Inflation Pressures are Easing
Former Global Chief Economist for JPMorgan Chase & PH.D Economics
We can see that gasoline prices dropped below $4.00 per gallon yesterday according to the AAA!
Semiconductor equity prices are well off their peaks. Chips were in short supply and put upward pressure on prices as the inventory of products using these semiconductors was constrained.
As the supply of semiconductors has risen, the forward earnings of these companies have fallen. While this may be bad news for semiconductor companies, it is good news for the rest of the economy since it will lower pricing pressures for products using these components.
Similarly, as more grains are exported safely out of Ukraine, it will put downward pressure on food prices which have been a source of inflation.
Other factors that have continued to put upward prices on the Consumer Price Index (CPI) include rental prices. The CPI measures rent prices by looking at leases in the past year, while popular rent indices computed by Red-Fin and Zillow reveal that rental prices have begun to ease from their Feb. 2022 peak! It will take another 6 to 9 months for CPI rent prices to reflect the drop.
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The M2-money supply also gives us a sneak peek of liquidity 6 to 18 months into the future has begun to ease. The yearly growth in M2 peaked at +26.9% in Feb. 2021 and is now growing by +5.9% as of its latest reading (June 2022). This suggests inflation will continue to ease unless we encounter additional economic shocks, i.e., another food blockade or an interruption of global energy supplies.
The Chart below reveals that lagging the yearly growth in the M2 money supply by 13 months reveals its likely future impact on the CPI!
Source: Board of Governors of the Federal Reserve System and Bureau of Labor Statistics
Can We Declare Victory?
It is still too early to declare victory. Inflation is still rising by 2 to 3X faster than the Fed’s 2.0% yearly target.
What occurs from here is controversial. Since inflation is caused by the supply side, and demand side factors, we know that the Federal Reserve can only lower inflation by tightening monetary policy to dampen demand. It has no ability to ease supply-side constraints which cause inflation. We leave it to the reader to decide whether they favor having the Fed do what it can to lower inflation pressures while risking a recession or whether the Fed should close its eyes and hope that supply-side constraints ease further and thereby lower inflation pressures.
Many Economists believe that monetary policy cannot be based on “hope,” the Fed must continue to raise short-term rates to ensure they reach their desired 2.0% inflation target. That doesn’t mean the Fed has to act like a bull in a China shop and cause a deep recession, but it’s too early to think about ending the Fed’s monetary tightening cycle or begin thinking of lowering short-term rates.
The choices are clear, the Fed can abandon its monetary tightening cycle and hope supply side pressures will ease miraculously to avoid causing a recession, or continue with its monetary tightening strategy and bring inflation pressures down further even if it means risking a recession.