Precious Metals Review

“While supply disruptions are subsiding, without slower demand, inflation will still be too high for Fed to stop raising rates

The bad news is that in April, for the second month in a row, inflation clocked in above 8%. The good news is that sometime in the next 12 months, it will very likely fall to around half that. This isn’t exactly a heroic forecast. Bottom-up analysis of the consumer-price index’s components, inflation-linked bond yields, and wage behavior all point toward inflation settling at roughly 4%.

The more important question is what comes after that? The hope by many—including the Federal Reserve—is that it keeps heading down toward the Fed’s 2% target by itself. But there are good reasons it will stay around 4% or even drift higher. That wouldn’t be acceptable to the Fed, and opens the door to even higher interest rates than markets now expect, more market carnage and a weaker economy.

The forces that drive inflation tend to move slowly, so the almost unprecedented surge since early 2021 means something anomalous is going on. In fact, only twice since the late 1940s has inflation risen as much as in the past year, and both were periods like the present, when supply shocks hit a hot economy.

In 1951, the economy was already booming when the Truman administration warned that mobilization for the Korean War would “pull men and materials, as well as plants, away from existing peacetime uses,” fanning inflation. JPMorgan economist Michael Feroli has constructed an index of economic disruption based on how much employment growth varies between individual sectors. It shows disruption was exceptionally high during the Korean War and the Covid pandemic. The Korean War analogy is comforting because while the Fed did tighten monetary policy, it avoided a recession. Inflation shot from 2% in mid-1950 to 9.6% the following April, and was back below 1% by December 1952.

In 1973, the Arab oil embargo hit an economy already trying to cope with soaring food prices and strong demand. As an analogy for the present, this episode is a lot less comforting than 1951: Inflation peaked at 12.3% in 1974, and the Fed raised interest rates sharply, triggering a deep recession. Even so, inflation only fell back to 5% in 1976—then headed higher.

What’s the prognosis now? Analysts are bothered that even though annual inflation eased to 8.3% in April from 8.5% in March, the monthly inflation rate remained stubbornly high as airfares (in part because of costlier jet fuel) and new-car prices rose sharply.

And yet looking forward, the supply disruptions that have fueled so much of the rise in inflation are likely to get better, not worse. Gasoline prices hit another record this week but aren’t likely to rise much more since oil has stabilized around $100 per barrel. The queue of container ships waiting off the coast of California has shrunk by more than half, and freight rates have plummeted. About three quarters of China’s top 100 cities by gross domestic product have now either loosened restrictions to pre-Omicron levels or removed them entirely, according to Ernan Cui of the research firm Gavekal Dragonomics. One sign that goods shortages are subsiding is that manufacturing, retail and wholesale inventories, which plummeted 5% between the start of the pandemic and last September, are up 3% since.

Omair Sharif, proprietor of the analytical service Inflation Insights, predicts the near-term course of inflation by digging into the industry-level dynamics driving specific components of the consumer-price index. In his baseline forecast inflation falls to 5.3% by December. At my request, he also computed scenarios in which prices of new and used cars, shelter, food and energy follow plausible high and low paths. The high scenario is 7.1%, and the low scenario is 4%.

More important, Mr. Sharif thinks monthly rates of inflation will be much lower over the balance of the year than last year. As a result inflation, annualized over three months, would fall to 2.5% in December in his baseline scenario, 2.2% in the low scenario and 5.1% in the high scenario. Meanwhile, inflation-linked bonds and derivatives are currently projecting inflation of 3% to 3.3% by early 2024, or 3.6% excluding energy, according to Barclays.

So inflation reaching 4% is a pretty safe bet. The hope, among investors and the Fed, is that from there, inflation gradually eases to between 2% and 3%. The problem is that in a year, inflation will be driven primarily not by supply but demand, i.e., whether GDP is at or above its potential (what the economy can produce with available capital and labor) or unemployment is at or below its natural level. GDP today is below its prepandemic potential trend, but the pandemic seems to have depressed potential by, for example, driving millions of people out of the workforce. Record job vacancies suggest the current unemployment rate at 3.6% is too low to be sustained in the long run.

Indeed, annual wage growth has accelerated from about 3.5% before the pandemic to between 5% and 6%. That is consistent with inflation of 4% if productivity maintains its recent, tepid pace, or 3% if productivity perks up. For the Fed to feel confident inflation is headed below 3%, it needs to see lower wage growth, which generally requires slower economic growth and higher unemployment, and it will keep raising interest rates until those things happen. If that means more carnage in the stock market—well, that’s a feature, not a bug.”

“Oil prices settled mixed on Thursday as supply concerns and geopolitical tension in Europe got the upper hand over the economic fears dogging financial markets as inflation soars.

Brent crude fell 6 cents to settle at $107.45 a barrel. WTI crude rose 42 cents, or 0.4%, to settle at $106.13.

"The trading has been thin and nobody knows what's going to move the needle," said John Kilduff, partner at Again Capital LLC in New York.

A pending European Union ban on oil from Russia, a key supplier of crude and fuels to the bloc, is anticipated to further tighten global supplies.

The EU is still haggling over details of the Russian embargo, which needs unanimous support. However, a vote has been delayed as Hungary opposes the ban because it would be too disruptive to its economy.

More broadly, oil prices and financial markets have been under pressure this week amid jitters over rising interest rates, the strongest U.S. dollar in two decades, concerns over inflation and possible recession.

Prolonged COVID-19 lockdowns in the world's top crude importer, China, have also impacted the market.

"The slide in demand growth could not come at a better time, with China seemingly on the brink of locking down the capital of Beijing at any given moment," said Bob Yawger, director of energy futures at Mizuho.

U.S. headline CPI for the 12 months to April jumped 8.3%, fueling concerns about bigger interest rate hikes, and their impact on economic growth.

"Soaring pump prices and slowing economic growth are expected to significantly curb the demand recovery through the remainder of the year and into 2023," the International Energy Agency (IEA) said on Thursday in its monthly report.

"Extended lockdowns across China ... are driving a significant slowdown in the world's second largest oil consumer," the agency added.

The Organization of the Petroleum Exporting Countries (OPEC)cut its forecast for growth in world oil demand in 2022 for a second straight month, citing the impact of Russia's invasion of Ukraine, rising inflation and the resurgence of the Omicron coronavirus variant in China.

On Wednesday, oil prices jumped 5% after Russia sanctioned 31 companies based in countries that imposed sanctions on Moscow following the Ukraine invasion.

That created unease in the market at the same time that Russian natural gas flows to Europe via Ukraine fell by a quarter. It was the first time that exports via Ukraine have been disrupted since the invasion.”