Going Strong, Alas

Phil Kernen

THE FINANCIAL NEWS these days is all about inflation—what caused it, what it means for American families and how we should address it. Little wonder: The annual U.S. inflation rate hit a 40-year high of 8.6% in May.

How can we track a slow-moving force like inflation to figure out when it’s starting to cool? I’d watch four areas: energy costs, housing demand, employment rates and retail spending. When I examine the latest trends from these four bellwethers, I don’t think inflation is near a turning point. Here’s why:

Energy. For inflation to peak, energy costs must peak first. We aren’t close to that happening. Oil prices are up 70% over the past year, and the first-order effects are clear from the price increases on related products. Gasoline is up 80%, heating oil is up 100% and natural gas is up 80%.

Examples of second-order effects—as higher energy prices are incorporated into the costs of non-energy goods and services—are growing, too. In addition, China’s reopening will increase demand for already-tight global energy supplies. All these trends need to slow and then reverse before inflation can turn down.

Housing. Both home prices and rents have skyrocketed over the past two years. For inflation to ease, housing cost increases need to slow as a result of reduced demand and declining housing sales. The Federal Reserve is taking an aggressive stance by raising short-term interest rates. Though the Fed has only increased rates by 1½ percentage points to date, financial markets have done heavier lifting by pushing up longer rates even more.

Mortgage rates have moved up with other interest rates. The average 30-year mortgage rate moved above 5% in April for the first time since 2010. Insufficient housing supply is a problem in nearly every geographic market. Still, higher mortgage rates should eventually put a damper on housing demand.

Thanks to the one-two punch of higher mortgage rates and robust housing price hikes, home sales are now mixed. After falling for the first four months of the year, new home sales in May 2022 were 11% above April 2022 but 6% below May 2021. Existing home sales in May were down 3% from April 2022 and down 9% from May 2021. Housing prices, however, aren’t yet falling.

Jobs. Inflation won’t peak while unemployment, currently 3.6%, is near its lowest level in 50 years. With workers so scarce, employers are forced to raise wages to find qualified candidates in a job market where there are two unfilled positions for every job seeker. The gap between unfilled jobs and job seekers needs to shrink to help drive wage growth back to sustainable levels.

In March, the Job Openings and Labor Turnover Survey (JOLTS) from the Bureau of Labor Statistics (BLS) reported 11.8 million open and unfilled positions. The employment report for March, also from the BLS, said that only 5.7 million workers were seeking employment.

The April JOLTS reported 11.4 million open and unfilled positions, while the employment report said that 5.9 million workers were seeking employment. This reduced gap between open positions and available workers is a small sign that the job market may be slowly moving toward a better balance.

Spending. Inflation won’t cool until consumers and businesses slow their spending. Financially speaking, the pandemic was good for consumers. Stimulus payments contributed an estimated $2.7 trillion in excess savings across all income levels. Because of this cushion, many economists believe consumers will be less affected by inflation at first, though how long they can look past higher prices is uncertain.

Recent earnings reports from big retailers reflect some consumer pushback. Profits were less than expected as retailers showed an unwillingness to pass along increased costs to consumers, despite the manifold problems at retail chains, including higher markdown rates on slower selling goods, inventory impairments on goods that won’t sell and lower-than-expected sales among “discretionary” goods like casual clothing and flat screen TVs.

The upshot: Current data suggest that inflation will be with us for a while. I continue to watch these four components closely. A growing body of evidence will, at some point, reflect changing behavior and a downturn in inflationary pressures across the economy. But we aren’t there yet.

Phil Kernen, CFA, is a portfolio manager and partner with Mitchell Capital, a financial planning and investment management firm in Leawood, Kansas. When he’s not working, Phil enjoys spending time with his family and friends, reading, hiking and riding his bike. You can connect with Phil via LinkedIn. Check out his earlier articles.

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