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Market News Long-term commodities determine short-term inflation. Why does the Fed believe that inflation is temporary?

Long-term commodities determine short-term inflation. Why does the Fed believe that inflation is temporary?

The Fed blamed the increase in inflation on unusual increases in the prices of durable products such as automobiles and electronics, saying it will not continue. Fed Powell argued that the rise in the inflation rate in the United States was mainly driven by temporary factors unique to the epidemic.

2021-09-13
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Fed Chairman Powell believes that the increase in inflation rate is mainly caused by temporary factors unique to the new crown epidemic. In a speech hosted by the Kansas Federal Reserve at the end of August, Powell provided more details about his thoughts. He specifically pointed out that, relative to the moderate increase in service prices, the sudden increase in durable goods prices proves that inflation will inevitably fall back to the Fed’s 2% target.



Two factors have driven the continued decline in U.S. durable goods prices for 25 years


For decades, Americans have enjoyed falling prices for cars, electronics, and furniture. Until the outbreak of the new crown epidemic. In the past year, the price of durable goods has been rising sharply. When the Fed is planning how to respond to an unexpectedly strong inflation burst, whether these prices will fall is a key part of the puzzle it faces.

The overall consumer prices of comprehensive services and goods have risen at an average annual rate of 1.8% for the past 25 years, until the outbreak of the epidemic. This increase was driven by rapidly increasing service costs, during which service costs increased by an average of 2.6% per year. The prices of durable goods (durable goods have a design life of at least three years) are just the opposite. According to the Personal Consumer Expenditure Price Index of the US Department of Commerce , the price of durable goods has fallen by an average of 1.9% per year from the beginning of 1995 to the beginning of 2020.

Powell cited several forces that have pushed the prices of durable goods down. One is globalization: competition from other countries, and some manufacturers outsource production. As a result, the cost of parts and products has dropped. The other is technology. New software and more advanced machines enable factories to produce products in a shorter period of time with less manpower, reducing their own costs, which ultimately translates into lower prices. More efficient transportation also reduces costs.

In contrast, prices in the service industry have continued to rise, including most consumption such as haircuts, doctor visits, and tax returns. Because they are the default labor-intensive industries, the productivity of these industries is not as high as that of factories.

Durable goods are soaring faster than service prices under the influence of the epidemic


The epidemic has reversed this situation, and durable goods have become a major driver of inflation. According to data from the US Commerce Department , the overall consumer price index (CPI) rose 4.2% in July from a year earlier. Prices of durable goods have risen by 7%. This is twice the 3.5% increase in service prices.

Powell said that at least 1 percentage point of the latest increase in the inflation rate is due to the soaring prices of durable goods. Rising prices of durable goods have an even greater overall impact on “core” inflation, which does not include food and energy prices. Data from the Federal Reserve showed that for the 18 months ending in June, the core inflation rate, excluding durable goods, was 2.2%, not far from the 12-year average of 2%.


(Inflation level-yellow; excluding food, energy and durable goods-blue)

There are two reasons for the increase in demand: the government has put a lot of money in the hands of consumers through multiple stimulus plans. Consumers are trapped at home and have fewer opportunities to travel, eat out, and visit museums. Their consumption has shifted to durable goods, many of which can be shipped without human contact. Researchers from the Cleveland Federal Reserve have found that the shift to services caused by economic stimulus and lockdowns has played an equal role in the growth of durable goods spending.

Family spending on sofas, cars, and kitchen appliances has increased. Companies have been struggling to transport supplies and produce products at a sufficiently fast speed due to lack of manpower and caught off guard against the surge in demand. The global chip shortage interrupted shipments of notebook computers, printers and cars. Labor and equipment shortages have caused delays in furniture delivery.

Although the price once soared, it may have begun to fall


Other data show the impact of the epidemic on prices that have experienced long-term deflation. Take second-hand cars as an example. In all car purchases, second-hand cars account for the majority. Their prices peaked in 2001 and then declined. According to the US Labor Department's Consumer Price Index (CPI), as of February 2020, the consumer price index has fallen by 14% from its historical high.

By the summer of 2020, the price of used cars will begin to rise sharply. In the year to July, this number has risen by 42%. Of the dozens of major product prices tracked by the Labor Department, only gasoline prices have risen faster.

The computer followed a similar trajectory. Before the epidemic, prices had fallen rapidly for 20 years. Then, during the epidemic, they began to rise. In June 2020, they experienced annual growth for the first time. In July of this year, the index soared 3.7% from the same period last year. From January 2000 to January 2020, house prices fell by 16%. Since February 2020, furniture prices have also risen by 7%.

Powell believes that once shortages, supply bottlenecks, and demand ease, prices will fall, or at least stop rising sharply. This situation may have already happened. Durable goods prices rose only 0.3% in July from the previous month, down from 1% in June and 2% in May. Second-hand car prices also rose slightly, and furniture prices fell for the first time since January.

In his speech by the Kansas City Fed, Powell said: "As the supply problem begins to be resolved, with the exception of automobiles, the inflation of durable goods has now slowed and may begin to fall. It seems unlikely that durable goods inflation will continue to correct over time. Overall inflation makes an important contribution.” He also said that he believes that the long-term factors that have driven down durable goods prices in the past — globalization and technology — will not disappear.

There are still important prerequisites for the fall in inflation, and the rise in energy and food prices cannot be ignored


Powell’s expectation that durable goods and inflation will fall has an important premise, that is, as the epidemic is brought under control, the market and price system will return to what they were before the epidemic. However, some analysts worry that the impact of the epidemic and soaring prices have brought irreversible changes to the market.

Inflationary pressures may be more severe and last longer than Powell said. As of July this year, as a non-durable commodity, the price of gasoline has risen as fast as the price of used cars. JPMorgan Chase said in a report last week that global food price increases are accelerating and may continue.

Service industry inflation may also rise. As one of the largest components of consumption, house prices and rents are rising rapidly. Employers in labor-intensive service industries are facing higher labor costs, and they may have to pass on through prices. In addition, the shipping network may also change. Companies may decide to purchase parts from other countries with higher labor costs or domestically in the United States, which may lead to price increases in the long run.

At present, inflation is undoubtedly the most concerned topic in the financial market. Although the market tends to believe the Fed's statement that inflation will fall, investors should also pay close attention to further trends in energy and food prices. Once the high prices show signs of irreversibility, the Fed may have to tighten monetary policy as soon as possible, which may bring new shocks to the market.
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