Executive Summary: Price Increases Abound; Federal Reserve Likely to Raise Fed Funds Rate to Above-Neutral Policy Levels; Some Relief Likely in Late 2022 or 2023
The Russia-Ukraine war has taken a terrible human toll and resulted in huge price hikes for energy and agricultural goods. Rising real estate prices and interest rates are stifling the demand for housing during a housing shortage in the U.S. after nearly 15 years of under-building. This in turn has caused rents to increase dramatically. Consumers are feeling the pain. In this Focus article, we do a deeper dive into the recent inflation numbers and review projections for the future.
Recent price increases may drive the Federal Reserve Bank, and other central banks around the world, to increase their policy rates faster and/or higher than once anticipated. In the US, the Fed Funds rate could increasefrom the current low (stimulative) rates to above-neutral rates by the end of 2022.
The inflation in commodity prices may reverse later this year and price declines in many categories of consumer goods should be anticipated by 2023 and 2024. However, wage increases will likely continue for 2022 and into 2023.
THE YEAR-OVER-YEAR RATE OF U.S. INFLATION IS LIKELY TO BE NEARLY 10%
On March 10, 2022, The U.S. Bureau of Labor Statistics reported the rate of inflation (Consumer Price Index for All Urban Consumers, or CPI-U) increased 7.9% year-over-year for February 2022. On March 31, 2022, the U.S. Commerce Department reported that the Personal Consumption Expenditures index, the Federal Reserve’s preferred measure of inflation, was up 6.4% year-over-year.[1] Excluding food and energy, the PCE price index for February increased 5.4 percent from one year ago.
Both foregoing reports don’t take into account the significant price increases seen in the month of March for many goods. The CPI-U data when released for March 2022 year-over- year, may be as high as 10% with the spikes in energy and commodity prices. However, inflation expectations for full year 2022 are 7.9% according to the Conference Board’s March 2022 report.[2]
OIL AND GASOLINE PRICES
On March 8th WTI crude oil spiked to as high as $129.79 a barrel from the $95.72 on February 28, 2022.[3] As of March 29, 2022 (12:24pm ET), oil is trading at $102.68 a barrel[4] – nearly $7 a barrel higher, a 7.3% increase in less than one month!
On March 29, 2022, AAA reported the national average of gasoline prices was $4.244 a gallon, up from $3.610 in February (a 17.6% increase).[5]
Joseph McMonigle, Secretary-General of the International Energy Forum (IEF), told Bloomberg on March 29, 2022, that future oil prices could spike to $150 per barrel, should the Russian oil supply worsen from imposed sanctions and limits of oil imports on Russia by the U.S. and many European countries continue or grow stronger.[6]
NATURAL GAS PRICES
Natural gas prices (Henry Hub) stood at $5.38 per btu as of March 29 (12:36pm), up from $4.40 on February 28th[7] – a 22.3% increase in less than one month. Natural gas represents about 40% of the sources to produce electricity, nationwide.[8] Electricity prices – many of which are set by state regulators – will likely increase over time.
BUT … OPTIMISM ABOUT ENERGY COSTS IN THE LONG TERM
Despite near-term rise in energy prices worldwide, there are positive long-term developments. For example, Germany is reconsidering plans to shut down its nuclear power plants, and France intends to build more.[9] The faster charging of electric vehicles (EV’s),[10] and other developments in battery technologies abound, with deployment of lower-cost solid-state battery technology in EV’s expected to occur around 2026.[11]
The oil overdependence from Russia has led to an even greater push for renewable energy technologies to be adopted and deployed over the next decade. These include projects with solar, wind, geothermal, and hydrogen technologies. Washington State passed legislation to end the sale of gasoline-powered cars by 2030.[12] The European Union is said to be in favor of banning the sale of gasoline-powered cars by 2035.[13]
Over the next few decades abundant energy will continue as renewable energy deployments, driven in large part by new technologies will be able to distribute energy at a lower cost than fossil fuel sources. Lower energy costs and other technological developments will also help provide clean drinking water more efficiently to many more homes across the world, helping to solve a world problem.
