Inflation Rolling Over

Inflation is the number one worry for markets and any signs of inflation coming down could trigger a rally in the stock market and credit markets. The arguments for inflation coming down are accumulating: 
1) Commodity prices are trending lower
2) With China reopening and supply chains normalizing, transportation costs for goods are coming down 
3) Inventories are growing at many retailers and this is putting downward pressure on goods prices
4) Rising car production is putting downward pressure on new and used vehicle prices 
5) Airline ticket prices have been falling during June, see also here
6) Increases in rents and home prices are moderating
7) A higher dollar is lowering import prices

Inflation rolling over would also dampen recession worries because lower inflation would mean that the Fed doesn’t have to increase interest rates as much.

The bottom line is that inflation may stay elevated for another month or two, but given the trends listed above, the probability is rising that inflation going into the second half of this year could come down faster than the market currently expects.

Chart showing falling commodity prices may signal lower inflation ahead
Source: Bloomberg, Apollo Chief Economist

Stagflation a Higher Risk in Europe

Electricity prices in Germany are ten times higher than pre-pandemic levels, and the strong increase in European power prices is driven by less wind than expected, worries about the winter balance, and Germany trying to fill the Russia supply gap for natural gas, see chart below. This stagflation theme of higher inflation and lower growth is more pronounced for Europe than the US.

Chart projecting oil prices will fall to the low 80s by December 2023
Source: Bloomberg, Apollo Chief Economist
Chart showing German electricity prices are ten times higher than pre-pandemic levels
Source: Bloomberg, Apollo Chief Economist

Record-high global air traffic

Despite central banks globally raising rates, there are still no signs of a slowdown in daily global flight activity, see chart below.

Has Inflation Peaked?

Last week consumer confidence came in at its lowest level since World War II, as consumers have grown increasingly pessimistic in the face of high inflation. Looking ahead to this week, we’re watching three data releases that are important for markets: the ISM manufacturing index, home price inflation, and PCE inflation. Perhaps most importantly, we’re expecting to see core PCE inflation come down as supply chain pressures start to ease. Supply chain disruption was a key contributor to high inflation. During the pandemic, there were significant challenges with transporting goods globally, and as such container prices spiked. However, we’re now seeing container prices come down, which is a positive development from a supply chain and therefore an inflation perspective. The bottom line is we are still experiencing very elevated levels of inflation, but current data combined with supply chain improvements and declines in commodity prices provide reasons to be optimistic that inflation will decline in the months ahead.

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Tourists Are Back

Pedestrian traffic in Times Square is now 94% of pre-pandemic levels, see chart below.

Chart showing the number of average daily pedestrians in Times Square is nearly back to pre-pandemic levels
Source: timessquarenyc.com, Apollo Chief Economist

How much do supply and demand drive inflation?

This new Fed paper looks at the sources of inflation and finds that demand factors are responsible for only one-third of the increase in inflation. With supply disruptions easing, we should, over the coming months, begin to see a meaningful decline in inflation even if aggregate demand remains solid. Note also in their chart below how demand-driven inflation (=the blue bar) has already peaked. This is very important for credit and equities because what we are waiting for in markets is for inflation to start to decline from its current peak at 8.6%. 

Fed: How Much Do Supply and Demand Drive Inflation?
https://www.frbsf.org/wp-content/uploads/sites/4/el2022-15.pdf

Slowdown Watch

Our chart book with daily and weekly indicators for the US economy is available here, and the bottom line is that there are still no signs of the US consumer slowing down.

Most importantly, container freight rates continue to decline, and combined with falling commodity prices, this will put downward pressure on inflation over the coming months. With this backdrop, the probability is rising that we will soon have the peak in inflation behind us.

Other noteworthy charts this week are the increase in mortgage purchase applications and the trend increase in movie theatre visits driven by Top Gun and Jurassic World Dominion.

Chart showing container freight rates across major routes are falling
Source: WCI, Bloomberg, Apollo Chief Economist
Chart showing that a rise in weekly mortgage applications may suggest inflation has peaked
Source: Mortgage Bankers Association, Bloomberg, Apollo Chief Economist
Chart showing rising box office receipts, a sign that consumers are not slowing down
Source: Boxofficemojo.com, Apollo Chief Economist

US Consumer Still Spending

The daily TSA travel data is strong, hotel occupancy rates are trending higher, Las Vegas visitor volumes are moving higher, and Nevada casino winnings are near all-time highs, see charts below. There are simply no signs of the US consumer slowing down, and with record-high household savings, despite all the talk about inflation, it will require many more Fed hikes before the economy starts to meaningfully cool down.

Chart showing that the number of travelers at TSA checkpoints are very strong
Source: TSA, Bloomberg, Apollo Chief Economist
Chart showing strong demand for hotel rooms
Source: STR, Haver Analytics, Apollo Chief Economist
Chart showing the number of visitors to Las Vegas are nearly back to pre-pandemic levels
Source: LCVCA, Bloomberg, Apollo Chief Economist
Chart showing winnings at Nevada casinos have rebounded sharply from the pandemic and are near record highs
Source: Bloomberg, Apollo Chief Economist. Note: Winnings includes total revenue from table, counter and card games and slot machines.

Outlook for goods and services

Globalization has been reversed because of COVID, Ukraine, and sanctions. As a result, goods inflation at 10% is now significantly higher than services inflation at 5%, see the first chart.

The high level of goods inflation has destroyed demand for goods in recent months, see the second chart. But consumer services spending such as air travel, hotels, and restaurants continues to grow quickly, partly driven by revenge travel and business travel.

Looking ahead, there is more room for growth in consumer services because spending on consumer services currently makes up only 65% of total consumer spending, which is still five percentage points below pre-pandemic levels, see the third chart.

The bottom line: With high household cash balances, strong employment, and high wage growth, we should continue seeing solid consumer spending with higher growth in consumer services.