Signs Inflation Has Peaked
Lumber, cotton, gas prices, and mortgage rates all edge downward
Welcome to all readers of The Sunday Morning Post, new and old alike. Thank you for being here. I hope everyone has a nice Fourth of July. Since most people are hopefully out doing something fun in the sun, I have just a quick piece today highlighting a few examples in the economy of prices actually falling, which could bode well for inflation overall in the weeks and months ahead.
There is an old axiom about how the people who were responsible for an error should not be in charge of finding the solution, and I think that is particularly true today when you consider the Federal Reserve. For much of 2020 and 2021, Fed officials brushed off concerns about inflation, referring to it as “transitory” and assuming it would settle out as COVID-related supply chain issues were resolved. This was clearly wrong, however, as many (though not all) of the supply chain issues have actually improved, yet inflation continues to run at its strongest rate in 40+ years.
Now the Fed is aggressively raising interest rates in order to hammer inflation back under control. On the one hand, the reasoning makes sense. The momentum of inflation can build upon itself as companies and consumers start to transact things around assumptions that prices are going to continue to rise, which often pushes prices upward even further. Wage inflation, while certainly good for the worker especially low and moderate income workers, also has a way of perpetuating itself and then rippling through the economy in the form of higher prices for all types of consumer goods, although this is tempered by the fact that, in general, although wages are rising, they are not rising as much as inflation. According to one recent poll, 66% of American workers say their wages are not keeping up with inflation.
But what if inflation were to resolve itself on its own, either with modest interest rate hikes to help keep things in check or just by the natural correcting forces in the economy. Sometimes the solution to higher prices is that eventually consumers pull back, demand eases, and prices retreat; in other words, the solution for higher prices is higher prices. There is a risk that at the very moment inflation might be getting under control, the Fed might ratchet interest rates up aggressively even further, which could tip the U.S. economy into an unnecessary recession.
Consider this: some of the horsemen of inflation are already showing signs of easing up. Consider this:
Lumber was priced at over $1,450 per 10,000 board feet in early March; today it is $657, a drop of over 50%.
Cotton futures were trading at over $143 per pound two weeks ago but have plummeted to $109 today:
Gas prices peaked at $5.016/gallon nationwide on June 14th according to AAA. Today the average price has edged down to $4.882, which is still pretty high, but at least for the consumer’s sake the price is modestly moving in the right direction.
Mortgage rates, after peaking over 6.00% earlier this month, have actually eased back down to the mid-5.00% range.
In my opinion, these price drops represent a peaking of inflation. Future Consumer Price Index readings should show a deceleration in inflation. This should give pause to the Federal Reserve about how aggressively they must continue raising rates in order to stave off higher inflation.
What Needs to Happen Next/What to Watch For
The next CPI release date is on July 13th. It will be an important one to watch. If the reading does not show signs of inflation easing up, the Federal Reserve will almost surely raise interest rates again later in the month by 0.75%. If inflation is not running as hot as expected, the Fed will still likely raise rates, but it will be by a more modest 0.25%-0.50%.
Energy prices do make up a notable portion of the overall CPI figure (about 7.5%), so the price at the pump will be key to watch. I know every time I drive by a gas station I am looking at that number to see if it is above $5.00 or not. More and more over the past week I saw prices closer to $4.80-$4.90 and I am hopeful that easing up of prices will continue over the next few weeks.
On the energy front, the Russian invasion of Ukraine has undoubtedly pushed prices higher. Global turmoil especially in that part of the world is bad for the world economy, needless to say. Ukraine is also a heavy exporter of wheat, corn, and sunflower oil. The ongoing war is one of the prime reasons why prices have shot up so high on these and other related goods.
It would be too optimistic to say that the war will end soon. But undoubtedly the War in Ukraine is a major driver of inflation right now and, hopefully, those pressures will eventually ease, first and foremost from a humanitarian perspective but also for the good of the global economy.
I am of the opinion that inflation is peaking. I think future CPI readings will show a deceleration of inflation. In other words, inflation is going to continue to run hot and well above the Fed’s targeted rate of 2.00%, but it won’t be in the 8.00% range for many more months and will ease back into a more manageable 4.00-5.00% range by the end of the year. That would be good news for borrowers including prospective homeowners, commercial businesses, and people seeking auto loans, credit cards, and other types of consumer debt, and, I would say, for the economy as a whole.
Ben Sprague lives and works in Bangor, Maine as a Senior V.P./Commercial Lending Officer for Damariscotta-based First National Bank. He previously worked as an investment advisor and graduated from Harvard University in 2006. Ben can be reached at ben.sprague@thefirst.com or bsprague1@gmail.com. Follow Ben on Twitter, Facebook, or Instagram. Opinions and analysis do not represent First National Bank.
Happy Independence Day!
When I think about the Fourth of July, what guides me is a line from Lincoln’s Second Inaugural Address in which he says, “Let us strive on to finish the work we are in, to bind up the nation's wounds.”
The work of building a just and more perfect union is never done. American is an ongoing experiment in which we should all have a voice and a role to play. May we all strive to do and be better and make our nation better through our efforts.