FOOD PRICES RISE
Due to the Russia-Ukraine conflict, food shortages will arise in some regions of the world, especially in parts of the Middle East, with a diminished production of wheat and fertilizer from these two countries.[14] Following a 3.9% increase in food prices in 2021, the U.S. Department of Agriculture now projects that food prices will increase 5.0% year-over-year,[15] which would be the highest food inflation rate since 5.5% in 2008.[16]
On March 28, 2022, US corn prices were $7.17 per bushel up from $6.77 in February, a 5.9% increase in less than one month.[17]
The SRW Wheat Index stood at $8.07 on Feb. 22, 2022, rising to $9.72 by March 28, 2022– an increase of over 20% in just 36 days.[18]
At the end of November 2021, the NSI National Soybean Index was at $11.82. By March 28, 2022, soybeans traded at $16.01 up from $15.87 on Feb. 28, 2022. [19]
Shortage of items at U.S. grocery stores such as milk, canned goods, cream cheese, pasta, and a few others continues.[20]
HOUSING PRICES CONTINUE TO RUN HOT
Prices for homes rose 19.2% in January 2022 from the year before, according to the S&P CoreLogic Case-Shiller US National Home Price Index.[21] Rising steel prices ($1,965 as of March 29th, up from $1,579 as of the first of the year)[22], volatile lumber prices (ranging from an estimated $9435 to $1,464 this year, now at $1,035)[23], and rising labor costs have all contributed to an increased cost of new home construction.
Yardi Matrix estimates that nationally apartment rents grew by $10 a month in February 2022, to a record national average of $1,628 a month – up 15.4% year-over-year. Rent increases varied significantly, with rent prices increasing faster than the national average in Florida, Phoenix, Las Vegas, Austin, L.A., Raleigh, Nashville, Atlanta, Charlotte, and Dallas.[24]
Are we in a “bubble” of housing prices? A report from the Dallas Federal Reserve Bank, issued on March 29, 2022, suggests that “housing … prices are out of step with market fundamentals … [R]eal house prices can diverge from market fundamentals when there is widespread belief that today’s robust price increases will continue. If many buyers share this belief, purchases arising from a ‘fear of missing out’ can drive up prices and heighten expectations of strong house-price gains … [However, based] on present evidence, there is no expectation that fallout from a housing correction would be comparable to the 2007–09 Global Financial Crisis in terms of magnitude or macroeconomic gravity.”
COVID-19 WORRIES PERSIST
At the present time, cases from the (first) Omicron variant have waned in much of the country. Yet, the risk to the economy persists, primarily (at the present time) from the increase in cases of the Omicron BA.2 subvariant – which now accounts for over 50% of new cases in the U.S.[25] Another surge in cases is possible, although some experts believe it won’t be as large a surge as seen in January and February of 2022.[26]
Several cities in China have gone into lockdowns, affecting the manufacture of goods and causing further disruptions in the global supply chain.[27] Cases also recently surged in South Korea, New Zealand, Vietnam, Australia, Hong Kong and Singapore.[28] These disruptions to manufacturing are likely to increase inflationary pressures, as the supply of certain goods diminishes.
On March 28, 2022 the U.S. Food and Drug Administration just approved a second booster (of either Modern or Pfizer/BioNTech) for persons ages 50 or older, plus immunocompromised persons age 18 or older.[29]
“LONG COVID” IS REAL – AND MORE WIDESPREAD THAN PREVIOUSLY THOUGHT
The impact of COVID variants upon health remains a concern preventing some adults from re-entering the workplace. Indeed, recent studies have documented long-term cognitive declines in nearly a fourth of all of those who contracted COVID-19, regardless of the severity of the initial disease.[30] The impact of these brain injuries over the very long term is unknown, but it does appear that millions of individuals in the U.S. will require ongoing care due to past COVID-19 infections.[31]
With some of those with long Covid likely disabled fully, and others seeing employment hours reduced as they battle ongoing symptoms, increased pressure on the labor markets results, which in turn can drive up wages – and inflation.
