Fastest in 40 years! Stagflation! A 1970s redux! Inflation has dominated headlines all year, majorly contributing to 2022’s unusual, sentiment-driven bear market. The fear is understandable. Fast-rising prices pressure people’s budgets and cause disruption. Rightly or wrongly, inflation stokes FED hikes fears and weighs on economic expectations. Theories abound on its causes, ranging from COVID lockdown-related disruptions, big government spending, vast money supply increases, war, tight labor markets and more. But, no matter which theories you champion, signs are emerging inflation may have crested. If so, that would be a major relief—a fillip for stocks’ recovery. Here I offer you a comprehensive look. Then draw your own conclusions where prices are heading.
Before continuing, two things: One, set politics aside. Inflation is politicized, but my aim is solely market-oriented. Two, to be clear, this year’s inflation has lasted longer than I anticipated. That makes it increasingly likely some of my views are wrong. It is a multifaceted issue in a world desperately seeking simple answers. Regardless, signs of easing price pressures are evident on many fronts.
Take energy, a chief inflation driver earlier: Now cooling energy prices are showing in US inflation data. They underpinned the July US Consumer Price Index’s slowing to 8.5% y/y from June’s 9.1%. How? Oil is down -34.1% from March 8’s high. The national average regular gasoline price is off -45.7% since early June. It likely doesn’t show in CPI data yet, but US natural gas prices are down -20% from August 22’s year-to-date high.
Food? Putin’s vile invasion of Ukraine drove up wheat and grain prices, fueling broad fears of worse to come—even famine. But wheat peaked May 17, tumbling -34.3% since. Corn prices, plagued by droughts, are still down -14.2% since mid-May’s highs. Meat eater? Beef and hogs are down -8.7% and -15.5% since highs on March 31 and August 10, respectively. On the dairy products side, eggs and milk are down -35.9% and -19.5% since their respective 2022 highs. To sum it all up globally: The UN’s Index of World Food Prices has fallen in five straight months, currently sitting -13.6% below March’s high.
Housing is another area many blame for inflation. Here shifts are more nascent, but the Case-Shiller National Home Price Index’s gains slowed from April’s 20.6% y/y to 18.0% in June. Looking ahead, the National Association of Home Builders’ August survey showed builders are starting to cut new home prices. Fannie Mae’s August survey shows would-be buyers and renters expect to pay less soon.
For businesses, the Institute for Supply Management’s manufacturing and services purchasing managers indexes both show easing price pressures. In August, 52.5% of respondents reported rising prices—down -7.5 points from July and -34.6 from March’s 2022 high. On services prices, which have followed goods at a lag tied to recurrent lockdowns and restrictions, 71.5% of respondents reported increased pressures—high, but down -13.1 points from April. Transport costs are off, too: The Baltic Dry Index, a gauge of maritime freight rates, is down -66% from this May’s high. Shanghai Freight rates are down -44% since January. This index, when down, is often feared by many as a recession warning. Maybe. But maybe part of it is all of the above, also.
Fret big deficit spending fueling fast price rises? Consider: Little noted, year-to-date through July, the cumulative US federal budget deficit was down -82.3% versus 2021’s first seven months. Key to this is an also little noted -24.1% reduction in year-to-date spending, as one-time COVID bursts fade. Other legislation, like the infrastructure plan and the recently passed climate bill, doles funds out over many, many years—too slow impact prices now, for better or worse.
Those thinking money supply stoked higher prices should also find solace in data. M2, a measure of currency in circulation, deposit accounts and money funds, peaked at 27.5% y/y the week of February 22, 2021. It was just 4.8% in early August, the latest figure available. The Center for Financial Stability’s broader M4 gauge hit 2.3% y/y in July, down from June 2020’s astronomical 30.7%.
Pessimists claim the tight labor market still augers higher wages sending prices spiraling. They missed the fact Nobel laureate Milton Friedman proved 60 years ago wages follow prices—they don’t lead them. Regardless, hiring slowed in the last six months while August’s labor force spike suggests more slack remains than many think.
All this is happening regardless of Fed actions. Monetary decisions always hit the economy at a long lag, through their influence on lending. Besides, the Fed’s fiddling with the interest rates affecting banks’ overnight borrowing costs won’t do much when banks are flush with cash and don’t need to borrow. It historically used reserve requirements to restrain credit in such scenarios. But they ditched those in 2020—complicating their “inflation fight” now. As long time readers know, I’ve always been a FED skeptic and consider it likely about the last observer to fathom what is actually happening. Of course, that’s just my bias.
Then too, inflation’s peak will only be crystal clear to all in hindsight. Maybe some spike ahead i can’t see means it hasn’t come yet. But many of these figures I’ve cited are forward indicators yet to show in stores—and inflation data. So no matter your inflation narrative, if you think these data suggest inflation is peaking, you had better position for a rally now. Fear and loathing of fast-rising prices played a big role in dragging sentiment—and stocks—down. Ebbing inflation would be a major relief for both stocks and bonds, rocket fuel for the nearby rally.
