INSIGHT: Inflation to be stronger for longer, even as commodities prices fall

NEW YORK (ICIS)—’Stronger for longer’ was the mantra for the commodity supercycle of the 2000s and more recently in 2021 for polyethylene (PE) margins. Instead, this now applies to inflation, even with commodities in a clear downtrend.

This will cause the US Federal Reserve to keep the foot on the rate hike pedal, potentially leading to even lower commodities – including chemicals – prices as the economy slows further and demand dissipates.

The US Consumer Price Index (CPI) for June came in hot, dashing hopes of a long-awaited peak in inflation. The headline June CPI showed a 1.3% gain from May and was up 9.1% year on year – the highest since 1981.

Excluding the more volatile food and energy components, core CPI rose 0.7% month on month and was up 5.9% from a year ago.

Source: US Bureau of Labor Statistics

Increases were broad-based and led by higher prices for shelter, used vehicles, health care, apparel, household furnishings and operations, car insurance and new vehicles, ICIS senior economist for global chemicals, Kevin Swift, pointed out.

“Some of the price categories are seeing persistent and now protracted gains, and that gains were widespread across these categories suggest that inflation will be high and above the Fed target for some time – many quarters and even years,” said Swift.

“Given still-tight labour markets, wage inflation is occurring and will remain persistent,” he added.

The economist sees the US Federal Reserve hiking interest rates by another 75 basis point (0.75 percentage point) in July, with a subsequent 75 basis point increase likely in September as well.

The persistently higher inflation readings have the market continuing to search for that elusive peak.

“We may see another CPI surprise to the upside when the July data are released next month but given oil prices are off and gasoline prices are following, pressure in this area may ease,” said Swift, who also noted alternative price data for certain categories such as used cars have turned down.

The economist sees a potential peak in year-on-year inflation in July or some time in Q3.

“This is not just a US issue, but is widespread in Canada, the UK, Europe and many emerging countries,” said Swift.

Kathy Bostjancic, chief US economist at Oxford Economics, sees US inflation remaining “sticky” through September, only easing towards the end of the year to around 7% for the US CPI, she said on a webinar on the US Economic Outlook on 12 July, a day before the CPI release.

“That’s going to keep the Fed really aggressive – on a 75 basis point hiking mode. We think there’s another 75 basis points to come in September,” she said.

It won’t be until the year-on-year CPI gains ease to around 7% that the Fed could start to scale back rate hikes. That could happen in Q4 and go into 2023, the Oxford economist added.

The strong US dollar, which reflects the country’s economic strength versus the rest of the world, should help keep a lid on goods prices as well as weigh on corporate earnings, with Q2 earnings season now under way.

“Watch the corporate earnings… You’re going to see a lot more corporations talking about the downward pressure on earnings from the stronger dollar,” said Bostjancic.

RISING SERVICES COMPONENT TO OFFSET GOODS DECLINE
What will keep inflation high in the next several months is a rising services component, even as goods inflation eases.

“Core goods inflation is still running very high… but has decelerated. Where you’re seeing some offset is in the core services – that’s travel, airfare, car rentals, dining out and also housing rental costs, which comprise 40% of core services prices,” said Bostjancic.

“And for now, housing rental prices are actually going to keep rising. What we have found is that home prices lead rental costs from 12-18 months. Even if home prices are starting to cool now, you’re going to see the lag impact put upward pressure on rental prices,” she added.

The Fed’s Beige Book survey of current economic conditions across districts released on 13 July showed indications of easing goods inflation, although still at elevated levels, along with continuing increases in services prices.

“Substantial price increases were reported across all districts, at all stages of consumption, though three quarters noted moderation in prices for construction inputs such as lumber and steel. Increases in food, commodities and energy (particularly fuel) costs remained significant, though there were several reports that price inflation for these categories had slowed compared with recent months but remained historically elevated,” the Beige Book report said.

“While several districts noted concerns about cooling future demand, on balance, pricing power was steady, and in some sectors, such as travel and hospitality, firms were successful in passing through sizable price increases to customers with little to no pushback. Most contacts expect pricing pressures to persist at least through the end of the year,” according to the report.

SHARP INFLATION FALL IN H2 2023
Looking ahead, inflation should gradually cool in Q4 2022 and into 2023, where it could fall off markedly as the Fed rate hikes take their toll.

“We actually see the possibility of inflation going below the 2% target rate, and that’s because we’re going to see further easing supply chain pressures, a cooling of aggregate demand, and there’s probably going to be increased investment. So ironically, we could be looking at an undershoot of inflation in 2023,” said Oxford Economics’ Bostjancic.

Even if headline inflation numbers moderate in 2023, keep in mind this would be compared to significantly elevated 2022 levels.

For the next 12-18 months, the Oxford economist sees a 35% chance of recession – a significant level but not her baseline view. Oxford Economics forecasts US GDP growth of 1.9% in 2022 and just 1.1% in 2023.

ICIS senior economist Swift expects year-on-year CPI inflation to moderate to 3.0% by Q3 2023, still above the Fed’s 2% target. He sees a 48% chance of a US recession in the next 12-18 months.

By Joseph Chang

Thumbnail shows dollars. Image by Shutterstock.