LABOR SHORTAGES PERSIST
In February, there were 1.8 openings for every unemployed worker.[32] Available jobs unfilled has contributed to the rampaging inflation, as many companies have had to raise pay to attract and keep workers. Over the 12 months ending in February 2022, the U.S. had a net employment gain of 6.4 million workers, [33] while job openings remained elevated, at 11.4 million.[34]
Before the start of the COVID-19 pandemic, there were usually more unemployed people than job openings.[35]Examining the ongoing causes of the decline in the number of workers:
- Early retirements account for about one-half since the start of the pandemic.
- Fears of COVID-19 turning into a long-term debilitating medical condition continues to keep some US workers at home.
- Day care services in certain areas have not fully rebounded keeping healthy parents of small children at home and not re-entering the labor force.[36]
FEDERAL RESERVE (FED) MAY HIKE INTEREST RATES QUICKER AND FURTHER
The “Fed Funds rate” is the overnight rate banks charge each other and with inflation running well above the FED’s 2% target, and “maximum employment” achieved more rate increases may occur.
The CME Group FedWatch Tool estimates a 71% probability of a rate hike of 50 basis points (0.50%) at the FED’s May 4, 2022, meeting. [37] The consensus is a target Fed Funds rate of between 2.25% and 3.00% by the end of 2022.[38]
Increased demand for goods from U.S. consumers has led to shortages due to the disruption of global supply chains brought on by the pandemic. Presently the global supply chain disruption has slightly abated, but it may take years for spending on services to rebound, and the demand for goods to decline back to historical levels. Should new COVID-19 variants emerge this could keep consumers out of restaurants, travel destinations, and entertainment venues.
If the labor shortages in the US continue, the increased deployment of technology since the start of the pandemic should continue. The adoption of technology accelerated productivity growth in 2021 to about 2%,[39] boding well for the U.S. economy in the long term and lessening the likelihood of a wage-price spiral.
Indeed, the Federal Reserve Chairman notes that one way to contain inflation is to reduce the number of jobs. He added that the FED hopes to reduce the number of available jobs as a way to cool wage increases and price inflation.[40]
Odd for a federal policy to desire a reduction in the number of available jobs. Yet, this is the strange and rapidly evolving economic world we now find ourselves inhabiting. Maybe, it’s why economics is often called “the dismal science.”
IN CONCLUSION
The present overheating of the U.S. economy will wane as both fiscal and monetary policy shifts from stimulative effects to an attempt to make a “soft landing.” There is no doubt that the Russia-Ukraine War has caused major disruptions across the world. We can only hope that a just peace will emerge, so that the suffering of millions of those affected can be ameliorated.
Wages will rise over time, hopefully enough to keep pace with inflation.
The current high rate of inflation, which over time erodes standards of living, should moderate by late 2022 and into 2023.
[1] Bureau of Economic Analysis, U.S. Department of Commerce, “Personal Income and Outlays, February 2022” (March 31, 2022 release.)
[2] Jordan Yadoo, “U.S. Consumer Confidence Rebounds Slightly on Firm Job Market,” Bloomberg (March 29, 2022).
[3] Markets Insider, Oil (WTI), from Business Insider (retrieved 3/29/2022).
[4] Id.
[5] AAA, National Gas Prices, retrieved 3/29/2022.
[6] Tsvetana Paraskova, “International Energy Forum: $150 Oil is Possible,” OilPrice.com (March 29, 2022).
[7] Markets Insider data, from Business Insider (retrieved March 29, 2022).
[8] Natural gas accounted for 40% of total utility-scale U.S. electricity generation by all sectors in 2020. U.S. Energy Information Administration, “Natural gas explained” (retrieved 3/29/2022).
[9] John Mauldin, “Things Are Getting Better,” Thoughts from the Frontline (blog) (March 25, 2022).
