Analysis: The Fed Pressure Index has once again correctly signalled significant inflationary pressures and Fed tightening
The current sharp rise in inflationary pressures, reflects 5-6 overlapping influences. Four are COVID related (elevated goods demand interacting with – and causing – supply disruptions; increased demand for housing; tight labour markets; and reopening frictions in services sectors); a major new cost pressure has emerged from Russia’s invasion of Ukraine and the flow-on impact on energy and food prices; and finally, Australian vegetable prices have been hit by recent floods.
In this weekly, we look at some indicators that might reliably provide warning of some unwind or easing of the supply chain disruptions. We find that the ISM Supplier Deliveries Index was one of the first to reflect problems and despite easing back a little, remains at very high levels. New Orders in the ISM (which typically leads Supplier Deliveries) and Container Freight Costs have also eased a little but remain elevated.
While Supplier Deliveries have eased a little, the ISM Prices component has recently reaccelerated, likely reflecting the surge in energy and food prices after the invasion of Ukraine. The combination of Supplier Deliveries and Prices – termed the Fed Pressure Index by a former colleague – has been an excellent indicator of both inflationary pressures and Fed tightening (or easing). At present the indicator remains at extremely elevated levels (see Chart of the Week) and remains consistent with continued aggressive monetary tightening by the Federal Reserve (and by the RBA) as rates remain below neutral levels and inflation well above target levels.
In addition, central banks are now also focusing on ensuring that the current inflationary impulses do not produce a more permanent change in inflationary psychology. This would be most likely to occur if wage increases accelerated sharply, which is something of a clear risk given very low unemployment rates and elevated demand for labour. This suggests central banks will remain very aggressive in their tightening moves in the near term as they seek to set policy to achieve a path back to inflation targets over the next couple of years. NAB expects the cash rate to increase by 0.5% at the July and August board meetings.
One observation worth noting is the sharpness of the acceleration in the various pricing and supply chain indicators. This is reflective of a different type of circumstance than a normal business cycle. Typically, a business cycle might overheat over a longer period. In this cycle, it’s been more instantaneous, reflecting both supply chains and the fuel shock. There is a possibility that these influences could reverse relatively quickly, though this is not currently signalled in any of the indicators considered.
In terms of key Australian events, it’s a relatively quiet week ahead of the RBA Board meeting next Tuesday. The key indicator to watch will be May retail sales, where we have a forecast for growth to slow to +0.5% m/m (around the 0.4% consensus). Our internal data flags downside risk. It will be more important how retail sales track in coming months as interest rate increases flow through.