2024 inflationary outlook:relief at last?
February 15, 2024
Annual inflation, as measured by the Consumer Price Index (CPI), reached a 41-year peak of 9.1% in June 2022. It subsequently declined to 3.1% by January 2024, with most economists and investment professionals expecting it to continue this downward trend.
In this report, The Mather Group LLC (TMG) will review significant causes of this recent inflationary spike; key factors contributing to its welcomed decline; and offer an outlook for the balance of 2024.
The target inflation level, as stated by the Federal Reserve Board (Fed), is 2.0% when using its preferred measure, the Personal Consumption Expenditures Index (PCE). This Index fell as well to 2.6% in December from its 7.1% peak in June 2022. As shown in the graphic below, the PCE, while calculated slightly differently than the CPI, closely follows this CPI trend.
It is important to note that the Fed’s inflation targeting policies have profound influences on the financial health of households, businesses and governments. Interest rates for credit cards, mortgages, business loans and government debt all rise in step when the Fed heightens interest rates to subdue inflationary trends. With the Fed having raised its Federal Funds Rate 11 times since 2022, a continuing fear is that, if sustained, these rate increases could result in a slowing economy or even a recession.
Peak Inflation Factors:
Analysts often ascribe four primary factors contributing to so-called “Peak Inflation.” A primary one was the $4.7 trillion of Covid-19 stimulus payments made to households, businesses and local/state governments. As shown in the graphic below, the Fed estimates that households accumulated excess savings (based upon historic savings rates) of $2.1 trillion by August 2021. By September 2023, households had spent $1.7 trillion of this amount both on goods, e.g., exercise bikes and streaming subscriptions. With $400 billion of excess savings remaining as of September 2023, its inflationary effect should be receding each month.
Source: Federal Reserve Bank of Boston
This unexpected level of savings and expenditures led to a second inflationary shock. When global supply chains were affected by Covid lockdowns and absent or laid-off workers, they were unable to fulfill many household and business demands. So, as demand exceeded supply, the cost of goods and services grew at a significant rate. Until recently, global supply chains became more balanced, and US workers continued to be hired at significant levels. These changes are offsetting these prior inflationary pressures.
A third inflationary factor was the price of commodities, which comprise 38% of the CPI. As shown in the graphic below, by early 2022 commodity prices were rising at a 14% annualized rate. More specifically, in the 3-month period after the 2022 Ukrainian crisis, the global price of wheat rose 28%. With Russia and Ukraine providing 25% of the global wheat supply, such rapid price increases are not difficult to understand.
Source: Bureau of Labor Statistics
While wheat prices have subsequently fallen by 48%, the prices of staples such as breakfast cereals have remained “sticky” and have not fallen as much to reflect these price decreases. Or, if prices did fall, one result has often been subtle packaging size reductions, so called “shrinkflation.”
A fourth inflationary factor was the level of inflationary expectations, or how households and businesses expected the trend of current inflation levels to continue. While many qualitative surveys exist to measure this outlook, the gold standard of such measurements is the 5- and 10-year Treasury Breakeven Inflation Rate (BIF).
This is calculated by subtracting the current yield on Treasury Inflation-Protected Securities (TIPS) from the current yield on similar maturity Treasury securities. So, if the current yield for 5-year Treasury bonds is 4.0% and the current yield for 5-year TIPS is 1.8%, then the market expects annual inflation to average 2.2% annually during the next 5 years.
As shown in the graphic below, the 5-year BIF peaked at 3.55% in March 2022, but it fell to a level of 2.22% by February 2024. This level is still slightly above the Fed’s target inflation rate of 2.0%, but it continues its downward trend. Of course, when considering equity market or inflation levels, past performance is not a guarantee of future results.
2024 Inflation Outlook:
While each of the four factors analyzed above continues to exhibit lower inflationary trends, it is not entirely certain that the Fed will achieve its 2.0% inflation goal and begin reducing its current interest rate levels in 2024. While TMG is cautiously optimistic that Peak Inflation has passed and rates should decline, it believes it is prudent to identify several factors which could affect this outcome.
With household spending representing 68% of US Gross Domestic Product (GDP) in Q4 2023, any change in these spending levels could impact our economy. Recently, lower income households have used their credit cards to confront the rising prices of staples such as food, dairy and paper products.
One result, as shown in the graphic below, has been a rising delinquency rate for credit card monthly payments as excess savings are diminished. At 3.0%, the delinquency rate now surpasses pre-Covid levels. Credit card issuers have raised their rates to reflect these delinquencies, offering an average rate of 20.7% in December 2023, or a rate 4.4% higher than at the start of 2022. If consumers reduce their spending when considering these rate increases, it could help to further reduce existing inflationary pressures.
Despite recent labor agreements with union auto workers, package delivery companies and film actors and writers, the overall path for hourly wage growth has been downward since reaching its annualized 6.7% peak in June 2022. As shown in the graphic below, it fell to 5.0% in January 2024, and is expected to continue declining during 2024. This metric is watched closely by the Fed, so further declines could support the Fed in reducing current interest rates later in 2024.
Just as geopolitical events in Eastern Europe drove the price of wheat upward by 28%, recent geopolitical events in the Middle East are contributing to a significant rise in the cost of and delays in seaborne supply chains. Ocean shipping represents 80% of international trade by volume, with the Suez Canal hosting 30% of all container ship traffic. However, because of risks and far higher insurance costs for transiting the Suez Canal currently, its traffic level has fallen by 64%.
Shipping companies have recently shifted their existing routes to avoid the Suez Canal and go around Cape of Good Hope at the tip of Africa instead. This route, according to Reuters, adds an additional 10 days and 4,900 miles to the seaborne journey, for an overall cost increase of 43%.
These cost increases are being immediately passed along to customers and will result in higher prices for imported goods for both households and businesses. According to Fed research, this rerouting around Africa could result in an additional 2.9% increase in import price inflation levels. If these shipping do not diminish soon, then this geopolitical event could offset current inflationary declines and delay Fed interest rate cuts.
Overall, TMG remains cautiously optimistic that Peak Inflation has passed and that the Fed will begin to reduce rates in 2024. TMG continues employing its risk management tools in consideration of these prospective Fed actions and inflationary outcomes.
Clients who adhere to their financial plan maintain the strongest pathway through this volatile 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; Drewry Shipping Consultants Limited; Federal Reserve Bank of Atlanta; Federal Reserve Bank of Boston; Federal Reserve Bank of St. Louis; Federal Reserve Bank of San Francisco; Federal Reserve Board of Governors; Goldman Sachs; International Monetary Fund; Morgan Stanley; Reuters; US Treasury; Wall Street Journal
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