With the rising costs of goods and services due to inflationary pressures, it's important to put inflation into the proper context. For some of us, the rising costs have not substantially hurt our pocket books. We look at the price of gasoline as we are filling up our tanks and we shake our heads. But for many others, this is not the case at all. For many others, this is becoming an unbearable situation. The current administration and the Fed are doing little to help ease inflationary pressures. What we've heard over the last 12 months is that it's "transitory" or that it's someone else's fault (i.e., OPEC).
It's somewhat reminiscent of the famous statement attributed to Marie Antoinette, who said "Let them eat brioche" after being asked about her subjects not having enough food to eat. Interesting trivia - the quote is up for debate as to whether Antoinette actually uttered the phrase or someone else in King Louis' court spoke the words. The French quote is often mistranslated to "cake" when in fact it was "brioche." That doesn't change the general meaning, as brioche was still a food of the wealthy at that time. Antoinette, whether she uttered the famous quote or not, was tone-deaf as to the plight of her subjects. She lived an extremely extravagant lifestyle and was opposed to social and financial reforms. Had she been more sensitive to her subjects, she might have avoided the guillotine. If the current administration doesn't shift gears, it might find itself out of a job faster than expected. Here's what we're seeing this week...
Inflation Is No Laughing Matter. People in financial services often talk about inflation in fancy-sounding terms and acronyms, like CPI, that mean nothing to those outside of our industry. However, when we put inflation into a perspective that can be easily understood by the average consumer, the light bulb starts to flicker.
For example, the median annual U.S. household income is $67,521. After federal, state, & local taxes, that comes to around $53,110 take-home wages. One year ago, as the average price of gasoline was $2.10, filling up your tank weekly was approximately $40. For this particular household profile, gasoline (assuming two family vehicles) would comprise about 8% of the family's annual budget. Fast forward to today, as the average price of gasoline is $3.45, and the new cost of filling up the family vehicles is about 13% of the family's annual budget. Since we need to drive to accomplish certain tasks in life - work, education, etc. - it doesn't take a rocket scientist to figure out consumers will start to make difficult decisions when it comes to their discretionary spending should gas continue to rise.
Gas is only one element of inflation and it would appear, based on the most recent Consumer Price Index released this week, that Producers are starting to pass higher costs onto consumers. While the PPI (blue line) has flattened slightly, CPI (orange line) has begun to increase and is starting to catch up to PPI. The market was looking for a 0.6% increase in CPI month-over-month, but the October print was +0.9%.
The tone-deaf response from this administration is a bit alarming as there are things that could be done to alleviate some of the pain from inflation. In the early days of this administration, the Keystone Pipeline was shut down.
The current pipeline still exists from Alberta, Canada to Port Arthur, TX. It carries 550,000 barrels of oil from Canada to the U.S. daily. The proposed line that was cancelled was going to bring 830,000 barrels of oil daily from Canada to the U.S. (+280,000 additional barrels daily)!!! Given the fact that the Biden administration has been documented asking OPEC to increase output multiple times this year, the Keystone cancellation seems vital to oil prices. When interviewed by Bloomberg late last week, Energy Secretary Jennifer Granholm was asked what her plan was to increase oil production in America. This was a timely question, especially since OPEC has been unwilling to increase production. The Energy Secretary's response to the question was laughter as she stated, "That is hilarious. Would that I had the magic wand on this." Seems like resuming the Keystone Pipeline construction would be an easy fix. But, almost as important, is the tone-deaf attitude of this administration for those families with median income who's annual budget just got cut by 5% due to higher gas prices. What's more, the Biden administration is studying the impact of shutting down the Embridge Line 5 pipeline. For some perspective, that pipeline pumps 23 million gallons of oil a day from the Straits of Mackinac (Michigan) into the rest of the U.S. What do you think would happen to the price of oil if that pipeline ceased operations?
