SSoaring prices for oil, wheat and other commodities, driven by Russia’s invasion of Ukraine, could prompt markets to price in high inflation over the long term, but economists still expect the inflation will fall between 2.7% and less than 5% by December, the Wall Street Journal reported. .
Forecasting inflation and its rises and falls has generally been complicated, but doable in a process that takes into account the performance of various parts of the economy, including supply and demand and the economic downturn. The onset of the COVID-19 pandemic has upended all standard inflation models based on parameters such as unemployment. However, economists need to break down forecasts into microcomponents to try to capture a more accurate inflation forecast.
Image source: The Wall Street Journal
Automotive and furniture industries
The automotive industry, particularly car prices, is a component of what constitutes core inflation, not for the number of purchases, but for the increase or decrease in their prices. Between January 2021 and January 2022, used car prices increased by 40.5% and contributed 1.1% to headline inflation. New car prices rose 12.2%, contributing 0.5% to inflation.
Prices within the auto industry have been pushed up largely due to supply chain issues and global semiconductor shortages. As production begins to catch up, increased supply will help drive prices down, but fallout with Russia could create problems for new automakers as Russia is a key exporter of used palladium in catalytic converters. Overall, many analysts are predicting lower prices by December for both new and used cars, which would lower headline inflation numbers.
Another industry impacted by supply chain issues is furniture and home supplies, which has seen demand rise faster than supply, with prices rising 9.3% in January 2022 and adding 0.4% to inflation. While manufacturers of furniture, bedding and appliances have strengthened their ability to fulfill orders in recent months, the conflict in Ukraine and subsequent supply chain impacts could further slow this. Aichi Amemiya, senior US economist at Nomura, predicts that by December 2022, furniture and bedding prices will have slowed to a 10% increase from 17% in January.
The role of rent and energy
Rent is about one-third of the CPI, as the Department of Labor determines housing costs based on current and new leases and is divided into tenants’ rent, then owners’ equivalent rent (OER), or an estimate of what a homeowner would pay to rent their home based on prices in their area. Rents, initially falling at the start of the pandemic, have since rebounded with the creation of 1.4 million new households in 2021.
OER in January rose 4.1%, the fastest since 2007, and rent to tenants rose 3.8%. These numbers are expected to rise, driven by the lowest rental vacancy rate since the 1980s and a buoyant job market.
Energy is another major inflation sector, rising 27% in January 2022 and adding 1.7% to inflation. The gas surge in January was responsible for much of the inflationary growth, with gas accounting for around half of energy consumption. With gas prices currently skyrocketing, the futures market anticipates that crude oil prices will eventually flatten and then decline by the end of the year, decelerating to 9.4% growth in December 2022 , adding to lower inflation.
Investing in deflation with the BNDD
the Quadratic Deflation ETF (BNDD) is offered by KFA Funds, a KraneShares company, and is an actively managed, ESG-focused fixed income ETF that seeks to benefit from lower growth, narrowing interest rate spreads interest rates, deflation and falling or negative long-term interest rates.
BNDD seeks to hedge against the risk of deflation while creating positive returns when the US yield curve flattens or inverts. It invests in Treasuries of different maturities either directly or via ETFs which invest in Treasuries. The options used by the fund are linked to the US yield curve, are traded on the OTC market and include long options, long spreads and butterflies (an options strategy that uses both bearish spreads and bullish) with the aim of limiting losses by the fund.
BNDD has an expense ratio of 0.99% and is actively managed.
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