These ISM sub-indices give implicit forecasts of the direction of prices and employment.
Thanks to the Iran War, prices (red line) are heading higher, and employment (blue line) lower.
The shift in just one month (March) is obvious. The longer this continues, the worse it'll get.
Australia's inflation rate has picked up, but that (mostly) is not a sign that inflation really is increasing, but is rather a result of state initiatives to reduce electricity bills with subsidies. When subsidies were introduced, headline inflation fell, and now they've expired, it's risen.
However, it's above the top of the RBA's inflation band (2 - 3 per cent), so the chatter is that the next rate change will be up instead of down. I'm not so convinced. Even the RBA* can't ignore the obvious signs that the economy is slowing. And it's quite likely that the Federal government will introduce a new subsidy for electricity bills in the next budget in March.
The cost of electricity is a hot topic, with the Right blaming renewables, and everybody else pointing out that prices are set by the highest-cost supplier, which is gas. So the sort-of-left-ish government, the Australian Labor Party (ALP) wants to defuse the agitation from the "Liberal" (= right-wing) opposition about the shift to renewables, and will prolly introduce a subsidy to cut the pain of high electricity prices while they wait for their painfully slow roll-out of renewables to take effect.
Coming back to the economy, my next post will be about how the Ozzie economy appears to have started to slow again, so it would be perverse of the RBA to raise rates. But then, they haven't exactly covered themselves with glory over the last few years, so who knows.
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| The ABS (Australian Bureau of Statistics) has now switched completely from quarterly CPI indices to monthly. The monthly indices are now the official CPI. |
The latest PMI data for the USA show that the economy is still advancing, perhaps a little more slowly.
S&P Global's comment on prices suggests inflation is likely to pick up:
Input cost inflation accelerated sharply in November, hitting the fastest rate for three years barring the jump in costs seen in May. Tariffs were again the predominant reason cited by companies for increased costs, alongside reports of higher wage rates. Service sector costs rose at the fastest rate since January 2023. In contrast, manufacturing input price inflation cooled to the lowest since February but remained well above the average seen over the past three years.
US inflation has started to rise, in consequence of the swingeing jump in tariffs. It took a bit longer than I expected, probably because stocks (inventories) were higher than I thought. But now that businesses have run down their pre-tariff stocks, they have no choice but to pass on their increased costs. No doubt, as inflation gathers momentum, they will also be indulging in a bit of "greedflation", as they did in the post-covid inflation surge.
But it's not just tariffs. The government's campaign against immigrants has meant that food prices are soaring, because immigrants pick and pack the USA's food. (Coffee is rising because of global warming, and because of 50% tariffs on Brazilian coffee imports)
In my judgment, neither of these forces is anywhere near over. Prices will continue to rise until equilibrium is reached, and that will be several months away.
The Fed could "look through" this surge in inflation, on the argument that it will not be a sustained jump in the inflation rate, but a one-off adjustment in price levels. "Cost-push" rather than demand-led inflation. That is what markets (shares, bonds and currencies) think will happen, and the next cut in rates later this month seems baked in.
This rise in inflation will reduce real (inflation-adjusted) incomes, reducing spending, deepening the economic downturn. This might seem to be an argument for further rate cuts, if it happens, but just as the inflation might be transitory, so would the economic downturn caused by that inflation.
Now, it is possible that wages may rise to compensate---which I do not think will happen---but if they do this will heighten Fed fears that higher inflation is becoming embedded in the system, which means they won't cut interest rates any further.
So, the Fed moves depend on data over the next few months. If the economy continues to weaken, and wage inflation doesn't accelerate, the Fed will prolly cut the Fed Funds rate again. If the economy stabilises, then the Fed will have the luxury of waiting for the inflation surge to slow, and it prolly won't cut rates again. If wage inflation starts to pick up, all rate cuts are out of the question.
I'm not at all sure what the inflation rate will peak at, but I wouldn't be surprised if it nears 5% by year-end or early in 2026. This will be a very uncomfortable environment for the Fed to cut rates, as opposed to keeping them stable. It will need to be quite sure that the rise in the inflation rate is transitory. And that its moves are not seen as a response to Trump's pressure, which would destroy its credibility.
On Friday, the US labour market statistics for August were released. The data confirm my bearish view of US economic growth.
The chart below shows the change in non-agricultural payrolls over 3 months, per month. Growth in employment fell steadily until mid-2024 (a lagged response to the rise in the Fed Funds rates in 2023), then began to rise. A renewed (global) recovery had begun. Then Trump's tariffs stopped this recovery in its tracks. Employment is barely growing now, and will prolly go negative in the next couple of months.
A similar story is revealed by the unemployment rate. Observe how the unemployment rate rose steadily, but stopped rising in mid-24, as the economy re-accelerated, and then started to fall, reaching a low point in January 2025. Since then, it's been rising.
And this chart shows the dilemma the Fed faces. The data come from the ISM (Institute of Supply Management) surveys. They show the average for manufacturing and services indices for prices paid, and employment. Notice how the average employment index, like the payrolls data, started to rise in mid-24, peaked in January 2025, and has been falling since. It's now below the 50% level, which means that the majority of respondents are cutting employment.
The other line on the chart is the "prices paid" index, again, an average of the manufacturing and services ISM indices. See how it's jumped since January 2025? The "prices paid" data tend to lead consumer price inflation, so the rise in CPI inflation that will prolly result from the jump in prices manufacturing and services industries are paying will only start showing up in consumer prices from now on.
