an update on the inflationary outlook
May 12, 2023
While the recent banking crisis is still a primary focus of analysts, depositors, the Federal Reserve Board (Fed), and state and federal regulators, the specter of inflation continues to pose potential challenges for corporations, investors, and households. As a follow-up to our September 2022 report, Inflation, the Federal Reserve Board, and the Markets, The Mather Group LLC (TMG) is providing an updated perspective on the factors driving inflation, as well as its potential effect on the economy and the capital markets.
Unlike the situation described in our earlier report, the level and direction of inflation are now trending downward. As shown in the graphic below, after peaking in June 2022 at 8.9%, the Consumer Price Index (CPI) fell to 4.9% in April 2023, almost halving its prior level.
TMG had previously identified several factors responsible for the rise in inflation from 2020 through the first half of 2022. These included supply chain disruptions; COVID stimulus payments supplying unexpected income to most households; worker shortages limiting the provision of goods and services; and commodity prices (such as petroleum) causing gasoline prices to soar. Each of these factors is examined further in this updated report.
Supply Chain Update
Remember in July 2021 when there were 100 container ships anchored off the ports of Los Angeles and Long Beach, California? Together, these two ports receive 40% of all containers entering the U.S. Prior to the pandemic, the average number of ships at anchor was 17. Manufacturers, retailers, and grocery stores all decried the extensive delays they were experiencing in importing raw materials, finished goods, and foodstuffs.
As significant as these delays were in driving supply chain disruptions, they also made the shipping cost of imports soar, as measured by the Freightos Baltic Index (FBX) Global Container Freight Index. This index measures the price of 40-foot containers shipped in the 12 major maritime shipping routes; specifically, it indicates the average shipping price of a 40-foot container for its entire transoceanic delivery.
As shown in the graphic below, the price averaged about $1,400 per container in March 2020 when the pandemic began, then soared to $10,996 by September 2021, a 785% increase. However, when a container ship anchors and is not unloaded, the port and the shipping lines charge other fees, further increasing the total cost of imported goods. In September 2021, toy manufacturers, such as Hasbro, said these extreme shipping costs added 300% to their transit costs.
However, May 2023 index prices have fallen 86% from their 2021 peak to just $1,497. So, one critical factor contributing to higher inflation levels dropped significantly and appears to have stabilized at lower, pre-pandemic prices.
COVID Stimulus Payment Update
The COVID National Emergency ended May 11, 2023. Its Economic Impact Payments program issued 476 million disbursements to households, totaling $814 billion. As shown in the graphic below, the Personal Savings Rate (personal savings as a percentage of disposable personal income) soared to 33.8% in April 2020, just one month after the first stimulus checks arrived. The rate then fell over the following seven months but jumped again to 26.3% after the final checks were issued in March 2021.
Obviously, restrictions on travel, shopping, and hospitality services were quite onerous during the pandemic, so unspent funds often went into savings instead. With the advent of vaccinations and other COVID treatments, mobility and spending patterns began to increase rapidly. This compressed spending cycle caused the price of consumer goods and services to soar, creating a significant factor driving inflation.
However, the savings rate fell to 5.1% in March 2023, dipping below the 8%-9% pre-pandemic average savings rate. With these excess savings depleted, this factor will contribute less to future inflationary pressures.
Worker Shortage Update
The unemployment rate remains below historic levels, but the labor situation is improving monthly. As shown in the graphic below, the onset of the pandemic caused the unemployment rate to soar. One result was that the labor force participation rate (the percent of eligible workers actively at work) fell significantly.
Despite a fall in these unemployment levels, a shortfall of workers continued, often due to pandemic-specific programs that enabled some workers to remain out of the workforce without undue financial hardship. These included significantly enhanced Medicaid and unemployment insurance programs; a suspension of student loan payments; rental payment subsidies and freezes; and a 15% increase in food stamp allotments.
Other forces driving the worker shortage were the closure of schools requiring one or both parents to stay at home with school-age children; a lack of available and affordable childcare options; and workers’ concerns about the risk of workplace COVID. In addition, an estimated 3.0 million workers took early retirement during the first 18 months of the pandemic, according to the St. Louis Federal Reserve Bank.
The situation is reversing today, with unemployment stabilizing and more workers reentering the workforce. Some inflationary forces are still at work as many businesses raised wages to attract needed workers.
