is other consumer goods. During the COVID-19 pandemic, many people lowered their service expenditures and increased their commodity purchases. At the same time, global supply chains were affected and shipping was delayed, causing supply to not meet demand and prices to increase.
According to the latest shipping data, supply chains have gradually returned to normal. Freight prices have dropped by 70% from their peak. Based on these trends, we expect that freight prices may return to the pre-pandemic level by the end of this year.
The above analysis suggests that except oil prices, the other 2 components of the commodity prices have retreated or are likely to retreat from their peaks soon. If the subsiding food prices and other consumer goods prices can offset the potential oil price hike, it’s possible to see a shaper fall in commodity price by the end of this year or at the start of next year.
The second aspect of CPI is rent. According to a research report from last year by the Federal Reserve Bank of Dallas, Zillow’s House Price Index (ZHP) has been 10 to 30 months ahead of the PCE Price Index when it comes to rent, with a correlation coefficient as high as 0.75. Growth for the ZHP slowed greatly from September of last year, but the peak was not seen until this April. This suggests that rising pressures on rent may stabilize in the first quarter of next year, but a more noticeable slowdown of rent growth may only occur by the end of next year.
The last aspect of CPI is service fees, which is the real headache of the central bank.
Fluctuations in service fees are much lower than that of commodity goods, but the stickiness is higher, reflecting that the trend has a strong tendency and it’s very difficult to alter the current direction.
The US service fees rose to a forty-year high of 6.4% in September and there’s no slowing tendency in sight. There are currently more than 10 million job vacancies in the US, while the unemployed population is only fewer than 6 million. This means supply does not meet demand in the labor market, and so the wage pressure is difficult to alleviate in the short term.
In conclusion, commodity prices have already started to decline and there is a chance that this will pick up pace in the near future. The rise in rent will possibly stabilize in the first quarter of next year, and the increase in rent may slow down in the second half of next year. As for service fees, the rising trend has no end in sight. As such, it is possible that inflation may only peak as early as next year’s first quarter, but if we wish to see a slowdown of inflation, this will have to be in the latter half of next year.
This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.
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