Inflation Fire Beginning to Cool?

7.5.2022

There are signs the inflation fire is cooling.?The Federal Reserve has demonstrated that although they are late to get started, Chairman Powell is committed to tightening financial conditions as much as is needed to bring down inflation.?Naturally, this posture has been painful for investors, as both the stock and bond markets are off to the worst start in 50 years.?But far more painful in the long-term for the US economy would be entrenched inflation well in excess of target levels.?The good news is that there are signs that the drastic measures being taken are having the intended effect.??

The first place to look is the market expectations of future inflation through the 5-year breakeven inflation rate.?This is the difference between the 5-year treasury rate and the 5-year treasury inflation-indexed security rate (TIPS).??Since the high in late March of 3.59%, it has backed down to 2.59%, suggesting that the market believes the Fed will be able to achieve a significant reduction in overall inflation.

Outside of market expectations, there is also real-world evidence that some of the supply side sources of inflation are easing, including a more than 50% reduction in shipping costs from China to the US as seen in the chart below.?It is still quite elevated above pre-pandemic levels, but far off the highs seen late in 2021.

Additionally, the Covid lockdowns in China, and in Shanghai specifically, appear to be lifted for the time being. And although it is too soon to say if they would again reimpose them should cases begin to rise once again, this is a welcome development to sources of supply side inflation.

The prices of other commodities have started to come down substantially as well, including copper, natural gas, wheat, and lumber.

Finally, as mortgage rates have doubled in the last six months, new home sales are finally cooling off back to pre-pandemic levels.?It is clear that housing prices have at least hit a ceiling in this environment.

There are several other areas of the economy where inflation appears to be moderating, including used car prices, but still also some that have not come down, including rents and airfares.

The one big wildcard remains oil prices, which are likely to remain stubbornly high for the duration of the crisis in Eastern Europe.?This, however, is an idiosyncratic aspect of the inflation problem over which we have little control.?

Overall, it does appear that inflation has likely peaked in the US during the second quarter and as we see the numbers evolve in the second half of the year in a downward trend, this should give the Federal Reserve the latitude it needs to ease up a bit on the economic brakes.

Securities offered through LPL Financial, member FINRA/SIPC.?Investment advice offered through Independence Square Holdings, a registered investment advisor.?Independence Square Holdings and Independence Square Advisors is a separate entity from LPL Financial.?

All indices are unmanaged and may not be invested in directly.?Economic forecasts may not unfold as predicted.?The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.?All performance referenced is historical and is no guarantee of future results.??