The 5 Reasons Inflation Is Falling

Colin Gerrety, CFP®, CIMA®
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The past year has been a rough time for the American consumer. The specter of inflation, which had not reared its ugly head in the official numbers since the early 80s, returned with a vengeance.

July 2022 inflation marked an 8.5% increase over the prior year as measured by the Consumer Price Index (CPI). This was a slower pace than the 9.1% year-over-year increase in June, with July itself being flat.

Tired of your cost of living going up and inflation wreaking havoc on stock and bond markets? Here’s the good news. There are several indicators that inflation may continue slowing down in the months ahead.

1) Falling Energy Prices

The price of a barrel of oil has fallen to about $93 per barrel from its high of $123 earlier this year, a drop of 25%. Meanwhile, average gas prices at the pump have fallen from about $5 to $4 per gallon. Other items, like fuel for heating homes or providing electricity, will also have an impact on inflation and should moderate as energy prices decline.

Energy prices are a big deal for inflation because they not only make up over 9% of the CPI basket (and more than that for many household budgets), but oil and fuel costs have a downstream effect on anything that goes through the supply chain. This affects food, raw materials, vehicles, clothing, and more.

 

2) Falling Commodity & Food Prices

Prices have come down for a number of commodities, perhaps in unexpected ways. For example, the price of wheat has actually fallen since the Russian invasion of Ukraine. This is shocking because these war-torn nations export about a quarter of the global wheat supply.

Other food commodities like corn and sugar have also fallen in recent months and should translate into lower costs at the grocery store, assuming businesses can pass these savings onto consumers. Food makes up over 13% of the CPI basket.

 

3) Falling Shipping Costs

The cost to ship goods internationally has fallen dramatically since last year. In 2020 and 2021, the cost of shipping from Shanghai to Los Angeles, one of the most trafficked international shipping routes, skyrocketed. Now shipping prices and congestion are alleviating, which should have the effect of reducing prices on imported goods.

Source: Charles Schwab, Bloomberg, as of 8/4/2022.

Additionally, the US dollar has risen against other currencies this year, further reducing the cost of imports.

 

4) Cooling Housing Costs

Housing is one of the stickier areas of inflation, meaning prices take longer to adjust to new conditions. It also makes up about 1/3 of the CPI basket, so it is a key area to watch. Housing is tricky because of the way it is measured in the CPI, with both rental costs and “owners’ equivalent rent” (a survey of what homeowners estimate their rent would be) playing a role. As a result, it takes time for actual rent prices to make their way into the CPI statistics. Housing prices themselves, believe it or not, don’t affect the CPI.

With interest rates having moved up, home mortgage costs for new buyers certainly haven’t fallen. However, the key to interpreting the current trend may lie in rents. Rents actually fell in 12 cities over the last month, the first time this has happened since 2020. This is a promising sign should housing costs continue to moderate.

 

5) Corporate Inventories

Sources: Charles Schwab, Bloomberg, Forbes, NBC News, MarketWatch, and Wall Street Journal as of June 30, 2022.

A big theme in this year’s market has been supply shortages turning into gluts. This can be seen in corporate inventories, with a number of major retailers reporting excesses. These higher inventories should lead to lower prices, so expect sales at your favorite retailer. However, certain items like cars still need time to normalize.

Keep in mind, the Consumer Price Index (CPI) is based on year-over-year comparisons. So, the CPI headlines may stay stubbornly high for a while when compared to last year’s lower levels. It will take several months of lower inflation before the annual CPI numbers start to really show a decline.

Additionally, the falling inflation shouldn’t be confused with falling prices. Inflation doesn’t simply mean that things are expensive; it means things are continuing to get even more expensive. For example, if gas prices are expensive and remain at $4 month to month, then their inflation rate is 0%.

The inflation problem isn’t going away today. There are still pressures that may result in higher prices in certain areas. Wages are going up (not a bad thing), but companies often pass those costs onto consumers, and there is still a housing shortage. So while we aren’t out of the woods just yet, there are signs that inflation will continue to moderate in the months to come.

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