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September 18, 2023

Energetic Inflation - Flexport Weekly Economic Report

Energetic Inflation - Flexport Weekly Economic Report

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Phil Levy

Chief Economist, Flexport

September 18, 2023

Whether August CPI showed an alarming revival of inflation or a minor uptick depends heavily on the weight one gives to volatile energy prices. Regardless, U.S. inflation remains well above the Fed’s target and above market expectations.

In Focus - Rosy Expectations

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This past week, the Consumer Price Index release nicely illustrated why connoisseurs of fine inflation data prefer core readings, which exclude volatile energy prices. All-inclusive headline inflation was 3.7% in August. That was a sharp uptick from 3.2% in July and 3.1% in June.

Those numbers compare the monthly CPI with its level 12 months earlier, and can thus be subject to base effects. A more timely approach is to look at change over the previous month. For August, that was even more alarming – the CPI rose 0.6%, which equates to a 7.4% annual rate. That was the highest monthly rate of change since June of 2022. For comparison, the June and July increases were at a 2.4% annual rate.

Does this mean that a new burst of inflation is upon us? Not necessarily; the culprit isn’t hidden. In August, energy prices rose 5.6% – for the month! That would be an annualized rate of 92.3%. Prior to that, however, energy prices had fallen 12.3% in the 12 months to July.

An analyst has to decide whether to get hung up on this volatile series – to go with headline numbers – or to opt for the more stable core inflation series. There are arguments for both but there are no good arguments for selectively ignoring energy prices. Yet that seemed to be the tone of recent commentary. Arguments about the “last mile” of the Fed’s inflation fight based their analyses on a drop from 9.1% inflation in June 2022 to the figure just above 3% in July – tantalizingly close to the 2% Fed target. Those took full advantage of a sharp drop in energy prices. If that’s the chosen approach, then there is no case for dismissing August’s numbers as an aberration merely attributable to gasoline and fuel oil.

If, instead, one looks at core inflation, as shown in the green line in the chart, then August inflation was 4.3%. It has been on a fairly steady decline since the September 2022 peak of 6.6%. There was an upward move in the August monthly core number, which rose at a 3.7% annualized rate, but this is still consistent with moderating inflation. If the true journey is from 6.6 down to 2.0, though, hitting 4.3 puts us at the halfway mark, not the last mile.

What, then, is the Fed to do next? The argument for refraining from further rate hikes hinges on the downward momentum of inflation and the belief that the effects of recent rate hikes have yet to play out. One can wait and see.

The argument for raising further relies on the ample distance from the inflation target, the strength in recent economic numbers, and concern about expectations. The last bit is illustrated in the chart with 5-year expectation numbers coming from bond markets (blue) and from a Cleveland Fed composite indicator (red). There are three notable features of these series: one, they are stable or descending; two, they are close to the 2% target; and three, since mid-2021, they have been well-below actual core inflation. It is the last of these that matters most. If core inflation were to steady at 4.3%, the August level, then how long would expectations stay near 2%?

If they were to rise to meet actual inflation, the last miles of the inflation fight could become significantly more difficult. That is something the Fed would be eager to avoid and could add a sense of urgency.

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Latest Flexport Metrics & Research

Today we release updates to our Post-Covid Indicator (PCI), Trade Activity Forecast (TAF), Flexport Consumption Forecast (FCF), and Trade Price Forecast (TPF).

Later in the week we look at India’s exports.

Economic Developments

U.S. retail sales (excluding autos and energy) rose 0.6% month-on-month in August, driven by a 0.9% increase in clothing and a 0.7% increase in electronics & appliances. Furniture, on the other hand, fell 1.0%. Compared to August 2022, retail sales were up 1.6%. The numbers were adjusted for seasonal and trading-day variations but not for inflation.

U.S. Consumer Sentiment dropped to a reading of 67.7 in September, down 1.8 points from August, but 9.1 points above September of the previous year. Notably, year-ahead inflation expectations cooled to 3.1% from 3.5%, reaching the lowest point since March 2021. Long-run inflation expectations also softened to 2.7%, just above the 2.2-2.6% range of the two years before the pandemic.

U.S. industrial production grew 0.4% in August, with a slight 0.1% increase in manufacturing. Mining and utilities saw bigger gains of 1.4% and 0.9%, respectively. A rise of 2.0% in machinery was offset by a decline of 5.0% in auto output. Apparel and leather production also fell 3.5%.

Euro area economic sentiment declined to a reading of -8.9 in September, down 3.4 points from August and the 5th consecutive negative reading. The situation indicator also fell to minus 42.6, down 0.6 points from the previous month.

Last week’s trade releases continued to show short-term trade momentum slowing slightly.

  • Euro area exports to non-Euro area economies fell 2.8% month-on-month in July while imports declined 18.7%. Year-to-date exports through July are still up 2.3% over last year, but imports are down 8.4%. Intra-Euro area trade was flat year-on-year. Figures are in nominal terms and not seasonally adjusted.

  • UK real exports increased 2.1% month-on-month in July, with a 4.4% rise in exports to the EU offsetting 0.2% drop in shipments to the rest of the world. Through July, total year-to-date exports are 1.3% below 2022; they are down 2.4% to the EU and 0.2% to non-EU countries.

  • India’s August goods exports were down 6.8% year-on-year in August in US dollar terms, coming in at $34.5 billion. Stripping out petroleum and jewelry, they were $26.0 billion, down 3.2% from a year earlier. Exports of electronic goods, which includes smartphones, were up 26.3% to $2.2 billion. India recently hosted the G20, where trade was on top of the agenda.

Political Developments

The ECB raised rates by 25 basis points to 4.0%, contending that, while declining, “inflation is still expected to remain too high for too long.” The statement announcing the move did suggest that the bank plans to pause tightening as “rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target.” Euro area core inflation fell to 5.3% in August.

In its Summer Economic Forecast, The European Commission revised down Euro area economic growth in 2023 to 0.8% from 1.1%, while updating Euro area inflation projections in 2023 to 5.6% from 5.8%. For 2024, growth was reduced to 1.3% from 1.6%, and inflation was revised to 2.9% from 2.8%. The EC’s predictions of weakened economic growth were released amid the ECB’s latest interest rate hike.

About 13,000 members of the United Auto Workers Union went on strike at plants of three US automakers, seeking wage increases amid increased profits and rising US auto exports. If the strike expands and US auto production falls, prices may increase and imports may rise.

The International Energy Agency is forecasting a “substantial market deficit” for oil through Q4 due to the extension of supply cuts by Saudi Arabia and Russia, which could now last until the end of the year. Global observed inventories were at a 13-month low already in August. Late last week, West Texas Intermediate and Brent prices both rose above $90/barrel, the highest they’ve been this year.

The World Trade Organization’s 2023 annual report warned that the risk of “economic fragmentation is real and growing.” An accompanying post from the organization’s chief economist showed that trade within geopolitically-aligned blocs has been growing faster than trade between unaligned blocs since the beginning of the conflict in Ukraine.

Disclaimer: The contents of this report are made available for informational purposes only and should not be relied upon for any legal, business, or financial decisions. Flexport does not guarantee, represent, or warrant any of the contents of this report because they are based on our current beliefs, expectations, and assumptions, about which there can be no assurance due to various anticipated and unanticipated events that may occur. This report has been prepared to the best of our knowledge and research; however, the information presented herein may not reflect the most current regulatory or industry developments. Neither Flexport nor its advisors or affiliates shall be liable for any losses that arise in any way due to the reliance on the contents contained in this report.

About the Author

phil levy headshot
Phil Levy

Chief Economist, Flexport

September 18, 2023

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