Taming Inflation*

*Editor’s note: On March 4, Russia enacted a law that criminalizes public opposition to, or independent news reporting about, the war in Ukraine. The law makes it a crime to call the war a “war” rather than a “special military operation” on social media or in a news article or broadcast. The law is understood to penalize any language that “discredits” Russia’s use of its military in Ukraine, calls for sanctions or protests Russia’s invasion of Ukraine. It punishes anyone found to spread “false information” about the invasion with up to 15 years in prison.

Financial expert Maxim Shein on the U.S. Consumer Price Index growth and its makeup.

The U.S. inflation data for July 2022 has been released. The annual U.S. Consumer Price Index growth decreased from 9.1% to 8.5%. Moreover, the Core Consumer Price Index, cleared of the effects of volatile energy and food prices, showed an annual growth rate of 5.9%. It has, incidentally, been declining since March 2022.

Before drawing conclusions from the Consumer Price Index data, it is necessary to clarify how it is calculated. It is very different from its Russian counterpart. Housing prices are the weightiest item — making up about a third of the Consumer Price Index. For homeowners, the U.S. Census Bureau calculates the hypothetical cost of renting a similar one. Over the past ten years, the housing price index has grown at 2-3% per year. In 2022, it accelerated, exceeding 5%. In general, housing costs correlate strongly with prices of homes but lag for about a year. Therefore, given that the median home value in the U.S. rose to a record $416,000 in June, we can assume that this item of the Consumer Price Index will keep inflation going for many more months.

Next in terms of impact on prices are transportation commodities and services (including the cost of cars, replacement parts and gasoline) and food-related items. They each account for 15% of the index. Utilities and medical care services follow, accounting for another 10% each. Finally, education and communication services and commodities (7%), culture and recreation services (6%) and apparel (3%) round off the list.

Obviously, the decline in global oil prices from the highs of June at $120 to $90 per barrel has had a dampening effect on consumer prices. After declining in March and April, the cost of cars and replacement parts has picked up again amid a rebound in the price of metals, computer chips and other components. However, the decline in demand will automatically slow price growth in the future.

On Sunday, Aug. 7, the U.S. Senate approved the climate and health care bill, which provides several initiatives, including those aimed at fighting inflation. There are expected tax hikes for corporations, notably a 1% tax on corporate stock buybacks. There are also measures to reduce public spending on health care. Democrats originally proposed a $3.3 trillion package of measures. However, the amount was reduced to $740 billion, with $300 billion going toward climate-related issues, which makes the final impact on inflation negligible.

As a result, the U.S. economy remains under inflationary pressure that the Fed can do little to counter. Raising interest rates is clearly not enough. Historically, when U.S. inflation has been above 5%, the Fed has always had to increase the refinance rates to a level that exceeds the domestic price growth rate. The refinance rates are now 2.75% and will likely not reach 3.5% in the next six months. Obviously, the upcoming midterm election, held in early November this year, does not give the Fed much room to maneuver, and the regulator takes this into account.

Indeed, the Fed does not base its decisions on the Consumer Price Index data. Instead, it looks at the U.S. Personal Consumption Expenditures index, where the weights of different items are strikingly different from the Consumer Price Index. Most importantly, housing and utility costs together account for only 15% of the Personal Consumption Expenditures index versus 42% in the Consumer Price Index. Therefore, the Personal Consumption Expenditures index is usually much lower. As of June, it was 6.3%, which is also a lot, but there is good reason to believe that the index could return to below 3% in 2023.

The stock market reaction to the Consumer Price Index data was immediate and positive. Stock indices rose by 2%, led by tech stocks. Tech stocks are the most sensitive to interest rates and inflation as their valuations are primarily based on future earnings expectations. The lower the rate at which they must be discounted, the greater their value. So traders immediately began pricing in a smaller interest rate increase from the Fed. Thus, if inflation does indeed continue to slow down (at least for a while), we will see a further rise in price quotations in the parts of semiconductors and media, technology and retail companies.

The author is the Director of Client Relations at BCS World of Investment. The author’s opinion may not necessarily reflect the views of Izvestia’s editorial board.