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Weekly Update 8/12/2022: Inflation Moderates in July

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Domestic Economic News

US inflation decelerated in July by more than expected, reflecting lower energy prices, which may take some pressure off the Federal Reserve to continue aggressively hiking interest rates. The consumer price index increased 8.5% from a year earlier, cooling from the 9.1% June advance that was the largest in four decades, Labor Department data showed Wednesday. Prices were unchanged from the prior month versus the expectation for a 0.2% increase. A decline in gasoline offset increases in food and shelter costs. So-called core CPI, which strips out the more volatile food and energy components, rose 0.3% from June and 5.9% from a year ago. The core and overall measures came in below forecast. The data may give the Fed some breathing room, and the cooling in gas prices, as well as used cars, offers respite to consumers. But annual inflation remains high at more than 8% and food costs continue to rise. While a drop in gasoline prices is good news for Americans, their cost of living is still painfully high, forcing many to load up on credit cards and drain savings. After data last week showed still-robust labor demand and firmer wage growth, a further deceleration in inflation could take some of the urgency off the Fed to extend outsize interest-rate hikes. Treasury yields slid across the curve while the S&P 500 was higher and the U.S. dollar plunged. Traders now see a 50-basis-point rate increase next month as more likely, rather than 75. The Fed will have another round of monthly CPI and jobs reports before their next policy meeting on Sept. 20-21. Gasoline prices fell 7.7% in July, the most since April 2020, after rising 11.2% a month earlier. Utility prices fell 3.6% from June, the most since May 2009. Food costs, however, climbed 10.9% from a year ago, the most since 1979. Used car prices decreased.

A key measure of US producer prices unexpectedly fell in July for the first time in more than two years, largely reflecting a drop in energy costs and representing a welcome moderation in inflationary pressures. The producer price index for final demand decreased 0.5% from a month earlier and rose 9.8% from a year ago, Labor Department data showed Thursday. The pullback was due to a decline in the costs of goods, though services prices only edged up. Excluding the volatile food and energy components, the so-called core PPI rose 0.2% from June and 7.6% from a year earlier. Both the overall and core figures were softer than forecast. The figures suggest some pipeline inflationary pressures are beginning to ease, which could ultimately temper the pace of consumer price growth in coming months. Commodity prices, including oil, have dropped sharply in recent months, and there are indications that supply-chain conditions are improving. Treasury yields remained lower while S&P 500 futures extended gains and the dollar weakened. Consumer-price data out Wednesday also showed a welcome moderation in inflation in July, largely reflecting a pullback in prices at the pump. Even so, inflation remains stubbornly high and will likely keep the Federal Reserve on an aggressive path to curb it.

Some 80% of the decline in goods prices was due to a 16.7% plunge in gasoline prices, the report showed. Diesel, iron and steel scrap and grains also decreased. Services prices rose just 0.1% in July, led by an increase in fuel margins and transportation and warehousing. Still it was the smallest advance in three months as prices for portfolio management, food and alcohol retailing and long-distance trucking declined. Thursday’s report adds to separate data from S&P Global and regional Fed banks that showed a pullback in prices paid for inputs like materials in July. Risks remain, however. While supply chains have started normalizing, the war in Ukraine, labor negotiations at West Coast ports and China’s zero-Covid policy represent potential logistics speed bumps for US producers. Producer prices excluding food, energy, and trade services -- which strips out the most volatile components of the index -- increased 0.2% from June and 5.8% from a year earlier. Costs of processed goods for intermediate demand, which reflect prices earlier in the production pipeline, slumped 2.3% -- the most since April 2020. More than half of the drop was attributable to a plunge in diesel costs. Excluding foods and energy, these costs dropped 0.2%. Overall the moderation in rising prices was welcome news and supportive of both stocks and bonds in Wednesday and Thursday trading.

In other good news this week, drillers have restored US crude production to the highest level since April 2020, when the pandemic began crippling the oil industry. Output reached 12.2 million barrels a day last week, breaking out of a two-week holding pattern, according to the Energy Information Administration. While the increase of 100,000 barrels a day seems modest, it comes during a period of extreme global supply tightness. The Organization of Petroleum Exporting Countries earlier this month committed to increasing its own output by the same amount in September to combat energy shortages following Russia’s invasion of Ukraine. The US is expected to add more oil supply to reach a record next year even as explorers battle soaring inflation and labor shortages across shale patches.

