Moderating inflation across the global and domestic economies has been driven by declining costs of goods, which through December fell by 4.8% on a three-month average annualized basis.
We now think it appropriate that the Fed consider a strategic pause in its rate increases.
While there are risks around further disruptions to global supply chains linked to the surge in COVID-19 cases in China, for now this is a positive and constructive development that will bolster overall economic activity.
We now think it appropriate given large declines in the primary causes of inflation over the past two years that the Federal Reserve consider a strategic pause in its price stability campaign this spring.
Much of the improvement in the inflation outlook has to do with the collapse in transportation costs and year-over-year declines in the price of oil and energy.
It now costs 78% less to ship a container from China to the United States than it did last year. Shipping costs from Shanghai to American seaports reached a peak last January, decelerated during the first half of the year and have plunged since June.
The decline in transporting goods from China to the United States has coincided with general improvements in the supply chain.
The latest reading of the RSM US Supply Chain Index stands at 0.4 standard deviations above neutral and is indicative of the modest normalization of global supply chains that is taking place.
In particular, there have been a normalization of the inventory-to-sales ratio and outsized increases in wholesale and retail inventories, all of which imply a greater supply of goods and lower prices.
Considering that there remain shortages of components (particularly computer chips) and assuming a somewhat lagged response of retail prices to increases in inventories, the monetary authorities can anticipate uneven reductions in the prices of goods.
Jabil, an electronics manufacturing services company, estimates a half-year wait for basic computer chips and up to a full year for high-end chips, with easing to take place over the course of the year.
The takeaway
The increased supply of consumer goods implies a further decline in inflation that needs to be factored into the setting of the federal funds rate.
We anticipate that a 25 basis-point increase, as opposed to a 50 basis-point increase, is now under consideration ahead of the Federal Open Market Committee’s policy decision on Feb. 1.
