By: Phil Kernen
Financial market news is full of inflation; what caused it, what it means for us now, and how we
need to address it. We can’t wish higher prices away, but how can we track a slow-moving force
like inflation to determine whether we are near an inflection point? We don’t think inflation is
near a turning point, but we watch the following factors to assess our progress.
For inflation to peak, energy costs must peak first. We aren’t close to that happening yet. Oil
prices are up 70% over the last year, and the first-order effects are clear from the price
increases on related products – gasoline is up 90%, heating oil is up 100%, and natural gas is
up 200%, to name a few examples. Examples of second-order effects – higher energy prices
incorporated into non-energy goods and services – are growing too. In addition, China’s
reopening will increase demand on a limited global supply. These trends need to slow and
reverse before inflation can turn.
Housing costs have skyrocketed over the last two years, both home prices and rental costs. For
inflation to decrease, housing costs need to fall by reducing demand and sales activity. The
Federal Reserve is taking an aggressive stance by raising short-term interest rates. Though the
Fed has only increased rates by 1.50% to date, financial markets have done the heavier lifting
by pushing up longer rates further.
Mortgage rates have moved up with other interest rates, and the average 30-year mortgage rate
crossed above 5% in April for the first time since 2010. Insufficient housing supply is a problem
in nearly every geographic market, and higher rates will put a damper on housing demand to
help balance the two. With higher mortgage rates and robust housing price growth combined,
housing sales are falling. New home sales in April 2022 were 16% below March 2022 and 27%
below April 2021. Existing home sales were down 3% and 6% from the same periods. Despite
that, housing prices are not yet falling.
Inflation will not peak while unemployment is at the lowest level in fifty years, 3.6%. With
workers so scarce, employers raise wages to find qualified candidates in a job market where
two unfilled jobs await one candidate. The gap between unfilled jobs and job seekers needs to
shrink to help drive wage growth back to sustainable levels.
In March, the Job Opening 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
reported that 5.9 million workers were seeking employment. A reduced gap between open
positions and available workers is a small sign that the jobs market may slowly move towards a
Inflation will not turn 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 pushback. Profits were less than
expected following an unwillingness to pass increased costs onto consumers despite other
issues, including higher markdown rates on slower selling goods, inventory impairments on
goods that won’t sell, and lower-than-expected sales in discretionary categories.
Inflation will be with us for a while, but the examples above are inputs we are watching closely.
A growing body of evidence will, at some point, reflect changing behaviors and a turn in
inflationary pressures across the economy. Keep your eyes open.