The monthly Consumer Price Index came out rather flat last week, up only 2.7% in August versus 2.9% in July. So is price inflation under control? Hardly. This looks to be the tail end of CPI price inflation below the 3% mark. We’re likely going to break through 3% by Q1 2019.
Remember about two months ago when the last GDP print was published and we saw a huge jump in soybean exports? The US soybean industry was doing everything it could to complete and ship orders to China before retaliatory tariffs kicked in. The same is happening now but the other way around with China, whose exporters have been racing against the clock to ship as many products as possible before the trade war worsens. Remember, only $50 billion worth of Chinese products are currently under tariffs, so we are still at the very beginning of this trade war from a practical standpoint.
The biggest factor in affecting core CPI minus food and energy for August was apparel, with costs down 1.4% compared to 12 months ago. That might not sound like a huge drop, but check the long-term data and it’s the biggest drop since 1949, even including the 1998 Asian financial crisis. Apparel prices were not included in the initial $50 billion tariff tranche, but they are included in the new list of $200 billion worth of products subject to new tariffs starting September 24th. This doesn’t even count President Trump’s threat to place tariffs on an additional $267 billion of goods if China chooses to retaliate to the $200 billion, and it almost certainly will. So it makes sense that Chinese exporters would be in a hurry to ship as much as possible now.
Interesting to see on the long-term chart for apparel prices is that they have not risen on net since 1990. That’s almost 30 years of price stability. Given new tariffs on $200 billion worth of Chinese goods set to go into effect in just a few days and the relative price stability for apparel, it’s hard to see these prices falling any further.
Seasonal price inflation factors are combining with artificial supply boosts prior to tariffs kicking in to mute the numbers. This won’t last much longer. When are we likely to see a significant uptick? Judging by long-term data averages going back to 1977 from the Bureau of Labor and Statistics which compiles the CPI, August is not typically the strongest month for month-to-month price gains anyway. It ranks 6th, with September, October, February and March in the top four. November and December are the two lowest due to holiday shopping season discounts among other things and those are still in front of us though.
So what we are likely to see here are modest jumps for September and October, which rank 4 and 5 on average for month-to-month price gains, then stable prices in November and December as the holiday shopping season kicks in. But things could really heat up staring in Q1 next year, seasonally the strongest period for price inflation.
Unfortunately for the dollar, Q1 is going to coincide with the big European Central Bank decision on finally putting an end to its bond-buying program. This could be huge and really add some hot sauce to the price inflation equation. The main reason for dollar index strength right now, which also puts a damper on price inflation, seems to be interest rate differentials between the eurozone and the US. The ECB’s interest rate remains at zero while the Federal Reserve continues to be on a rate hike path. Two more rate hikes by the end of the year will further exacerbate this differential and continue driving demand into the dollar, at least until interest rates start to rise in the eurozone and offset this.
If the ECB indeed does end its bond-buying in December, which it has indicated it will do, then interest rates will rise across the board in the eurozone, cutting the interest rate differential between the US and Europe at the very time when price inflation seasonally heats up anyway. This is on top of tariffs on over $500 billion in Chinese imports going into effect if Trump follows through on his threat of tariffs on $267 billion worth of goods, and even worse, a threatened rise in the tariff rate beginning in 2019, as Trump has also indicated he could do.
Altogether, we have three developments coming to a head that should push price inflation as measured by the CPI over 3% annually by the end of Q1 2019. First, downward pressure on supply by constriction of imports, which will be made worse by the artificial priming of the pump in the supply of goods taking place now just prior to major tariffs taking effect. Second, the prospect of rising interest rates in the eurozone at about the same time, with the ECB scheduled to end its bond-buying program by the end of 2018 which should help catalyze a downtrend in the dollar index. Third, Q1 is typically the seasonal strong point for consumer price gains anyway, even without the above two factors. Commodity ETFs should be accumulated now before these pressures come to a head.
Disclosure: I am/we are long GDX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.