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Weekly Update 4/14/2022: Inflation May Be Peaking as Earnings Season Begins

Domestic Economic News

Inflation has been running at elevated levels and the data this week confirmed that. At the same time, the current pace of month-over-month increases and high annual numbers is unlikely to continue for an extended period and there are some signs that certain components of the various measurements are beginning to stabilize and even decline as supply chain issues begin to ease. U.S. consumer prices rose in March by the most since late 1981, evidence of a painfully high cost of living and reinforcing pressure on the Federal Reserve to raise interest rates even more aggressively. The consumer price index increased 8.5% from a year earlier following a 7.9% annual gain in February, Labor Department data showed Tuesday. The widely followed inflation gauge rose 1.2% from a month earlier, the biggest gain since 2005. Gasoline costs drove half of the monthly increase, and food was also a large contributor. Economists in a Bloomberg survey called for the overall CPI to increase 8.4% from a year ago and 1.2% from February. The March CPI reading represents what many economists expect to be the peak of the current inflationary period, capturing the impact of soaring food and energy prices after Russia’s invasion of Ukraine. While the Fed has opened the door for a half-percentage point increase in interest rates, inflation isn’t likely to recede to the central bank’s 2% goal anytime soon – especially given the war, Covid-19 lockdowns in China and greater demand for services like travel. At the same time, risks that inflation will tip the economy into recession are building. A growing chorus of economists predict that activity will contract either because consumer spending declines in response to higher prices, or the Fed will over-correct in its effort to catch up. However, the majority still expects the economy to grow. Excluding volatile food and energy components, so-called core prices increased 0.3% from a month earlier and 6.5% from a year ago, both less than projected and due in large part to the biggest drop in used vehicle prices since 1969. The figures are a welcome respite from the sustained heated core increases of late, and fuel costs look to ease in response to the recent pullback in oil prices. However, food, rent, and a few other items look to remain troublesome and act to slow the expected retreat in inflation in the year ahead. Treasuries rose after the data showed core inflation rose less than forecast in March, while the dollar erased an early advance to weaken in early Tuesday trading. Underneath the monster headline print in the March CPI (8.5% year on year) are signs that core goods demand has softened -- showing that the Fed’s thesis about transitory inflation may have legs after all, though not for the right reasons. Russia’s invasion of Ukraine not only has caused a surge in commodity prices but indirectly has cooled demand generally via a more hawkish Fed and worsening consumer sentiment. Slower core-goods inflation is partly offset by higher services inflation, underscoring the challenge the Fed faces in taming price pressures even if supply and demand in the goods sector were to balance. The Fed needs to hike rates expeditiously, but if goods demand continues to cool they may not need to hike as aggressively as the market -- now pricing in almost three 50-bps rate hikes this year -- currently expects.

Prices paid to U.S. producers jumped in March from a year ago by the most in records back to 2010, topping all estimates and underscoring persistent early-stage inflationary pressures that risk feeding through to consumers. The producer price index for final demand increased 11.2% from March of last year and 1.4% from the prior month, Labor Department data showed Wednesday. The monthly gain was broad across categories and also the largest on record. Excluding the volatile food and energy components, the so-called core PPI increased 1% from a month earlier and was up 9.2% from a year ago. That stands in contrast to the latest consumer price report which showed a softening in the pace of core inflation as noted above. The PPI and CPI reports reinforce pressure on the Federal Reserve to raise interest rates more aggressively. Central bankers have opened the door to a half-percentage point increase in interest rates in May. The median forecasts in a Bloomberg survey of economists called for a 10.6% year-over-year increase and a 1.1% monthly advance. February figures were also revised higher.

The data show an intensification of pipeline pressures during the first full month of Russia’s war in Ukraine that pushed up energy, food and metals prices. In addition, transportation bottlenecks and labor shortages are complicating matters for manufacturers and other producers trying to balance supply with steady demand. The PPI data showed prices for transportation and warehousing services spiked a record 5.5% in March. The increase was driven by higher truck transportation of freight costs and airfares. The risk is that the increase in input costs for producers will be passed on, at least partially, to consumers as firms try to protect margins. The war in Ukraine, which started in late February, led to a spike in energy prices on fears that cutting off Russian oil and gas would limit supply. Crude oil prices have since retreated on concerns pandemic-related lockdowns in China will limit demand. Prices of goods climbed 2.3% in March for a second month. More than half of the increase was due to a 5.7% jump in energy prices. The cost of services, meanwhile, advanced 0.9% after a 0.3% rise in February. More than 40% of the gain in services costs reflected higher margins in trade that includes wholesalers and retailers. Producer prices excluding food, energy, and trade services -- which strips out the most volatile components of the index -- rose 0.9% from February, the biggest gain since the start of 2021. The measure rose 7% from a year ago. Costs of processed goods for intermediate demand, which reflect prices earlier in the production pipeline, increased 2.1% from a month earlier. More than 60% of the broad advance was due to energy, particularly jet fuel. Compared with a year earlier, the measure was up 21.7%.

U.S. retail sales picked up in March, helped by a surge in gas station receipts that masked mixed results in other large spending categories as consumers contend with decades-high inflation. The value of overall retail purchases climbed 0.5%, Commerce Department figures showed Thursday. While that was just shy of expectations, the prior month was revised up sharply to show a 0.8% increase. The March advance was led by a 8.9% jump in spending for gasoline. Excluding receipts at gas stations, sales fell 0.3% last month as vehicle and e-commerce purchases -- the two-largest spending categories -- declined. The figures aren’t adjusted for inflation. In some discretionary categories, such as apparel and restaurant spending, the rise in nominal sales outstripped inflation and suggested that the easing in pandemic-related restrictions is helping consumer spending, while in other components it was clear that inflation played a large role in boosting spending. After the largest monthly percentage increase in average gasoline prices in six years, and along with rising food and shelter costs, Americans have tougher spending choices to make beyond essentials.

