Forecasting interest rates is fraught and future changes in price levels even more so. That said, it is reasonable to expect that 2023 may feel a bit different than last year: inflation will likely ease. Will it sink to the levels we just saw a few years ago? Of course not, or certainly not any time soon. Nonetheless, we are likely at a near-term inflection point.
The inflation we’ve seen over the past two years has been something of a double-whammy. The 2021 spike was driven by a staggering rebound in demand from a flatlined economy during COVID. The 2022 story was punctuated by the Russia-Ukraine War. Spanning both regimes were the supply chain upheavals and inventory imbalances that arose as firms attempted to negotiate these uncertain times. And the backdrop for all of this, needless to say, is the extraordinary monetary accommodation writ by the Federal Reserve and other central banks, which jawboning, aside, won’t be going away fast. However, that’s not the marginal factor here—it’s demand and input prices, and on those we can see changes.
Just today, we saw the Retail Sale release, which reported an (adjusted) -1.1% decline in December in purchases at stores, restaurants and online. This was the largest drop since last year, on top of a decline in November, which was revised lower to a -1.0% mark. We also see the CPI falling a (seasonally-adjusted) -0.1% in December 2022, MoM, contributing to a 6.5% YoY mark for December, which was down 260 bps from the peak YoY number recorded in June 2022. It’s not just headline numbers, either: 3- month changes for both core goods and core services are also starting to soften.
We are seeing relaxation in energy prices. Oil and natural gas prices have been falling over the past half-year, underperforming their forwards. But the nascent easing in CPI is not only visible in the headline numbers.
Costs (PPI and PMI input costs and output costs) are declining (see chart below), while inventories are suddenly rising at the fastest pace in three decades. Backlogs and delivery times indexes have eased, and shipping costs have rapidly cooled: spot indexes of international container freight costs which have dropped roughly -80% from their peak in 2021.
Source: Institute for Supply Management (ISM)
>50 = expansion
<50 = contraction
Grey shading = recognized recession
Of course, we are still seeing flare-ups in certain specific areas.
The Florida orange crop has been pounded by bad weather, hurricane damage, and a disease called “citrus greening”—leading to the smallest harvest in 90 years.
Egg prices are similarly skyward, also a consequence of disease. Here, it is a result of something called highly pathogenic avian influenza (HPAI). This scourge has resulted in 43 million fewer egg-laying hens since the outbreak began in February 2022. In just the past few weeks, U.S. egg inventories fell -29% below where they were at the end of last year. This storm has resulted in wholesale prices over 100% higher than they were last year. Today, the white truffle might be the cheapest ingredient in the omelet.
These are both idiosyncratic turns of events, that while highly specific, are just the latest example of how quickly unanticipated events can propagate through the supply chain and lighten consumers’ wallets. But they are the exceptions to what we are seeing elsewhere.
In terms of what this means for the markets—it all depends on what else happens! Price easing from supply improvements should tend to be generally positive, but we also expect further demand cooling (retail sales, etc.). Striking the balance there will be the hard part, and it does seem to be the case that supply changes have tended to be adverse shocks. Therefore, it’s probably wise to not make radical moves. If inflation slowly eases, or can’t find direction, the surest bets may be in areas like health care and consumer staples, which could perform, albeit less well than growth (in disinflation) or energy (if prices are higher for longer.)
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