The most recent consumer price index (CPI) report puts inflation at 9.1%, an unsustainably high rate for prices to keep rising. While there’s no news yet on what the July report will bring, there are positive signs all over the economy that the country is avoiding a recession and inflation is starting to cool.
Commodities Are at the Tip of the Anti-Inflation Spear
Fuel has been the biggest driver of overall inflation for months, with the average price per gallon peaking above $5 in June — but that was then.
“We’re already seeing gas prices decrease, which is a positive sign,” said Andrew Rosen, CFP, financial advisor and president of Diversified LLC.
As of Aug. 5, the cost per gallon has fallen for 51 days straight. Gas prices are, of course, tied to oil, but oil isn’t the only commodity that has seen prices fall for weeks on end. According to the Wall Street Journal, the cost of natural gas, wheat, corn, lumber, copper, cotton and other raw materials spent the summer in a state of freefall. More recently, the World Bank reported the same trend on a global scale, with the price of food, fertilizer, agriculture products, metals and energy dropping worldwide.
“We’re seeing decreases in commodities and raw materials,” Rosen said.
One theory is that inflation has likely peaked and that the commodities market is the first domino to fall — and that the current trend in raw materials will soon drag down prices economy-wide.
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Prices Will Fall First in Fed-Adjacent Parts of the Economy
Just as in the early 1980s, the Federal Reserve has wielded interest rate hikes like a battle ax to fight today’s inflation. Back then, success came at the cost of a major recession. So far in 2022, the economy has avoided that outcome despite multiple hikes that increased the Feb’s borrowing rate from near zero at the start of 2022 to 2.5% today. According to CNBC, Fed officials predict combined increases of another 1.5% before the year is over.
Naturally, the ripple effects of economic cooling will emanate from that starting point.
“The segments that are most impacted by what the Fed can control will get relief first,” Rosen said.
Housing is the industry most directly in the Fed’s line of fire. With mortgage rates around 5% — they had been approaching 6% — homebuyers can afford far less house than just a few months ago. Although home values are still high and the market has proven resilient, prices cooled at a record pace in June and inventory flooded the market at the highest rate in 12 years, according to mortgage data firm Black Knight.
The Cost of Goods and Services Will Drop — In That Order
When prices do finally cool off, they’re likely to fall first among businesses that sell things followed by those that do things.
“The goods part of the economy should get relief faster than the services side,” said Gene Goldman, chief investment officer of Cetera Investment Management.
He cited three reasons:
During the pandemic, stay-at-home consumers shifted spending from services to goods, causing goods inflation to surge to half of the overall CPI. Today, supply chains have recovered and people have already purchased most of the things they need, which is forcing prices down.
The Fed’s rate hikes and the threat of a recession have forced consumers to reduce spending on goods.
Services-related inflation will remain elevated as post-pandemic consumers pursue travel and other experience-related spending.
It’s Not a Question of If, but When and How Far Prices Will Fall
Between commodities, housing and the goods sector, there are plenty of reasons to be optimistic — but there are still too many unknowns to make hard-and-fast predictions.
“Inflation will go back down, the question is what it will take to get us there,” Rosen said. “How much interest rates will need to increase, what will happen to consumer spending and earnings along the way, and how global events such as the war in Ukraine play out.”
While relief appears likely on the horizon, that horizon probably extends to the end of next year.
“Projected inflation levels over the next five years range from 2.3%-2.9%, so prices shouldn’t stay elevated as they are indefinitely,” Rosen said. “We expect to see decreases across the board as we go into 2023 and should hope to end 2023 around 3% inflation.”
Until Then, Consumers Are Keeping Their Belts Tight
Many households emerged from the pandemic in rough financial shape, and the worst inflation in 40 years only squeezed budgets even tighter.
“Consumers are becoming more aware of how these pricing hikes impact their daily lives,” said Vipin Porwal, consumer expert and CEO of the online shopping platform Smarty. “It’s clear that the extreme upswing of costs has made consumers take a second look at what they’re spending.”
He cited his company’s own research on inflation and consumer behavior, which showed that consumers are most likely to fend off inflation by:
Putting off the purchase of a car
Avoiding expensive specialty food items like avocados
Not buying new clothes
Eating and drinking at bars and restaurants less frequently
Stockpiling nonperishables like laundry detergent, cleaning supplies, water and paper products
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