Why A Strong Dollar And Retail Inventory Blunders Could Help Push Inflation Down By Next Year

Topline

Despite increased concerns over a looming recession, a growing number of experts believe that upcoming discounts and easing supply chain disruptions may help cool the rate of inflation more quickly than expected, potentially offering a much-needed respite to cash-strapped Americans and investors wary over the implications of rapidly tightening monetary policy.

A wave of looming discounts at big-box retailers, and potentially even lower gas prices, could help … [+] inflation fall faster than markets suggest.

Corbis via Getty Images

Key Facts

Though spiking gas prices may push overall inflation higher this year, core inflation, which excludes volatile food and energy prices, has peaked “and will fall faster than markets and the Federal Reserve expect,” economists at Pantheon Macro wrote in a Wednesday note.

With a stronger dollar starting to make imports cheaper and rising inventories starting to quell supply shortages, the economists project inflation, which unexpectedly hit a 41-year high of 8.6% in May, will fall to 4.9% by the beginning of next year as core inflation eases from 6% to 3.7%—enough for Fed officials to ease up on the interest rate hikes that have been rattling markets.

Retailers facing more spending-hesitant consumers are “sitting on mountains of inventory” and on the cusp of an aggressive wave of discounting next month after piling on merchandise due to pent-up demand during the pandemic, notes analyst Adam Crisafulli of Vital Knowledge Media.

Among those set to cut prices on goods ranging from apparel and furniture to televisions and appliances are big-box retailers like Walmart, Costco and Target, which last month teased the upcoming discounts to help manage inventory costs after a disappointing earnings shortfall.

“Inflation’s underlying forces may be shifting in a more favorable direction,” says Crisafulli, positing an “important shift” is possible within the coming weeks, and also citing “significant declines” in the prices of commodities like wheat, corn, copper and iron ore.

There’s even positive news for gas prices: Wholesale prices have dropped to roughly $3.75 per gallon from about $4 in recent weeks, meaning that retail gas prices—sitting close to $5 per gallon—are set to fall “quite sharply” in the next few weeks, according to Pantheon, though it’s unclear how long the respite may last.

Contra

Two areas that likely won’t help inflation ease soon: Automobiles and rent prices (which have led price spikes throughout the pandemic) are still suffering from historically low inventory levels despite rising rates starting to quell red-hot demand.

Key Background

Fueled by government stimulus, supply chain constraints and, more recently, the war on Ukraine, prolonged levels of high inflation pushed the Fed to embark on the most aggressive economic tightening cycle in decades—crashing markets and sparking recession fears. “People are really suffering from high inflation,” Fed Chair Jerome Powell testified before Congress on Thursday, noting it remained “absolutely essential” for the Fed to restore price stability, before acknowledging it would be “very challenging” to avoid a recession while doing so.

Target

After Target’s earnings last month, market analyst Tom Essaye of the Sevens Report pointed out retail customers are buying less high-margin merchandise (like apparel and electronics) to instead spend more on lower-margin food (like bread and eggs), and also shifting spending away from brand names to cheaper private labels—signs that “consumers are starting to get squeezed by inflation.”

Chief Critic

“The three biggest challenges for investors over the next few months will be inflation, inflation and inflation,” says Sébastien Page, a chief investment officer at T. Rowe Price. “It’s the transmission mechanism for all the other risks we are facing.”

Crucial Quote

“Whether the Fed’s actions lead to a marked slowdown or an outright contraction will become clear over the quarters to come,” Andrzej Skiba, head of fixed income at $127 billion BlueBay Asset Management, said in emailed comments Wednesday. “A lot will depend on whether inflation responds quickly enough.”

What To Watch For

Inflation data for June is set to be released on July 13. On average, economists project prices will rise at a yearly pace of 8.7% this month, according to the Cleveland Fed. That would push annual inflation to the highest level since December 1981.