[10] See, e.g., Joe Wiesefelder, “Do the 2022 Hyundai Ioniq 5 and Kia EV6 Really Have Faster Charging Times Than Other EVs?,” Cars.com (March 22, 2022).
[11] See, e.g., Adrian Padeanu, “Toyota Confirms Production Car With Solid-State Battery On Sale By 2025,” Motor1.com (Jan. 7, 2022).
[12] Shirin Ali, “Washington state sets target to end gas sales by 2030,” TheHill.com (March 28, 2022).
[13] Steve Hanley, “Germany Gets on Board with EU ICE Ban,” CleanTechnica (March 18, 2022).
[14] Joel K. Bourne, Jr., “War in Ukraine could plunge world into food shortages,” National Geographic (March 25, 2022).
[15] Chuck Abbott, “USDA Says Food Inflation Rate to Soar, Highest Since 2008,” Successful Farming (March 28, 2022)
[16] Id.
[17] Source: Progressive Farmer (DTN), retrieved March 29, 2022.
[18] Id.
[19] Id.
[20] Sarah Wong, “6 Grocery Items Still Facing Shortages,” EatThis.com (March 6, 2022).
[21] S&P Dow Jones Indexes, retrieved March 29, 2022.
[22] Source: MarketWatch, NYSE American Steel Index, retrieved March 29, 2022.
[23] Markets Insider, Lumber prices (Business Insider), retrieved March 20, 2022.
[24] Yardi Matrix, National Multifamily Report (Feb. 2022).
[25] Kenny Holston, BA.2 version of omicron is now dominant variant in U.S., CDC says,” NBCNews (March 29, 2022).
[26] Ariel Cohen, Lauren Clason, Sandhya Raman, and Jessie Hellmann, “Administration, health experts nervously eye new virus variants,” The Hill (March 30, 2022).
[27] Rhoda Kwan and Miyasha Nulimaimaiti, “‘No easy exit’: Omicron outbreak tests China’s anti-Covid strategy,” NBCNews (March 30, 2022).
[28] Julia Hollingsworth Graphics by Henrik Pettersson and Krystina Shveda, “They were Covid-19 success stories — then they saw massive outbreaks. These charts show what’s really going on,” CNN Phillipines (March 31, 2022).
[29] Eric Sagonowsky, “Pfizer, Moderna win over FDA for second round of COVID-19 boosters in older adults,” Forbes (March 29, 2022).
[30] William A. Haseltine, “Covid-19: Long Term Brain Injury,” Forbes (March 14, 2022).
[31] Id. Professor Haseltine concludes: “Our social support systems must recognize Covid-19 related long-term disability as a reality and assure those who suffer are protected. It is now clear that our encounter with Covid-19 will not fade with the pandemic but will endure for decades.” For additional observations, please visit https://www.forbes.com/sites/williamhaseltine/2022/03/14/covid-19-long-term-brain-injury/?sh=331ecca5454c.
[32] Christopher Rugaber, “US job openings, quitting at near record high in February,” OPB (March 29, 2022).
[33] U.S. Bureau of Labor Statistics, Job Openings and Labor Turnover (released March 29, 2022)
[34] Id.
[35] “U.S. job openings, quitting at near record high in February,” Associated Press (March 29, 2022)
[36] Daniel Bachman, United States Economic Forecast, Deloitte® Insights (March 17, 2022).
[37] See https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html.
[38] See https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html.
[39] Daniel Bachman, United States Economic Forecast, Deloitte® Insights (March 17, 2022).
[40] “US job openings, quitting at near record high in February,” Associated Press (March 29, 2022).
Dr. Ron A. Rhoades serves as Director of the Personal Financial Planning Program at Western Kentucky University, where he is an Associate Professor of Finance within its Gordon Ford College of Business.
Called “Dr. Bear” by his students, Dr. Rhoades is also a financial and investment adviser with Scholar Financial, LLC. To request further information about Scholar Financial, LLC’s fees and services, please email AdvisorINFO@ScholarFinancial.com. Thank you.