On a negative note, US productivity slumped for a second-straight quarter as the economy shrank, driving another surge in labor costs that risks keeping inflation elevated and further complicates the Federal Reserve’s efforts to tame price increases. Productivity, or nonfarm business employee output per hour, decreased at a 4.6% annual rate in the second quarter after falling at a 7.4% pace in the previous three months, Labor Department figures showed Tuesday. That marked the weakest back-to-back readings in data back to 1947. On a year-over-year basis, output per hour fell by the most on record. With the drop in productivity, unit labor costs jumped at a 10.8% rate in the second quarter from the prior three months. The increase from a year earlier was the biggest since 1982. Labor costs are the biggest expense for many businesses, so firms often adopt new technologies and upgrade equipment to make their workers more productive, helping blunt the inflationary impact of higher wages. However, labor costs are outstripping the central bank’s inflation goal by nearly five times on an annual basis, suggesting sustained upward pressure on consumer prices and ultimately making the Fed’s inflation fight more difficult. The unemployment rate has fallen back to its pre-pandemic level of 3.5% -- matching a five-decade low -- and job openings outnumber the unemployed by nearly two to one. The competition for workers has fueled a jump in wages across industries, especially among lower-income workers. While hourly compensation advanced in the quarter, it fell 4.4% on an inflation-adjusted basis. Applications for US unemployment insurance rose for a second week and held near the highest level since November, indicating continued moderation in the labor market. Initial unemployment claims increased by 14,000 to 262,000 in the week ended Aug. 6, Labor Department data showed Thursday. The median estimate in a Bloomberg survey of economists called for 265,000 applications. Continuing claims for state benefits ticked up to 1.43 million in the week ended July 30. Jobless claims have been rising as more companies, particularly in the tech sector, announce layoffs and freeze hiring due to economic uncertainty. Demand for workers may drop as the Federal Reserve raises interest rates, but so far, employers are largely trying to hold onto the ones they have amid widespread labor shortages. That was reinforced by July’s jobs report, which showed US employers added more than double the number of jobs forecast and the unemployment rate dropped to match a 50-year low. And as mentioned a below-forecast rise in consumer prices on Wednesday and the PPI report on Thursday may take some of the pressure off the Fed to go as big with its next interest-rate hike.

On a positive note, US consumer sentiment rose in early August to a three-month high on firmer expectations about the economy and personal finances. Inflation expectations were mixed, with consumers boosting their longer-term views for prices slightly, while reducing their year-ahead outlook for costs. The University of Michigan’s preliminary sentiment index rose to 55.1 from 51.5 in July, data showed Friday. Consumers expect prices will climb at an annual rate of 3% over the next five to 10 years, from 2.9% in July. They see costs rising 5% over the next year, the lowest since February, compared to last month’s 5.2%. The sentiment gauge exceeded all but one forecast in a Bloomberg survey of economists who had a median projection of 52.5. The gain in sentiment was driven solely by a pickup in the outlook. The university’s measure of expectations increased to a three-month high of 54.9 from 47.3 in July. Meanwhile, the gauge of current conditions fell to 55.5 from 58.1. “In spite of this strength in the labor market and some signs of improvement in inflation, consumer sentiment remains very low by historical standards,” Joanne Hsu, director of the survey, said in a statement. “In the current context, even strong labor markets have been raised as negative news for business conditions, as consumers recognize the challenges businesses may face with hiring.” The university’s index of consumers’ economic outlook over the coming year improved to a four-month high, while their expectations for personal finances were the firmest in three months.

Interest Rate Insight and the Fed

Economists are divided on whether slower US consumer-price growth for July means the Federal Reserve could ease its aggressive rate-hiking program, making 75 basis-point moves less definite. Markets are now pricing in the likelihood of a 50 basis-point increase in September rather than 75 basis points, and less than 100 basis points of hikes over the next two meetings. Whether it’s 50 or 75 in September is probably going to go down to the wire. The central bank’s policy-setting Federal Open Market Committee raised its benchmark rate by three quarters of a percentage point in July for the second straight month, marking the most aggressive back-to-back increases in more than a generation to tame inflation back to its goal of 2%. Both headline and core CPI inflation were surprisingly soft in July, but with recent wage and productivity data signaling price pressures ahead, the Federal Reserve is unlikely to step back from the inflation fight just yet. Another soft print is likely in August as gasoline prices have continued to decline. Market perception of an imminent dovish Fed pivot has eased financial conditions, complicating the central bank’s task to tamp down inflation and raising the risk it will have to reset market expectations. Fed Chair Jerome Powell told reporters after the July 27 decision that officials could increase rates by the same amount at the next meeting -- depending on readings from the economy between now and then -- though they would slow at some point in the future. The dollar plummeted as traders took a cooler-than-expected reading of US inflation as a sign that the Federal Reserve could ease its aggressive rate-hiking program. The Bloomberg Dollar Spot Index fell as much as 1.2% on Wednesday, its biggest decline since the shock of Covid hit markets in March 2020. The weakness comes after US inflation decelerated in July by more than expected, reflecting lower energy prices. The lower relative value of the U.S. dollar actually is helpful for earnings because many of our core stocks earn significant revenues overseas that are translated back into U.S. dollars when companies report.

Impactful International News

China will likely report a further recovery in its economy in July although the strength and longevity of that rebound is far from certain as Covid outbreaks continue to spread and a property slump shows no sign of easing. Official data on Monday will probably show a raft of key indicators -- including industrial output and retail sales -- improved last month as business and consumer activity gradually picked up from the worst of the Covid lockdowns in the second quarter. The government will publish the data at 10am local time on Monday. The economic picture might be mixed, though, as property investment probably slowed, and the unemployment rate likely remained elevated. Independent high-frequency data have also painted a more negative picture of the economy’s outlook, with truck flows -- a proxy for economic output – significantly lower in July than at the same time last year and home sales last month plunging from a year earlier. With policy makers signaling a “wait-and-see” attitude toward more stimulus and inflation creeping up, the data for July will offer important clues on the policy direction for the rest of the year. We highlight this because China is the second largest economy in the world next to ours and many U.S. companies do business there.


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