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June 20, 2023

Working the Core - Flexport Weekly Economic Report

Working the Core - Flexport Weekly Economic Report

phil levy headshot
Phil Levy

Chief Economist, Flexport

June 20, 2023

The cheery headline CPI number for May was deceiving. More reliable, recent core components of the same report show persistent inflation well above the Fed’s tolerance levels.

In Focus - Recent CPI Moves

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Question: Why would the Fed not retreat from its rate-hike policy now that inflation is under control?

Answer: Because there is little indication that inflation is under control.
This was front-of-mind this week, between the Fed’s rate-setting meeting and the release of the May Consumer Price Index (CPI). Apparently-comforting inflation numbers led to questions like the one above. The broad CPI rose only 4.0% over the 12 months to May, the smallest increase since the 12-month period to March 2021. Looking at a shorter and more recent time horizon, the broad CPI rose 0.1% (seasonally adjusted) from April to May. That’s an annualized rate of 1.2% - below the Fed’s 2% target. Comforting, right?

In fact, the May CPI numbers should not be interpreted as comforting at all. We’ll delve into two issues with this week’s chart, which proposes a better time period over which to analyze the data an appropriate index to use for inflation.

First, the time period. Traditionally, we look at either the one month or twelve month change in price levels to gauge inflation. Each can have issues. The one-month measure can be volatile. For the broadest CPI measure, it was up 0.1% in March and May, but it was up 0.4% in February and April, and up 0.5% in January; the January reading corresponded to a 6.2% annualized rate.

The 12-month measure smooths out some of these monthly fluctuations, but it then begs the question whether the measured inflation took place a long time ago and has since dissipated. Suppose, for example, that monthly inflation went from zero to 6% in a single month, then back to zero. For a full year, 6% would show up as the annual number, even though there might not be an ongoing inflation concern.

The chart addresses both of these by finding a middle ground. It looks at monthly inflation numbers over the last three months (March-May) and then annualizes the rates. The results are both recent and smoothed.

If we stopped there, we’d have the still-comforting 2.4% “all items” increase, which looks even better than the comparable 4.0% 12-month number.

The concern comes when we look at the role different components are playing. The broad measure is heavily influenced by volatile – and plunging – energy prices (the green data to the right of the graph gives detail). Over this recent quarter, energy prices have dropped at a 23.3% annualized rate! Food prices have also been very tame, up an annualized 0.8%.

This accounts for the significantly higher core CPI number which excludes food and energy, and was up an annualized 4.9%, well above the Fed’s 2.0% target. The gray bars provide a further breakdown of core CPI into goods and services components, with goods prices rising at an annualized 5.7% rate and services at a 4.9% rate (rounding can throw off weighted averages).

The red bars break down services (58% weight in overall CPI) into shelter (6.6% rate, 34.6% weight) and transportation (8.3% rate, 5.9% weight), omitting the medical care services category (6.4% weight).

These numbers show that core inflation is high, stable, and recent. That will not comfort monetary policymakers.

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Latest Flexport Metrics & Research

This past week we released updates to our Post-Covid Indicator (PCI), Trade Activity Forecast (TAF), Flexport Consumption Forecast (FCF), and Trade Price Forecast (TPF).

Economic Developments

U.S. retail sales for May were up 0.3% month-on-month and 0.7% year-on-year, led by nonstore retailers, where sales were 6.5% higher than last year. The figures are adjusted for seasonality and trading day differences but not prices, which make them difficult to interpret without extra effort. Excluding cars and car parts and gasoline stations, sales are up 5.6% through the first five months of the year compared to the same period last year.

The June Michigan Consumer Sentiment Index hit its highest level in four months, increasing by 8% to 63.9 from 59.2 in May. Although more than 27% above the lows of the same time last year, the preliminary June result remains below historic standards, mainly due to softening income expectations. And while the majority of those surveyed ‘still expect difficult times’ in the year ahead, expectations about the economy in both the short term and further ahead improved by 28% and 14%, respectively.

