The
Ebb of Energy & Eating Costs
In
the spring of 2011, U.S. consumers were hit with high energy and food prices.
This double whammy drove headline consumer prices, as measured by the Consumer
Price Index (CPI), from a 1.1% year-over-year gain in late 2010 to nearly 4.0%
by the fall of 2011. A rapid acceleration in food and energy prices accounted
for most of the acceleration in overall inflation. Combined, these two
components of the CPI account for less than 15% of the overall index. But
because consumers make purchases of food (grocery stores) and energy (gas
stations) quite often, rising prices in these two categories captured the
public’s (and the media’s) attention.
Pain at the Pump and in the Grocery Aisle
The
sharp acceleration in food and energy prices made headlines nearly every day in
the spring and summer of 2011; after all, many Americans make several visits to
gasoline stations and grocery stores every week. Higher prices and more related
media coverage were a large contributor to the slide in consumer sentiment over
the spring and summer of 2011. However, the acrimonious debate in Washington
over the debt ceiling and the volatility in financial markets due to the debt
ceiling debate and the European sovereign debt problems were also to blame.
Growth
in real consumer spending (which accounts for two-thirds of economic activity)
slowed sharply between late 2010 and the middle of 2011, from a 3.6% pace in
late 2010 to under 1.0% in mid-2011, partly because consumers were diverting
some of their discretionary incomes to purchase “must-have” items like
groceries and gasoline.
Just
how rapid were the price increases in these categories? Energy prices in the
CPI accelerated from 4.0% year-over-year in late 2010 to 22% year-over-year in
mid-2011, as a gallon of gas increased from under $2.75 in the fall of 2010 to
nearly $4.25 in the spring of 2011. The rise in gasoline prices, in turn, was
driven largely by the Arab Spring uprisings that rolled across the Middle East
in the winter and spring of 2011, driving oil prices from around $70 per barrel
in September 2010 to as high as $114 per barrel in April 2011.
Food
price inflation accelerated from under 1.0% year-over-year in the fall of 2010
to a 6.3% year-over-year gain in the fall of 2011. That rapid increase, which
was accompanied by almost constant reinforcement from local and national media
about rising prices for staples like bread and milk, was a result of a
near-doubling of agricultural commodity prices between mid-2010 and early 2011.
The rise in prices for agricultural commodities was largely the result of
supply shocks caused by poor weather, reduced inventory levels of key
agricultural commodities, and a full resumption of economic activity in low and
middle income countries around the world.
Fuel Fares
This
year, food and energy prices are more muted, and should head lower over the
remainder of 2012, with food prices leading the charge lower. Gasoline prices
again reached $4 per gallon this spring but have receded sharply since the
early April peak in prices. Here again, gasoline prices are being driven by oil
prices. Until recently this year, oil prices have held in a narrow range
between $95 and $110 per barrel, hitting the high end of that range in late
February 2012, amid concerns over an attack on Iran’s nuclear facilities. Since
early May 2012, oil prices have dipped to nearly $90 per barrel amid concerns
that global economic growth will slow as the European fiscal crisis flares up
again. A spike higher in oil prices is possible later this year if: 1) there is
more unrest in the Middle East; 2) there is an active Atlantic hurricane
season; or 3) tensions around Iran’s nuclear capabilities flare up again.
However, oil prices are likely to remain near $100 per barrel, which suggests
that gasoline prices should remain under $4 per gallon. Gasoline near or under
$4 over the remainder of the year would put little upward pressure on the CPI
for energy products, and would help drive headline CPI back under 2.0% by the
end of the year.
Grocery Prices Going Down
The
bigger driver of further deceleration in headline inflation, however, may be
food prices. Changes in the price of agricultural commodities leads to changes
in food prices, as measured in the CPI by around seven months. As noted above,
prices of agricultural commodities surged in 2010 and early 2011, but have
moderated since, turning negative on a year-over-year basis late in 2011.
Prices of agricultural commodities have dropped by nearly 25% since peaking in
early 2011, and are down 17% from a year ago. The drop in prices of
agricultural commodities came as weather improved, inventories were built, and
as some global trade policies normalized. If the traditional relationship holds
between prices of agricultural commodities and the CPI for food, we could see
food prices turn negative on a year-over-year basis by the fall of 2012. This
would continue to push headline inflation below 2.0% (from the current 2.3%
year-over year reading), providing the Federal Reserve with enough wiggle room
to embark on another round of quantitative easing (QE3) if necessary later in
the year.
On
balance, the surge in food and energy prices that drove headline inflation
sharply higher in the spring and summer of 2011, which weighed on consumer
sentiment and sharply curtailed consumer spending in early to mid-2011, has
faded. Prices of energy and agricultural commodities have been much better
behaved in 2012, and point to decelerating headline inflation over the
remainder of 2012.
___________________________________________
IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are
not intended to provide specific advice or recommendations for any individual.
To determine which investment(s) may be appropriate for you, consult your
financial advisor prior to investing. All performance reference is historical
and is no guarantee of future results. All indices are unmanaged and cannot be
invested into directly.
The fast price swings
in commodities and currencies will result in significant volatility in an
investor's holdings.
The Consumer Price
Index (CPI) is a measure of the average change over time in the prices paid by
urban consumers for a market basket of consumer goods and services.
Quantitative Easing
is a government monetary policy occasionally used to increase the money supply
by buying government securities or other securities from the market.
Quantitative easing increases the money supply by flooding financial
institutions with capital in an effort to promote increased lending and liquidity.
This research material has been prepared by LPL Financial.
This research
material has been prepared by LPL Financial.
To the extent you are
receiving investment advice from a separately registered independent investment
advisor, please note that LPL Financial is not an affiliate of and makes no
representation with respect to such entity.
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