Still, household balance sheets remain healthy by several measures, with the unemployment rate near the lowest in five decades at 3.6% and elevated savings throughout the pandemic. Separate data Thursday showed initial jobless claims rose slightly last week but remained at a historically low level. Applications for benefits increased by 18,000 to 185,000 in the week ended April 9, a low level that suggests imminent recession fears are exaggerated. The less volatile four week moving average remains very low at 172,000 and lower than the average reading of 218,000 from 2019, which was of course pre-pandemic. Although employment remains below its pre-pandemic level, the low level of jobless claims is a stark reminder that demand for labor continues to substantially exceed supply. Ten of the 13 retail categories showed growth last month. Outside of gas stations, sales at general merchandise stores, electronics and appliances merchants and clothing outlets also rose. Non-store retailers, the second-largest sales category and volatile from month to month, fell 6.4%. Receipts at grocery stores increased 1.3%, which may have reflected a pickup in food prices. Restaurant sales, the report’s only services component, increased 1% after a 3% gain. Some eateries are removing more expensive menu items and promoting deals in response to consumers feeling the squeeze of inflation. Still, dining out will be one of the first luxuries to go for price-conscious consumers, as well as impulse purchases, driving and other experiences, according to a nationally representative survey conducted by the Harris Poll for Bloomberg News. The poll found about 84% of Americans plan to cut back on spending as a result of higher prices. So-called control group sales -- which economists use to calculate gross domestic product and exclude food services, auto dealers, building materials stores and gasoline stations – fell 0.1% in March from a month earlier.

Interest Rate Insight and the Fed

After rising in Monday trading in anticipation of elevated CPI and PPI numbers as reported above, bond traders felt some welcome relief as money began to flow back into the fixed income market provided some relief and retrenchment in interest rates across the yield curve in Tuesday and Wednesday trading. As we have written before, a lot of the news is already baked into fixed income prices and the view that we may be experiencing peak levels of inflation right now seems to be gaining traction. At this point it would be a challenge for the Fed to surprise markets at their upcoming meetings because bond traders have priced in an aggressive Fed rate hiking cycle. We maintain a level of optimism that their tough talk and early action will have an impact on inflation and we should see some relief on both the inflation front and their rate hikes in the second half of the year.

Impactful International News

China’s lockdowns to contain the country’s worst Covid outbreak since early 2020 have battered the economy, stalling production in major cities like Shanghai, and halting spending by millions of people shut in their homes. The restrictions are intended to eradicate any trace of the virus in the community, but they’ve also pressured everything from manufacturing and trade to inflation and food prices. Premier Li Keqiang has repeatedly warned of risks to economic growth, telling local authorities on Monday they should “add a sense of urgency” when implementing existing policies. The government is holding firm to its Covid Zero approach for now, a strategy economists say will push growth down to 5% this year, below the official target of around 5.5%. Here’s a deeper look at how the lockdowns are impacting critical sectors across the world’s second-largest economy.

Commodities Hit

China posted sluggish commodities imports in March, as elevated prices due to the war in Ukraine and tightening virus restrictions took their toll on demand. Natural gas purchases were worst affected, dropping below 8 million tons to their lowest level since October 2020. Crude and coal purchases were also running well behind last year’s schedule. Chinese demand for jet fuel is projected to drop by 25,000 barrels per day from a year earlier, a 3.5% fall, according to the International Energy Agency. The IEA previously expected 10,000 barrels per day of growth. The number of daily flights in China, as averaged over seven days, has fallen below the lowest level seen in 2020, with less than 2,700 active flights on Tuesday, according to Airportia, a real-time flight tracker. China’s domestic metals fabricators are facing hurdles to transport raw materials and finished products, which have led to output cuts. Six out of twelve copper-rod plants in Shanghai’s neighboring provinces surveyed by Shanghai Metals Market earlier said they either have halted or plan to halt output. The researcher also predicted a rise in aluminum inventories. Meanwhile, Chinese buyers have slashed liquefied natural gas purchases in the world’s biggest LNG importer as prices soar and domestic demand stalls. Imports in the first quarter fell 14% from the same period last year, according to shipping data, and private companies are spurning offers to use once-highly coveted slots at state-owned receiving terminals.

Port Congestion

Shanghai’s city-wide lockdown has created congestion at the world’s largest port, with queues of vessels building there and at other stops handling diverted shipments. The number of container ships waiting off Shanghai as of April 11 was 15% higher than a month earlier, according to Bloomberg shipping data. A shortage of port workers in Shanghai is slowing the delivery of documentation needed for ships to unload cargoes, according to ship owners and traders. Meanwhile, vessels carrying metals like copper and iron ore are left stranded offshore as trucks are unable to send goods from the port to processing mills, they said. Data on Wednesday also showed the lockdowns having a notable impact on imports, which fell 0.1% on year in March, the first contraction since August 2020.

Most Asian stocks rose Thursday after China again indicated looser monetary policy is on the way and bond traders dialed back aggressive bets on Federal Reserve interest- rate hikes. An Asia-Pacific equity gauge climbed a second day as Japan and China pushed higher. U.S. and European equity futures were steady following a tech-sector rally on Wednesday that helped Wall Street snap a three-day drop. China is expected to cut a key policy interest rate for the second time this year on Friday and reduce the reserve requirement ratio soon -- the nation’s cabinet has strongly signaled the latter as Covid lockdowns sap the economy. That would be welcome news for the global economy!

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