NORTH AMERICA OUTLOOK

Inflation Is The Focus

by Dr. Chris Kuehl

There has been a great deal of moodshifting as 2023 gets underway. At this juncture, it is as easy to find a pessimist predicting a deep and prolonged recession as it is to find an optimist asserting the downturn will be mild. Why the variability?

The easy answer is that some very significant motivators for the overall global economy have started to change, and nobody is quite sure how real these changes are. The fundamental question through all of 2022 was what to do about inflation. The rate had exploded to levels not seen in 40 years, and at this stage, the numbers are still high but not as high as they have been. The assertion is that global inflation started to peak in the fourth quarter of last year, and the data suggests that this is true. The latest CPI showed inflation down to 6.5%, and just about a year ago, it was at 9.2%. The wholesale inflation rate fell by .06 when the expectation was for a fall of about 0.1%. There have been declines in the producer price index, commodity prices, and even shipping rates. The inflation rate is by no means low – the Federal Reserve watches the performance of the PCE (Personal Consumption Expenditures), and it has dropped to around 4.5% (their target is 2.0% to 2.5%). Why does all this matter to the manufacturer? Beyond the obvious reason that it means that prices for inputs are slightly lower, there is the connection between inflation and the interest rates that are set by the central banks. The Fed has indicated that it will slow and even halt hiking rates when it determines it has done enough to break the back of inflation. Has that point been reached?

Generally, the central banks (including the Fed), use employment as their indicator, but the job market has been skewed by the chromic worker shortage. This has been very obvious in the manufacturing sector. By this point, many in the industrial community would have been laying people off, but they are reluctant to lose the trained and skilled people they had to work so hard to find. This has meant a delay in the employment gauge, and the banks are looking at other indicators to determine whether they have done enough. One of these is the performance of the Purchasing Managers’ Index, and the U.S. is now down to 47.4. Globally there are now 22 nations that have fallen below that 50 line. Two of the most notable exceptions have been Mexico (51.3) and India (57.8). Canada is not all that far from expansion, with a reading of 49.2.

Obviously, interest rates matter, and now there is considerable debate over what they might look like in the months to come. There are still those that predict rates at 5.0% or even 5.5%, but there are many that are asserting they will not go that high after all. The trigger for this reassessment has been the erosion of inflation. There have been many indicators pointing towards that easing. Wholesale inflation fell more than expected, the Germans have seen their Producer Price Index fall, energy prices are down, and so are shipping rates. Inflation is undoubtedly still high and still at levels not seen in close to three decades, but the trend has been in a direction that has the markets believing that central banks are close to halting interest rate hikes. If past patterns hold, that means that rates could start heading down again as soon as the coming summer.

Canada and Mexico are also looking to their central banks for guidance. The Bank of Canada is hiking rates to a peak of 4.5% - the highest seen in years. The message from the BoC is that Canada’s economy is still close to overheating and still has the resilience to handle more hikes. The commodity surge has faded a little, but oil prices are still high relative to what they had been. Natural gas prices are falling pretty quickly, however. The unemployment rate remains very low, and this is still a marker as far as the BoC is concerned. Until the jobless number climbs, there is a sense that rates can go up a bit higher. This hike is expected to be followed with a pause. Inflation fell to 6.3% in the last reading, but that is still three times higher than would be preferred.

Mexico is seeing higher inflation in contrast with the U.S. and Canada and that has Banxico considering another rate hike in February. The inflation rate had been dropping but has risen to 7.85% - well past the target rate of 3.0%. The interest rates have been shoved past 10% and may jump a bit more at the next meeting. Three factors seem to have been driving inflation, and they are certainly familiar to both the U.S. and Canada. Labor rates are climbing for skilled and trained workers, and that has spurred consumer spending. Then there is the rise in commodity prices (especially food). Finally, there has been supply chain pressure even as reshoring and nearshoring accelerate. Many items remain in short supply, and that results in more upward price pressure; i.e., inflation.

Author profile: Dr. Christopher Kuehl (Ph.D.) is a Managing Director of Armada Corporate Intelligence and one of the cofounders of the company in 1999. He has been Armada’s economic analyst and has worked with a wide variety of private clients and professional associations in the last ten years. He is the Chief Economist for the National Association for Credit Management and is on the Board of Advisors for their global division –Finance, Credit and International Business. n