Since the beginning of 2021, the inflation problem in the U.S. economy has continued to increase. In March 2022, the U.S. consumer price index (CPI) increased by 8.5% year-on-year. After removing food and energy products with high price volatility, the core CPI increased by 6.4% year-on-year, the highest level since 1982. On a month-on-month basis, the US CPI increased by 1.2% in March, a new high since the current round of inflation, but the core CPI growth rate fell to the lowest in six months, at 0.3%. Overall CPI and core CPI diverged, showing a trend of slowing inflation growth.
Judging from the contribution to the CPI, the impact of the Russian-Ukrainian conflict on food and energy prices was fully manifested in March. In the total 1.2% month-on-month increase, core goods and services increased by 0.32%, accounting for about 25% of the overall inflation rate, of which core services increased by 0.34%, and core commodities were still slightly deflationary; food increased by 0.13%, accounting for about 10% %; the energy category increased by 0.83%, contributing 65% to overall inflation. Specifically, energy prices rose 11% month-on-month. Among them, gasoline (18.3%) and fuel oil (22.3%) prices rose in the forefront.
The drag on the US economy from inflation is obvious. According to official data released by the United States, although the US gross domestic product (GDP) in the first quarter of 2022 achieved a year-on-year growth of 4.3%, it contracted by 1.4% in a month-on-month sense, and the growth was not as good as expected. So, is the inflation problem in the US expected to be resolved in the short term, as some officials and professionals expected?
The reason for the higher inflation in the United States is that the main consumer demand has shifted to commodities, superimposing supply chain bottlenecks
Since the outbreak of the new crown epidemic, the consumption of goods in the United States, especially the consumption of durable goods, has grown at an unprecedented rate, but there has been a supply chain bottleneck on the supply side. This imbalance between supply and demand is the cause of this round of inflation in the United States.
Since March 2020, the United States has launched a fiscal stimulus package totaling $5.7 trillion in less than a year, accounting for about 1/4 of GDP, a large part of which is directly distributed to residents. The repeated outbreak of the epidemic has restricted the service expenditure of American residents, and consumer demand has concentrated on commodities; among the consumption of commodities, the consumption of durable goods has grown faster. A typical proxy is car prices, which are up 37% in 2021 for used cars. According to estimates by the Federal Reserve Bank of San Francisco, fiscal support has boosted U.S. inflation by about 3 percentage points by the end of 2021. However, on the supply side, there has been a supply chain crisis manifested by material shortages and port congestion. The shortage of new car supply caused by “lack of core” is the main reason for the booming used car market. The two ports of Los Angeles and Long Beach account for about 40% of all ports in the United States, with a peak of 161 cargo ships queuing at the ports in late September 2021. The supply chain crisis has also led to the “self-fulfillment effect”, which is mainly reflected in two aspects: one is the “long whip effect”, that is, the shortage of the supply chain leads to excessive panic among retailers and manufacturers, which further increases the order volume and leads to shortages Further aggravating; second, the supply chain management strategy of some companies has also changed from the “Just In Time” (Just In Time) that emphasizes efficiency and minimum inventory to the “Just In Case” (Just In Case) that emphasizes production safety and sufficient supply.
Core inflation experienced a rotation from goods to services, with inflationary pressures widening
Since 2022, U.S. domestic consumption is undergoing a rotation from goods to services, inflation has become more persistent, and pressures are “broadening.”
After the epidemic eased, the consumer spending of US residents shifted from goods to services, which also brought about a shift in inflationary pressures. From February 2022, the month-on-month growth rate of core CPI services in the United States began to exceed that of core commodities, and the gap between the two further widened in March. Used car prices fell a further 3.8% in March, the biggest drop since 1969, after falling 0.2% in February. According to statistics from Mannheim, the largest used car wholesale platform in the United States, used car inflation is expected to continue to slow in the future. Among the service inflation in which the CPI accounts for more than 50%, the rise in housing inflation is the most significant. Tenant rents and housing equivalent rents (OERs) have grown rapidly, holding above 0.4% month-on-month since November 2021, the highest in five years. Meanwhile, the leading indicator of house prices suggests that there is still room for upside in housing inflation in the first half of 2022. OER and tenant rents are weighted up to 40% in core CPI, while rents are highly “price sticky”. As a result, housing inflation serves as a solid bottom for core inflation.
In terms of the labor market, the situation of “more people living and less” is still significant, leading to rapid wage growth and the risk of a wage-price spiral. The U.S. Job Openings and Labor Turnover Survey (JOLTS) released by the U.S. Department of Labor in February showed 11.266 million job vacancies, close to an all-time high. The Employment Cost Index (ECI), the broadest measure of labor costs, rose 1.4% quarter-on-quarter and 4.5% year-on-year in the first quarter of 2022, the highest in 20 years. Inflationary pressure brought by wages will be widely transmitted to various industries, and once the wage-price spiral is formed, it is difficult to reverse in the short term. The CPI diffusion indicator shows that the sub-item of inflation rate exceeding 4% year-on-year accounts for nearly 80% of the overall item. This suggests that price increases have become a general phenomenon, not just based on some specific industries.