This is not to say that we shouldn't pursue some forms of green energy. I'm a big fan of the Tesla. However, the base Model 3 (the least expensive Tesla) costs $43,000 with no special options. If we use the family profile above, a 5-year loan on a Model 3 Tesla would account for 18-19% of the family's annual budget - and that's just 1 car (note, most families are 2-car families). However, a new Honda Accord or Toyota Corolla that is not electric, but requires gas, is only $25,000. A 5-year loan on that vehicle is much lower and would only comprise 11% of said family's annual budget. So, until the technology improves and costs come down (which given the rate of inflation that's not likely in the near future), electric or "green" energy is not feasible for every demographic. Again, this smacks of being tone-deaf and along the lines of Marie Antoinette, i.e., not understanding basic economics for the median U.S. household.
Fed Moving On From Powell? At his press conference during the global warming summit in Scotland last week, President Biden was asked if he was planning to renominate Jerome Powell as chairman of the Fed. The President decided to avoid the question. However, two days later, back in D.C., Chairman Powell was seen meeting at the White House with President Biden and Fed governor Lael Brainard.
This is important as Brainard is an uber-dove when it comes to monetary policy. In fact, the table we highlighted a few weeks ago shows she is nearly the most dovish member of the current Fed board. She is certainly the most dovish member with current voting rights. If she were to be nominated, an interest rate hike could be further off in 2022 or not until 2023. This would be a policy mistake if the shipping crisis and inflation are not subdued or improving by March of next year. Recent comments by J.P. Morgan illustrate the current Fed policy as problematic, "The open mindedness and lack of conviction from the Fed means that rates markets will be freer to reprice in response to incoming data." The new Infrastructure bill is likely to add to inflationary pressures as spending is likely to increase at the federal and state levels. The U.S. Chamber of Commerce has stated that the Reconciliation Bill yet to be voted on actually has a much higher price tag than the $1.75 trillion advertised. One way of disguising the true cost of the bill is that certain provisions of the bill expire, but could be extended upon expiration. This makes the total amount look small than it will be in reality. If we were to see the closure of the Embridge Line 5 pipeline and thus, a delay of interest rate hikes by new Chairwoman Brainard, along with the passage of the Reconciliation Bill, that could spell a disaster for inflation and force consumers to the sidelines. We will need to watch this situation carefully.
Some Help In The Shipping Crisis? There's some good news on the supply chain front. According to GM, the automaker is seeing better "flow" of semiconductor chips into their factors and that "most" of assembly plants in North America are back to operating at normal production levels. That's great news as you've likely noticed bare auto lots as you drive past.
That doesn't mean, though, that the shipping crisis is over yet. There are more than 100 container ships anchored off the Long Beach / LA ports. The situation at the ports has not improved, but has worsened. When the shipping crisis first became a major story, there were 30 or so ships parked off the coast. That number has nearly quadrupled in just 4 months. Before we would declare any real progress made in the crisis, the number of anchored ships would need to drop in half.
The Baltic Global Dry Index ($BDI) had declined by 52% since the beginning of October, which was positive news in terms of producer costs, but it has since resumed moving higher (+5% over the last week). Much of the drop in the BDI was related to cancellations of shipments from China & India due to COVID restrictions and the backlog at U.S. ports. According to Freightos, there is also some evidence of easing demand in Asia-US ocean shipments.
How Long Does The Consumer Remain Strong? This is the critical question with regard to future growth. Earlier this week, markets pulled back on concerns that inflation would hamper future growth prospects. If demand is indeed dropping in overseas imports, that would be a bad thing.
The U.S. consumer comprises two-thirds of US GDP. The expectation is that the U.S. consumer will help lift growth as we finish the 4th quarter. The market is expecting Retail Sales for October to come in at +0.7%. The Chicago Fed’s weekly estimate of retail activity has risen every week since September 7th and has also been relatively stable with the exception of February of this year. Finally, 4th quarter GDP is expected to come in much higher than the 3rd quarter.
The Atlanta Fed’s GDPNow estimate is for an increase of 8.2% in the 4th quarter. It’s next year that begins to become a concern. If inflation stays at its current growth rate, at what point do consumers abandon discretionary spending in lieu of essentials? Inflation has averaged +0.5% each month for the past 12 months. If that trend continues into next year, year-over-year inflation would end up around +12% by the end of 2022. At that point, we would expect some significant adjustments in consumer behavior. You could expect consumer staples and energy to be the primary focus of spending in the average U.S. household.
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