Inflation Pressures Easing, but It’ll Be Awhile Before Consumers Feel It
NEW YORK — Though there has been some improvement in the metrics used to measure inflation, a slowing U.S. manufacturing sector among other factors suggests the risk of a looming recession continues to be strong, according to an economist with ING’s economic and financial analysis arm.
In recent weeks all eyes have been on Federal Reserve Chair Jerome Powell and the Fed’s board of governors for signs they’ve found a way to tame runaway inflation without hurting the job market in any significant way.
In pursuit of this so-called soft landing, the Fed has been raising interest rates — it hopes just enough and no more — to slow the economy and rein in consumer prices without causing a recession and a sharp rise in the unemployment rate.
“We believe we can do that. That is our aim,” Powell said Wednesday while speaking at a European Central Bank forum in Sintra, Portugal.
But the Fed’s ability to achieve its goal has “gotten harder,” he said, as a result of the Russian invasion of Ukraine, which has disrupted commerce and driven up the prices consumers pay for food and energy in particular.
“The pathways have gotten narrower,” Powell told his audience.
Initially, the Fed, like the European Central Bank and many others, were slow to come to grips with the threat of inflation, seeing rising prices as an aberration caused by supply chain bottlenecks and an economy that bounced back furiously from the coronavirus pandemic.
But as inflation stubbornly continued to rise, the Fed responded by raising its short-term benchmark rate 0.25 percentage points in March and 0.50 percentage points in May.
Most economists believed another half-percentage-point increase was in the offing at the Fed’s June meeting.
Instead, a woeful report from the Labor Department showed that consumer prices had shot up 8.6% in May from a year earlier — the biggest jump since 1981.
Shaken, the Fed responded by pushing the rate up by 0.75 percentage points — the biggest hike since 1994.
The big question is, what’s next? And that’s why an analysis published Friday by James Knightley, ING’s chief international economist, seems so compelling.
Explaining his role at ING, Knightley told The Well News, “I work for a European bank in New York, and we are here to help the bank itself and our clients identify what is going on in the world, what are the risks and opportunities out there, including scenario analysis.
“I am one member of a team that covers all parts of the world and covers specific sectors as well as the FX market, interest rates and commodities,” he added.
His assessment of the current health of the economy is based on the latest report on manufacturing from the Institute for Supply Management.
It found, among other things, that U.S. manufacturers are hiring fewer workers as new orders slow and backlogs grow at a much slower rate.
Asked whether this contraction was caused by the Fed or by consumers changing their buying habits, Knightley said it could be down to a number of things.
“Falling equity markets and more and more talk of recession may be making companies more cautious about expansion,” he said. “Consumers may indeed be feeling the squeeze from higher prices and are pulling back on spending.
“Overseas demand may also be a factor, while lingering supply chain issues are also holding back the sector — if you can’t get the specific chips you need then there is no point ordering the other bits you need to make something,” he added.
Knightley said while the auto sector has been a focal point of concern, the Institute for Supply Management found seven out of 18 industries reporting a decline in new orders in June.
In order they were wood products; furniture and related products; paper products; transportation equipment; electrical equipment, appliances and components; chemical products; and food, beverage and tobacco products.
In terms of employment, six industries reported a decrease in workers in June.
These were, in order, paper products; petroleum and coal products; furniture and related products; miscellaneous manufacturing; chemical products; and transportation equipment.
“According to the Institute for Supply Management, the weaker employment in these industries appears to be driven primarily by worker turnover, followed by an inability to find suitable workers,” Knightley said.
Far more difficult to pin down is what’s behind recent changes in supplier delivery rates.
Quoting directly from the Institute for Supply Management report, Knightley said, “The index continues to reflect suppliers’ difficulties in meeting demand from panelists’ companies, but there are clear signs of easing.
“In June, suppliers remained in a labor-constrained environment, based on panelists’ comments and the Employment Index remaining in contraction territory. Transportation networks reflected improvement compared to May. Among supplier delivery comments, 6% noted stable month-over-month improvement,” he said.
“It is difficult to break down the reasoning at this stage,” Knightley admitted. “It may well be that relaxation of COVID rules globally, and falling freight shipping costs by sea are helping the situation the most, together with less vigorous demand since companies have been able to rebuild inventories to a certain extent over the past 12 months.”
While the Institute for Supply Management report suggested inflation metrics are improving, Knightley said it still could take a while before American consumers “feel” that inflation is subsiding.
“Consumers tend to really notice the prices of products and services they frequently purchase — things like gasoline, food and haircuts for example. In these situations, people are buying identical products and roughly know how much they cost.
“Now gasoline prices might eventually fall, but it is unlikely that services prices will fall back so consumers may not notice it for a long time — there is always the confusion between disinflation (slower inflation readings) and deflation (falling price levels).
“To be honest, we don’t think inflation will really start slowing until the second quarter of 2023, but they may not notice it themselves very quickly, so consumers will be complaining for a while.”
In short, Knightley said, “the slow-down is underway, and the Fed is purely focused on getting inflation back to target.”
“For this to happen quickly we would ideally like supply conditions to improve to better balance with demand,” he said. “Unfortunately this could take a while so the onus is on the Fed to hit the brakes on the economy. … [As a result] there will be economic pain.
“Consequently the risk of recession is on the rise — the deeper and faster you move into restrictive territory, the greater the chance of a downturn, and we are already seeing slower activity with the Fed still set to hike by a lot more,” he said.
Despite the dire assessment, Knightley said he is still hopeful the U.S. will avoid a recession, but admits, “I am getting less and less confident by the day.
“Nonetheless, I would point out that the Fed doesn’t leave it long between the last rate hike in a cycle and the first rate cut. It has averaged just six months over the past 50 years,” he said. “Consequently, if they are convinced inflation is falling quickly I suspect they will swiftly reverse course on rate hikes and start cutting again from next summer.”
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