How long will it take for commodity slide to cool inflation?

This analysis is from BloombergNEF. It appeared first on the Bloomberg Terminal.

Background

The Bloomberg Commodity Spot Index fell 20% from its June high to its July low on concern economic growth will falter in the U.S., Europe and China. That sentiment could take months to result in lower consumer prices, given ongoing supply challenges and wage pressures.

That uncertainty is causing tension. “There’s an intense tug-of-war happening in the economy and markets,” Dan Suzuki, deputy chief investment officer at Richard Bernstein Advisors, told Bloomberg. How the Federal Reserve responds to that tension remains to be seen, but some experts believe rate hikes are likely.

“[T]his is the time to be raising rates to try to stem the inflation expectations and inflation under the system,” said Randall Kroszner, a former governor at the Federal Reserve, in an interview with Bloomberg Surveillance.

The issue

While commodities accounted for more than half of inflation in the U.S. in June, there are signs that prices for downstream goods and services are also being driven higher. Yet slower economic growth and higher prices are starting to erode demand for raw materials.

Energy at 3.0%, food at 1.4% and other commodities at 1.5% were the most significant contributors to headline CPI of 9.1% in June. The Fed indicated after raising its benchmark rate by 75 basis points on July 27 that it will eventually slow the pace of rate increases, noting that some indicators of spending and production “have softened.”

Fuel and food price surges fed into higher costs for clothes, lodging and travel. But deflationary forces are reappearing in manufacturing sectors such as televisions and phones as supply chains reopen after the pandemic. Lodging costs appear to have peaked, as high gasoline prices scuppered some road trips.

Tracking

Fuel and food price surges fed into higher costs for clothes, lodging and travel. But deflationary forces are reappearing in manufacturing sectors such as televisions and phones as supply chains reopen after the pandemic. Lodging costs appear to have peaked as high gasoline prices scuppered some road trips. It is worth keeping an eye on the downtick for fuel and air fares.

The US natural gas market hasn’t been left unscathed by uncertainty over Russian pipeline supplies and the bidding war between Europe and Asia for liquefied natural gas.

U.S. gas inventories (orange) held in underground caverns and depleted aquifers stood at 2,400 billion cubic feet as of July 15, about 340 bcf below the five-year average for that time of year (dotted white).

BloombergNEF analyst Enrique Gonzalez writes that while the summer may be dominated by hotter-than-normal weather and strong power burns, slower economic growth and the Freeport LNG terminal shutdown may allow storage to be partially replenished. However, 92% of historical weather scenarios keep inventories below five-year average levels for end-of-summer 2022, he wrote.

While forward markets see gas prices falling after this winter, they may remain elevated for many years.

While gas prices (amber) are seen falling rapidly by this time next year, after a tough winter, they are priced to remain significantly above year ago (blue) expectations all the way out to 2026. The pattern is similar for the European benchmark. LNG exports, Russian flows and curbing consumption are crucial to keeping prices under control.