New York, NY, June 26, 2023 ~ The current Federal Reserve Board continues to focus on the Phillips Curve framework to forecast changes in future inflation based on changes in employment and wages. This framework failed to explain the inflation of the 1970s and also failed to anticipate the 2021 spike in inflation as evidenced by the disastrous “transitory” theory of inflation. The Fed has also failed to recognize that inflation peaked in June of last year and has been rapidly declining since July of 2022.ort oil in the $75-85 range although, in our view, we are below that level as sentiment in the market is too pessimistic on China demand and the risk of recession.
In an effort to dismiss the precipitous decline in inflation, despite continued strong employment, the Fed has stated it is now focused on the “entrenched” inflation in so-called “Super Core Services” which it believes is caused by a tight labor market. We analyzed the non-shelter services (Super Core) component of CPI and quickly recognized that wages are not the key driver of most components of Super Core, particularly transportation and communication services.
In fact, the primary reason that Super Core is elevated is that auto-related services such as auto repair, insurance, and leasing have surged by an average of almost 15% over the last year as the ongoing production problems in the auto industry have produced a huge shortage of automobiles for sale.
There are currently only 134,000 new cars for sale vs. a historical average of over 800,000. This shortage has caused a surge in demand for the repair of used automobiles and caused a shortage of auto parts, resulting in large increases in the prices of auto-related services.
In order to separate the effect of Pandemic related shocks on the auto industry, we have launched the Super Core Ex Autos index (Super Core Ex Autos Index). The Super Core Ex Autos Index for the last twelve months showed an increase in Super Core of only 2.3% versus the Fed’s reported Super Core of 4.7%. This differential show that the Fed’s fears about “entrenched” Super Core inflation due to strong employment are ill-founded. In fact, a recent San Francisco Fed paper demonstrated that wages had a de minimis impact on Super Core inflation.
Projections for June and Beyond
We project that June CPI-U, CPI-R, and PPI will come in at 3.1%, .9%, and .2%, respectively, as we anniversary the peak in inflation that occurred in June of 2022. We hope that, after this data is reported, the Fed will belatedly recognize that it's aggressive tightening of monetary policy during 2022 has been successful despite the fact that employment has remained strong, and will therefore continue to pause further rate hikes. Additional rate hikes at this time are extremely risky as the regional banking industry is still fragile and the potential impacts of tightening credit conditions are not yet known.
Affects of Russion - Ukrainian War
The impact of Russian sanctions on the oil market is muted by the fact that Russia has effectively evaded the export sanctions for oil. Consequently, in our view even a regime change that ended sanctions would not impact the world oil market significantly. Russia exports approximately 8MM barrels per day, which is down only slightly from pre-war levels, and is approximately 8% of global demand. However, if there was a full-scale rebellion in Russia that disrupted production, that would likely cause a huge spike in global oil prices. Instead, the more significant impact of an end to the Ukraine war and sanctions would be on the European natural gas market, as exports from Russia would likely resume. We continue to believe that fundamental supply and demand factors should support oil in the $75-85 range although, in our view, we are below that level as sentiment in the market is too pessimistic on China demand and the risk of recession.
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