Inflation is seemingly past its peak across most major economies, but of course it is still extremely high and well above target levels. A return to target is not likely until 2024, with average inflation rates looking high. However, this disguises the improvement that will come through during the course of the year, which should gradually ease the upward pressure on interest rates. It is therefore not surprising that UK Prime Minister Rishi Sunak made a pledge to halve inflation this year, as the tide is with him.
In our analysis of inflation, we have continually focused on the battle between demand pull and cost push pressures, and these now seem to be heading in the right direction. We are continually monitoring key inflation inputs as it is integral to our macro analysis, particularly in the US, and this provides some room for hope (most of the comments that follow relate to the US but apply equally to other major economies).
- Money supply growth (M2) has eased in the US, with the YOY rate flat (the lowest since March 1995) and likely to turn negative fairly soon.
- The New York Fed global supply chain price index has eased markedly. Given slowing activity, supply chain pressures are expected to ease even further, as highlighted by corporate sentiment indices.
- Commodity prices have been heading lower across the board. Oil, natural gas, industrial metals, and agriculture are all well off their peak levels. Climate patterns have recently helped Europe at precisely the right time, with the Dutch TTF gas price at 1-year lows. The US, of course, gets the full benefit of the declines, given the strength of the dollar. But other countries also benefit, though to a lesser extent.
- Freighter and container pressures have also eased considerably and are heading back towards pre-COVID levels. Lower demand will help in the coming months. As an example, the Baltic Global Container Index has fallen from a peak of $11,100 to $2100.
- Survey-based inflation pressures are also easing. The ISM Prices Paid Index fell for a ninth successive month to 39.4 in December, from over 80 in April, and is at the lowest point since early 2020.
- Inflation expectations, which are closely watched by the FOMC, have continued to edge lower.
However, there are areas of concern that may well make central banks wary. Focusing on the US is always instructive given the amount of data that is available, although similar trends can be seen across most major economies.
- The US labour market remains tight. Job openings (JOLT) still remain high, as illustrated by the ratio of job openings per unemployed, which was unchanged at 1.7 in December and remains well above the series average of 0.6.
- Non-farm payroll growth is holding up, although the 3-month average eased to 272k in November, down from over 600k at the start of the year, and the unemployment rate remains at historically low levels.
- Wage growth remains higher than pre-pandemic levels. The service sector is of particular concern, given labour shortages across many industries, such as hospitality and retail.
The Fed has increasingly highlighted the labour market, but waiting for a turnaround in the labour market is fraught with danger as it is a classic lagging indicator, and once it moves, it can remain weak for a prolonged period. The FOMC is still projecting a higher unemployment rate over the next year, with some private sector projections for a rise to 4.7%. The added danger of a lagging indicator is that it seeps through into consumer demand and acts as a further restraint on growth.
To find more about the latest house views from London & Capital’s Investment Desk, read the full AndPapers Q1 2023 here.
