Bond Compass

PriceStats® Analysis: The Inflation Problem

A look at quarterly measures of inflation, based on prices of millions of items sold by online retailers, to help investors anticipate and evaluate the impact of inflation.

Q3 2022

Inflation: The Global Edition

The acute and spreading problem of inflation has only gotten worse since our last quarterly update. Indications that inflation persistence was spreading more broadly into the economy and starting to impact consumer expectations were enough to cause central bankers to increase their pace of rate increases.

While the Federal Reserve (Fed) proved to be the most aggressive with a 75 basis point hike in June, it was not alone in surprising the market. The Swiss National Bank raised rates by 50 bps, its first rate hike in 15 years, and the European Central Bank (ECB) is signaling that it may soon join the 50 bps club. The Bank of Japan is proving to be the only outlier, keeping to its zero-interest rate policy while rate expectations for every other G-10 country rapidly move toward neutral.

PriceStats is indicating that these policies are warranted, with inflation continuing to rise across the G-10. While nascent signs of stability are emerging, there are few signs of falling prices. Japan also remains an outlier from PriceStats’ vantage, its pricing having peaked just below 3% but more recently trending back toward 2%.

The speed of inflation gains since the start of the year has surprised many. While there is a chance prices could get back to target quickly, that is not yet evident in our online price indicators. To manage risk, it may be prudent to expect more upside surprises and possible policy divergences from here.

Signs of Normalcy Emerge in the US

Signs of Normalcy Emerge in the US

While prices in the US remain too high, there are increasing signs that food and fuel are responsible for a disproportionate share of the upward inflationary pressure.

This gets to the core of the Fed’s capability to influence demand imbalance via discretionary spending categories. The Fed has often focused on core readings of inflation that exclude food and fuel, two spending categories nearly equally driven by supply considerations. And this is certainly the case now, with the Russia-Ukraine war having a large impact on energy and food costs.

Higher prices and tighter financial conditions have already slowed demand at lower income levels, with mass-market retailers citing quickly expanding inventories as an ongoing challenge from retrenching consumers. PriceStats readings of consumer consumption categories show that while food and transportation costs remained well above 10-year averages in June, many other categories were closer to longer-term averages, suggesting a return to normalcy in at least some consumption categories.

While these results are encouraging, the outsized gains in food and fuel will keep overall inflation levels high, which in turn will continue to influence forward inflation expectations. The Fed may quickly approach a crossroads in its commitment to fighting inflation, if falling demand begins to accelerate and overall growth falls more dramatically than it predicted.

Food Insecurity Issues Intensify

Food Insecurity Issues Intensify

While the pain at the pump seems to get most of the attention, the rapid increase in food costs is likely causing an equal, if not greater, challenge to most families. This is because food is actually a much larger part of the average CPI basket globally, accounting for 13% of US spending and up to 40% in some emerging markets.

Food costs are also very visible for most consumers, which plays into consumer expectations about future prices. The challenge for central bankers is that, like with energy, they have very little influence on the dynamics of food prices, which are surging in lockstep with other commodities.

The war in Ukraine has been a catalyst, driving wheat, fertilizer and substitute crop prices higher. Inclement weather is also impacting a wide swath of countries, from droughts in the US to heat waves in India and flooding in Europe. This has raised concerns over food security, leading to rationing of exports by several countries, which in turn puts further pressure on food inflation.

We estimate that between 25% and 33% of overall developed market and emerging market inflation gains are attributed to rising food costs, a trend that remains mostly intact based on our PriceStats data. The impact of higher food prices will be felt differently by developed and emerging markets, with advanced economies better able to absorb higher costs while seeking substitutes to help defray costs.

Emerging markets, on the other hand, spend a greater portion of their budgets on food and often rely on imports, making their populations more vulnerable. Previously, this has led to civil unrest, the 2011 Arab Spring uprising being a notable example — a direct result of rising food costs. So while developed market central banks like to strip out food and energy costs from inflation forecasts, their emerging market counterparts cannot be as flexible. That may keep them hawkishly active, even as demand challenges emerge.

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