However, despite these wage increases—which the Fed feared could fuel higher levels of inflation—wage gains are declining. As shown in the graphic below, while the CPI soared during the pandemic, the increase in the Employment Cost Index (total wages and salaries paid for all private industry workers) never rose at the same rate as the CPI. Instead, it has continued to fall since Q2 2022.
Thus, the rise in the labor force participation rate and the slowing Employment Cost Index suggest that these forces contributing to higher inflation levels is waning.
Commodity Price Update
Raw material and energy costs were often cited as key contributors to rising inflation during the pandemic. While raw materials such as copper are a primary input to manufacturing, higher energy costs affect not only manufacturers but also households and service providers. There were several drivers of these commodity price increases, such as the Eastern European geopolitical crisis, higher shipping costs, reduced commodity extraction levels, and continuing supply chain disruptions.
Energy costs make up about 9% of the CPI, and, as shown in the graphic below, the relationship between West Texas Intermediate (WTI) crude oil prices and the CPI has been quite strong since the onset of COVID. Notably, this linkage appears weaker prior to the pandemic.
However, since its peak of $115 per barrel in June 2022, the price of WTI fell 30% to $80. Understandably, and for other reasons reported above, the CPI fell significantly, too. It is important to note that the price of WTI is not driven simply by supply and demand, but by other forces such as geopolitical risk and credit market conditions. Hence, any continued slide in energy pricing could halt or even reverse in the future. Currently, however, the fall in WTI is contributing to lower inflation levels.
Market Outlook Update
Given the reversal in earlier levels in inflation, how are markets responding to these positive inflationary changes? Let’s turn to the Treasury bond market to evaluate this result. One of the primary indicators of the credit market’s long-term inflationary outlook is the 10-year breakeven inflation rate. This measure simply subtracts the current yield of 10-year Treasury Inflation Protected Securities (TIPS) from the current yield of 10-year Treasury securities. The difference is the credit market’s outlook for inflation during the next 10 years. (However, past performance does not guarantee future results in either the credit or equity markets.)
When this difference is widening, inflationary expectations are rising. When it is level or even narrowing, then inflationary expectations are stable or falling. As shown in the graphic below, despite the significant rise and recent descent of the CPI, the breakeven inflation rate fell from its 2.88% peak in April 2022 to a level of just 2.27% in April 2023.
It never reached 3.0% despite all the recent inflationary pressures. This lower level is quite close to the Fed’s annual inflation target of 2.0%, which suggests that the credit market’s inflationary expectations may not support a need for further Fed interest rate hikes.
Overall, TMG believes the multiple factors that drove inflation levels higher during the pandemic have stabilized or are even diminishing. If these trends continue, then the Fed’s aggressive rate hikes may end soon, and perhaps begin to reverse within several quarters. This may result in the desired “soft” or “no” landing for the economy, avoiding a significant recession instead. TMG will issue its updated recessionary outlook report shortly, focusing on the potential magnitude and timing of any economic downturn.
TMG continues to employ its risk management tools in response to inflationary trends, and clients who continue to adhere to their financial plan maintain the strongest pathway through this inflationary period. Your trusted advisor at TMG is ready to respond to any questions or concerns you might have, and to help ensure that your financial plan remains both timely and actionable. Please reach out to your advisor for guidance at any time.
Sources: Bloomberg; Bureau of Economic Analysis; Bureau of Labor Statistics; City of Long Beach Harbor Administration; City of Los Angeles Harbor Administration; Energy Information Administration; Federal Reserve Bank of St. Louis; Federal Reserve Board; Freightos; Hasbro, Inc; Goldman Sachs; Morgan Stanley; Reuters; Statista; The White House; US Treasury; Wall Street Journal
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An index is a portfolio of specific securities, the performance of which is often used as a benchmark in judging the relative performance of certain asset classes. Indexes are unmanaged portfolios and investors cannot invest directly in an index, as an investment vehicle replicating an index would be required. An index does not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown. Please feel free to contact us for additional information on any indices mentioned.
Indexes
- Consumer Price Index (CPI): A measure calculated monthly by the Bureau of Labor Statistics that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care. It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them. Changes in the CPI are used to assess price changes associated with the cost of living.