Russia-Ukraine conflict pushes up food and energy prices, upside risks remain
The frequent occurrence of extreme weather around the world and the escalating conflict between Russia and Ukraine have pushed international food prices to a record high, which has also been transmitted to food prices in the United States. Since the second half of 2021, the frequent occurrence of extreme weather has severely damaged the global food system, and the resulting price increases are also known as “climate inflation”. As two important grain-producing countries in the world, the intensification of the conflict between Russia and Ukraine has further deteriorated the global supply. The production of wheat and corn in Russia and Ukraine account for about 30% and 20% of the total global supply, respectively, while wheat is the staple food for more than 35% of the world’s population, and there are limited alternatives. The disruption of supplies from Russia and Ukraine has led to a recent surge in global food prices. The Food Price Index of the Food and Agriculture Organization of the United Nations averaged 159.3 points in March, up 12.6% month-on-month, jumping sharply to the highest level since the index was established in 1990. Among them, the price of wheat surged by 19.7% month-on-month, and the price of corn rose by 19.1%. In addition, Russia is also the largest exporter of nitrogen fertilizer, and its production of ammonium nitrate (the main component of nitrogen fertilizer) accounts for more than 60% of the total global supply. The combination of these factors means that food prices will only be higher in the future. The rise in international food prices has also been transmitted to domestic food prices in the United States. In the inflation in March, food prices in the United States increased by 8.8% year-on-year, and will maintain a high growth rate in the future, becoming an important support for high inflation.
Energy prices are a key factor in determining whether U.S. inflation has peaked. Although energy accounts for a small proportion in the CPI, it will have an impact on the entire downstream products and fluctuate violently. Therefore, energy prices are the main driving force for the US inflation to reach a new high in March, and it is also the key to determine the trend of overall inflation in the future. Global energy prices started rising in late February and surged sharply in March due to the Russia-Ukraine conflict. In terms of oil, Russia is the world’s third largest oil producer after the United States and Saudi Arabia, and the world’s second largest exporter of oil and refined petroleum products after Saudi Arabia. Due to the direct impact of the conflict between Russia and Ukraine and the joint sanctions imposed on Russia by the United States and many Western countries, Russia’s oil exports have been greatly affected, and global crude oil prices have risen sharply. Brent crude oil prices rose to $120/barrel from $90/barrel at the end of February, but have now retreated. Despite repeated requests from the United States and the European Union, the Organization of the Petroleum Exporting Countries (OPEC) represented by Saudi Arabia has always been reluctant to increase crude oil production; the Biden administration’s announcement of a large-scale release of oil reserves has failed to significantly reduce international crude oil prices.
In terms of natural gas, Russia is the largest natural gas supplier in Europe, providing Europe with natural gas that accounts for 30% to 40% of its total consumption, and natural gas accounts for 20% of Europe’s total energy demand. Gas and electricity prices in Europe have risen by around 120% since the end of February. Although this will not directly affect U.S. inflation, in order to coordinate joint sanctions against Russia, the U.S. has pledged to export an additional 15 billion cubic meters of LNG to the EU during the year, thereby indirectly pushing up U.S. domestic gas prices. The prospect of the Russia-Ukraine conflict is still unclear, and sanctions against Russia are still escalating, which will continue to put pressure on energy prices from the supply side; the unexpected economic weakness in the United States in the first quarter and concerns about the Chinese epidemic blockade have brought new changes on the demand side. of uncertainty. But overall, energy prices are still biased upward, but volatility may be high and will be a key factor in determining whether U.S. inflation continues to rise.
It is worth noting that energy prices have a far greater impact on inflation in the EU than in the US. In March 2022, the EU’s Harmonized Consumer Price Index (HICP) also reached as high as 7.9%, the highest since data began in 1997. However, unlike the headline inflation in the US, the EU’s core HICP is only 2.9%, much lower than the US. The main driver of EU inflation is energy, which has contributed more than 50% to euro area inflation since April 2021. Correspondingly, the conflict between Russia and Ukraine will also put more upward pressure on the EU inflation trend. The risk of headline inflation in the EU will be greater than in the US.
Uncertainty over Fed tightening path
Milton Friedman, the representative of the American “monetary school”, has a well-known saying: “Inflation is a monetary phenomenon everywhere.” Although the current high inflation in the United States is affected by many structural and sudden factors, but the Fed is still to blame. The Federal Reserve has always insisted that inflation is only “temporary” and is unwilling to tighten the extremely loose monetary policy in the early stage of the epidemic. It will not change its attitude until early 2022, trying to calm down by creating aggressive interest rate hike expectations through a tough “hawkish” stance. high inflation. Since 2022, the Federal Reserve has raised interest rates by 25 and 50 basis points in March and May, and the market generally expects to continue raising interest rates four times during the year, with an overall rate of 2.5%. Federal Reserve Chairman Jerome Powell has repeatedly emphasized his desire to achieve a “soft landing” for the economy amid tightening, that is, keeping inflation under control while maintaining economic growth. But an unexpected contraction in U.S. GDP in the first quarter of this year has created more uncertainty about the Fed’s future tightening path. The Fed may have to choose between controlling inflation and recession, overemphasizing the balance and risking falling into stagflation. Once the tightening process is less than expected, the US inflation level may usher in a sharp rebound.
Overall, core inflation in the US has undergone a rotation from goods to services, with pressures becoming “broader” and more persistent. The prospect of the conflict between Russia and Ukraine is unclear, food prices will continue to remain high, and energy prices will fluctuate and rise. These factors make the US inflation trend still facing upward risks. At this time, it is still too early to predict that inflation will peak. Due to factors such as the base effect, fiscal decline, and the Fed raising interest rates, inflation in the United States is likely to peak in the second quarter. Even after the peak, the pullback in inflationary pressures will be long and slow, making it difficult to get back to the 2% target in 2022.