Euro area headline inflation slowed to an annualized rate of 6.1% in May and core inflation, which excludes energy and food, alcohol and tobacco, was down to 5.3% from the 5.6% reading in April. Closely-watched and volatile energy prices were negative for the second time in three months, coming in at -1.8%. The ECB’s latest inflation projections, however, include concerns that underlying pressures on prices remain (see immediately below).

Euro area economic sentiment fell to its lowest level since December last year in June, coming in at -10.0 after a reading of -9.4 in May. Inflation expectations deteriorated 2.7 points to -84.6, another signal in support of the ECB’s current outlook for prices.

UK GDP in April was estimated to have grown 0.2%, putting it only 0.3% above pre-pandemic levels, which the ONS marks as February 2020. In the three months to April GDP was up 0.1% compared to the previous three month period ending in January. The contribution of the services sector, which has been volatile post-Brexit, was 0.6% but that was diminished by contractions in production (-0.3%) and construction (-0.6%).

Last week’s major trade data releases, though lagging by one to two months, showed US imports as potentially one of the few growth markets for major exporters around the world in the first half of the year. Elsewhere, the picture was less encouraging.

  • The first estimate for Euro area trade in April showed goods exports to the rest of the world decreasing 3.6%, while imports fell by 11.9%. Intra-Euro area trade was also down 5.2% by the same measure. The figures are not seasonally-adjusted. Year-to-date exports were still up 5.4% compared to the same period last year. Imports were 2.9% lower.

  • UK real goods exports increased 3.4% month-on-month in April, with a 7.3% rise in non-EU exports offsetting a 0.5% fall in exports to the EU. The main contribution to the growth in non-EU exports was in mechanical machinery (to New Zealand) and cars (to China). There was also an increase in medicines and pharmaceutical exports to the US.

  • Japan’s exports declined 3.1% month-on-month in May on a seasonally-adjusted basis. The country and product data, which are not seasonally-adjusted, showed machinery exports to China down 3.0% but semiconductors up 14.3%, with overall exports 3.4% lower than April. Exports to the US were up 9.4%, driven largely by transport equipment, which was up 33.5%. On a unit basis, motor vehicles jumped 59.0%.

  • Singapore’s non-oil re-exports declined 10.1% year-on-year in May, largely due to a 19.8% fall in electronics shipments, which were also down by 27.5% in April. Integrated circuits – or microchips – dropped 27.8% and parts thereof by 25.6%, followed by consumer goods (-19.7%). Singapore is one of the world’s busiest ports and is a key transshipment hub for inter-Asia and intra-ASEAN trade of intermediate and finished goods.

Political Developments

The Fed paused monetary tightening last week after ten consecutive hikes, leaving the fed funds target rate at 5 - 5.25%. Fed Chairman Powell cited ‘the uncertain lags which monetary policy affects the economy’ and ‘potential headwinds from credit tightening’ as two reasons behind the decision, while also noting that ‘nearly all’ FOMC members view further rate increases as necessary to bring inflation down to the 2% target (see this week’s Weekly Economic Report above). The move – and the messaging – left some Fed watchers confused.

The ECB raised its key interest rate a quarter-point to 3.5%, pointing to the strength of indicators suggesting underlying price pressures, with the bank’s projections for inflation having been revised upward based on “past upward surprises and the implications of a robust labor market for the speed of disinflation.” The day after the ECB announcement, the IMF released a report on the Euro area that included a call for continued monetary tightening.

The Bank of Japan left its short-term policy interest rate unchanged at -0.1% and will continue with its policy of yield curve control, which seeks to keep the yield on 10-year Japanese government bonds within 0.5% above or below zero. The bank acknowledged that while the recent CPI readings (less fresh food) have shown inflation slowing, it remains around 3.5% due to pass-through of rising import costs.

The People’s Bank of China cut its one-year lending rate by 10bps to 2.65% on concerns that key indicators – such as exports and measures of business confidence – are showing signs of a stall in the post-covid recovery. The move by the PBOC comes amid reports that the government is planning a billion dollar stimulus package that includes new spending on infrastructure, as well as incentives for property investors to buy homes.

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

June 20, 2023

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