Commodities

INSIGHT: Inflation to be stronger for longer, even as commodities prices fall

NEW YORK (ICIS)—’Stronger for longer’ was the
mantra for the commodity supercycle of the
2000s and more
recently
in 2021 for polyethylene (PE)
margins. Instead, this now applies to
inflation, even with commodities in a clear
downtrend.

This will cause the US Federal Reserve to keep
the foot on the rate hike pedal, potentially
leading to even lower commodities – including
chemicals – prices as the economy slows further
and demand dissipates.

The US Consumer Price Index (CPI) for June came
in hot, dashing hopes of a long-awaited peak in
inflation. The headline June CPI showed a 1.3%
gain from May and was up 9.1% year on year –
the highest since 1981.

Excluding the more volatile food and energy
components, core CPI rose 0.7% month on month
and was up 5.9% from a year ago.

Source: US
Bureau of Labor Statistics

Increases were broad-based and led by higher
prices for shelter, used vehicles, health care,
apparel, household furnishings and operations,
car insurance and new vehicles, ICIS senior
economist for global chemicals, Kevin Swift,
pointed out.

“Some of the price categories are seeing
persistent and now protracted gains, and that
gains were widespread across these categories
suggest that inflation will be high and above
the Fed target for some time – many quarters
and even years,” said Swift.

“Given still-tight labour markets, wage
inflation is occurring and will remain
persistent,” he added.

The economist sees the US Federal Reserve
hiking interest rates by another 75 basis point
(0.75 percentage point) in July, with a
subsequent 75 basis point increase likely in
September as well.

The persistently higher inflation readings have
the market continuing to search for that
elusive peak.

“We may see another CPI surprise to the upside
when the July data are released next month but
given oil prices are off and gasoline prices
are following, pressure in this area may ease,”
said Swift, who also noted alternative price
data for certain categories such as used cars
have turned down.

The economist sees a potential peak in
year-on-year inflation in July or some time in
Q3.

“This is not just a US issue, but is widespread
in Canada, the UK, Europe and many emerging
countries,” said Swift.

Kathy Bostjancic, chief US economist at Oxford
Economics, sees US inflation remaining “sticky”
through September, only easing towards the end
of the year to around 7% for the US CPI, she
said on a webinar on the US Economic Outlook on
12 July, a day before the CPI release.

“That’s going to keep the Fed really aggressive
– on a 75 basis point hiking mode. We think
there’s another 75 basis points to come in
September,” she said.

It won’t be until the year-on-year CPI gains
ease to around 7% that the Fed could start to
scale back rate hikes. That could happen in Q4
and go into 2023, the Oxford economist added.

The strong US dollar, which reflects the
country’s economic strength versus the rest of
the world, should help keep a lid on goods
prices as well as weigh on corporate earnings,
with Q2 earnings season now under way.

“Watch the corporate earnings… You’re going to
see a lot more corporations talking about the
downward pressure on earnings from the stronger
dollar,” said Bostjancic.

RISING SERVICES COMPONENT TO OFFSET
GOODS DECLINE
What will keep
inflation high in the next several months is a
rising services component, even as goods
inflation eases.

“Core goods inflation is still running very
high… but has decelerated. Where you’re seeing
some offset is in the core services – that’s
travel, airfare, car rentals, dining out and
also housing rental costs, which comprise 40%
of core services prices,” said Bostjancic.

“And for now, housing rental prices are
actually going to keep rising. What we have
found is that home prices lead rental costs
from 12-18 months. Even if home prices are
starting to cool now, you’re going to see the
lag impact put upward pressure on rental
prices,” she added.

The Fed’s Beige Book survey of current economic
conditions across districts released on 13 July
showed indications of easing goods inflation,
although still at elevated levels, along with
continuing increases in services prices.

“Substantial price increases were reported
across all districts, at all stages of
consumption, though three quarters noted
moderation in prices for construction inputs
such as lumber and steel. Increases in food,
commodities and energy (particularly fuel)
costs remained significant, though there were
several reports that price inflation for these
categories had slowed compared with recent
months but remained historically elevated,” the
Beige Book report said.

“While several districts noted concerns about
cooling future demand, on balance, pricing
power was steady, and in some sectors, such as
travel and hospitality, firms were successful
in passing through sizable price increases to
customers with little to no pushback. Most
contacts expect pricing pressures to persist at
least through the end of the year,” according
to the report.

SHARP INFLATION FALL IN H2
2023

Looking ahead, inflation should gradually cool
in Q4 2022 and into 2023, where it could fall
off markedly as the Fed rate hikes take their
toll.

“We actually see the possibility of inflation
going below the 2% target rate, and that’s
because we’re going to see further easing
supply chain pressures, a cooling of aggregate
demand, and there’s probably going to be
increased investment. So ironically, we could
be looking at an undershoot of inflation in
2023,” said Oxford Economics’ Bostjancic.

Even if headline inflation numbers moderate in
2023, keep in mind this would be compared to
significantly elevated 2022 levels.

For the next 12-18 months, the Oxford economist
sees a 35% chance of recession – a significant
level but not her baseline view. Oxford
Economics forecasts US GDP growth of 1.9% in
2022 and just 1.1% in 2023.

ICIS senior economist Swift expects
year-on-year CPI inflation to moderate to 3.0%
by Q3 2023, still above the Fed’s 2% target. He
sees a 48% chance of a US recession in the next
12-18 months.

By Joseph Chang

Thumbnail shows dollars. Image by
Shutterstock.

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