March 20, 2023
Persistent Inflation - Flexport Weekly Economic Report
The Fed meets this week and will wrestle with both growing banking concerns and ongoing worries about inflation. New inflation data offered little reassurance that the fight against rising prices is won.
In Focus - Rising Prices by Any Measure
This past week marked the one-year anniversary of the Federal Reserve’s current tightening cycle. The Fed had just observed the Consumer Price Index (CPI) hit a recent high of 8.0% in February of 2022 and started moving the Fed Funds Rate up from 0.0% to 4.5%. With inflation well above the Fed’s 2% target, and with a strong labor market, there was little doubt it was time for the Fed to raise rates.
This week the Fed’s policy-making committee will decide what to do next. There is still a strong labor market, but there are new concerns spreading through the banking sector. In the case of Silicon Valley Bank, those concerns can be traced back to the sequence of Fed rate hikes.
This begs the question: is inflation now sufficiently under control that the Fed can back off or at least pause?
New data this week from the Bureau of Labor Statistics showed that the broadest CPI measure (the thick dark line in the chart) in February 2023 was down to 6.0%, well below the inflation rate a year ago and below the 6.3% figure for January.
A separate release for the Producer Price Index (PPI), not shown in the chart), also revealed inflation letting up. The measure for Final Demand was up 4.6% in February 2023. One year before, it was 10.4%.
Do these improving figures mean the Fed can relent?
There are two major problems. First, the horizontal gray line at 2% in the chart shows the Fed’s announced target for inflation. It’s well below either the broad CPI or PPI measure.
The second major problem concerns the components of inflation. The headline CPI includes volatile food and energy prices. Food prices are up 9.5% over the 12 months to February; energy prices are up 5.2%. Excluding those, we’re left with Core CPI, the dashed line which ended up at 5.5% in February, exactly what it was in January and exactly what it was in December 2021. Unlike the broader CPI, the more reliable core figure does not appear to be steadily subsiding.
Diving deeper, two broad subcomponents of Core CPI tell conflicting stories about inflation. The green line represents “Commodities Less Food and Energy Commodities.” It peaked at 12.4% in February 2022 and has since fallen to a mere 1.0%, below the Fed’s inflation target.
The rising red line is “Services Less Energy Services.” It hit 7.3% this past month and has risen every single month since September 2021.
These two components don’t balance each other out. The weight of the Commodities CPI is 21.3% of the overall index; the Services CPI’s weight is 58.1%.
What harm could come, though, in pausing the inflation fight? The potential harm comes in inflation expectations. According to the Cleveland Fed, those are currently at 2.3%. The question is how long they will stay there if stable inflation measures are running at or above 5%. If inflation expectations climb, the Fed’s task becomes significantly harder.
The Fed will be acutely aware of banking problems this week. The data show why it will be difficult to set aside its inflation fight.
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From last week: The Curious Case of U.S. Inventories. We cover the paradox of steady personal consumption with falling imports by examining inventories.
Euro area inflation ticked down 0.1% to 8.5% on an annualized basis in February, the fourth straight month it has declined since hitting 10.6% last October. However, core inflation, which excludes energy and food, continues to move in the opposite direction, rising to 7.4%.
By last Friday, the yield on 10-year treasuries had fallen 62 bps in the eight trading days since the collapse of Silicon Valley Bank, ending the week at 1.29%, the most volatile trading period since March 2020.
The University of Michigan’s measure of U.S. Consumer Sentiment in March was down for the first time in four months, falling 5.4% from February. It was still 6.7% higher than in March of last year. 85% of the respondents were surveyed prior to the current financial sector turmoil sparked by the failure of Silicon Valley Bank and Signature Bank.
Advance estimates showed U.S. retail sales for February, adjusted for seasonality but not prices and excluding food services, were down 0.1% month-on-month but up 4.0% year-on-year (when commodity prices were up only 1.0%) The biggest year-on-year gains were in general merchandise stores (10.5%) and health and personal care stores (8.0%).
Japan’s imports fell 3.0% in February from the previous month on a seasonally adjusted basis, while exports increased by 4.4% by the same measure.
The OECD revised its outlook for economic global growth upward for 2023 and 2024 to 2.6% and 2.9%, respectively, citing China’s re-opening and declining food and energy prices, among other factors. The organization’s chief economist urged central banks to continue tightening so long as core inflation (see this week’s essay above) remains high.
The ECB hiked interest rates by 50 bps based on its current projections for inflation to “remain too high for too long.” The move was in line with guidance the bank provided after its February decision.
Bank borrowing from the Federal Reserve’s discount window, a lending facility for banks facing liquidity strains, reached a record high of $153 billion this week. In addition, there was $11.9 billion in borrowing under the new Bank Term Funding Program and $142.8 in borrowing by banks seized by the FDIC. After Federal Reserve assets peaked in April 2022 at just over $8.9 trillion, they had slowly moved down to $8.3 trillion at the beginning of March before last week’s borrowing expanded them by just under $300 billion.
An investigation into the economic impact of the section 232 tariffs on steel and aluminum by the U.S. International Trade Commission found they contributed to a $1.3 billion increase (1.9%) in domestic production of steel products and a $0.9 billion increase (3.6%) in production of aluminum products, but also found resulting price increases caused a $3.5 billion decline in downstream output between 2018 - 2021.
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