Market comment 2022

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Recently, some analysts have begun to explore the idea that inflation may moderate in the coming months. But this decline likely won't be due to the efforts of the Powell Fed. It “increasingly looks like markets mistook [the] 'bullwhip' effect of supply chain (including food) for secular inflation,” Tom Lee, Fundstrat’s head of research, wrote in a note Sunday. The “bullwhip effect” describes, roughly, the tendency of businesses to over- or under-estimate the amount of inventory they will need relative to consumer demand, resulting in volatility in orders across the supply chain. 

In the case of the past year, retailers over-estimated, leading them to broadly over-order from wholesalers, who then in turn over-ordered from their own suppliers – leading, in aggregate, to a major mismatch between consumers’ actual demand and inventories on hand. The bloated inventory levels at Walmart (WMT), Target (TGT), Gaps (GPS) and other retailers this past earnings season served as recent examples of how this effect played out in real-time. “I do not believe companies want to permanently carry higher inventory. It is expensive … and introduces huge balance sheet risk,” Lee said. “Thus, companies will want to trim inventories when supply visibility improves. The logical implication, for me, is prices will come down.”

“June is bound to see another big jump in the headline index, thanks to the surge in gas prices in recent weeks, but the abrupt drop in wholesale prices … means that retail gas prices are set to fall quite sharply over the next few weeks,” Ian Shepherdson, chief economist at Pantheon Macroeconomics, wrote in a note. “At the same time, core pressures are starting to moderate, thanks mostly to slower wage growth at the margin, so we would be surprised to see the core CPI keep rising at the recent 0.6% per month pace.”

Shepherdson said he expects headline CPI to rise by 1.0% in June but then average an only 0.3% rise over the next few months thereafter. And this could then give the Fed leeway to slow its pace of tightening by the end of this year, he argued, even as it refuses to budge from its hawkish rhetoric for now. “Policymakers know very well that the path of inflation, especially the core rate, over the remainder of this year mostly is baked-in and is impervious to their interest rate decisions. Monetary policy works with long lags,” Shepherdson said.

Inflation will probably fall, but it won't be the Fed's doing: Morning Brief