Rising inflation will lead to falling real incomes, which, combined with increasing uncertainty, will mean that consumer spending (~70% of GDP) will falter. Consumers already judge that jobs are "harder to find" (from the Conference Board survey; see below), and they're right. But combine a faltering labour market with falling real incomes, and it's hard to see how this gathering storm will be stopped without the Fed cutting the Fed funds rate.
Will the Fed "look through" the jump in inflation, arguing that it's transitory? To me, it's not clear that the inflation increase will be short-lived. Companies will take advantage of the huge tariff increases to up their own prices, even as the prices they pay will also soar. Plus we're seeing plenty of anecdotal evidence that food prices are jumping, because they are picked and packed by immigrant labour. There is no sign that Trump or his lackeys will reverse policy.
But then I'm not in any way linked to the Fed. I will say that the senior Fed economists and analysts I have met over the years have been formidably intelligent and well-educated. (Though how much longer that will last is unclear). The costs of a mistaken forecast will be significant. If inflation is transitory, cutting the Fed funds rate will be the right policy. If not, the Fed risks higher inflation becoming embedded in the economy.
The markets are convinced the Fed will cut rates later this month. Bond yields have fallen, and the dollar is taking a hammering. But equities have been more cautious. Shares are substantially overvalued, and the rise in share markets has been primarily driven by AI/tech companies. I deeply mistrust the AI bubble. It reminds me of the dot com bubble, and when that burst, there followed a 50% decline in the S&P 500 over the next 2 years. The combination of stagflation and overvaluation could be lethal for shares.
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| Once again, a recovery from mid-2024 is derailed by Trump's tariffs in 2025 |
Inflation is (temporarily) levelling off, at about the Reserve Bank's target.
Big increases over the year: fruit and vegetables (7.6%: who would have thought that alternating drought and floods would increase food prices?), tobacco (12.2%, taxes), rents (5.2% -- still a rental crisis), education (5.7%). Big decreases: electricity (-9.6%, thanks to direct government subsidy) and petrol (-7.6%, falling world oil price).
My forecast is that inflation will continue to decline slowly. Oz won't be retaliating to Trump's tariffs, but China's loss of the US market may well encourage its exporters to aggressively discount exports to other countries, helping push down our inflation. This price weakness will be increased by a rising A$. Also, the world oil price is likely to keep on falling. And although the Australian economy is picking up (see next post) it's not exactly overheating,
CPI inflation rose a little in January, but the trend is clearly down.
Note that, for the most recent months, the monthly CPI is less representative than the quarterly, and may be slightly revised when more quarterly data become available.
Part (but only part) of the decline over the last year has been because of government subsidies (Federal and State) to reduce retail electricity prices.
The US whole-economy PMI fell in February (provisional data). The fall was confined to services; the manufacturing PMI actually rose. Unlike manufactures, services don't have long order books, which take time to adjust. If people start to be concerned about the economy, they can immediately cut spending. Manufacturing takes longer to come to a grinding halt. So the fall in services (to below 50%!) is very significant. It suggests that the public sees Trump policies as bad for their financial prospects, which is borne out by the plunge in his ratings on the economy. Of course, just as spending can decline, so it can rise. A reversal of trade wars, and an ending to DOGE could see a rebound. But the longer uncertainty continues, the deeper the downturn, and the slower the reversal.
I personally don't see Trump changing direction, which means inflation and unemployment will rise from here.
I showed a chart of world bond yields here. This chart shows the average for world bond yields, weighted by their PPP GDP, and covering countries which together make up 83% of world GDP, and is compared with the US 10-year bond yield. The US makes up ~22% of world GDP. I have excluded Argentina and Turkey from the calculation of world bond yields, because their inflation rates (and therefore bond yields) are so high they would distort the picture. However, Russia is included, and its bond yield has risen substantially since the invasion of Ukraine, for obvious reasons.
Note how the world average has in the past been above the US yield, and how for the first time in decades, is now about the same --- including Russia --- as bond markets adjust to raised US inflation and bond issuance risks.
The conclusions from my previous piece are unchanged: at this stage in the cycle, bond yields should be falling. And they are not.
Normally, at this stage of the cycle, bond yields would be falling, and they aren't. Why? For two reasons. One, Trump's tariffs and his deportation of migrants will drive up inflation in the USA, which will inhibit the Fed from cutting the fed funds rate in the short term. And maybe longer term too. The second is also Trump's fault. The bond market is very wary of his tax cuts for billionaires. This will cause the US deficit to balloon. The Republicans plan to increase the debt ceiling by an incredible 4 TRILLION dollars.
Note that the 25-year downtrend in yields, which underpinned advances in the stock market and property, has been decisively broken.
By which I mean that it's stopped falling.
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| My calculations; big 8 GDP-weighted |
Meantime, US inflation has stopped falling, and Trump's tariffs and his expulsion of immigrants will drive up US inflation rates. We may end up with "stagflation", a situation where growth is low but inflation is high, not good for markets or politics.
The chart below shows the inflation rate for the "Big 8" economies, compared with the percentage of world economies (50 in total) where inflation is above 6%. The "Big 8" economies are: the USA, the Euro Area, China, Japan, the UK, Brazil and India, which together make up ~70% of world GDP.
World inflation is more or less back at the 1997 to 2020 levels, as is the number of countries with inflation above 4%.
However, the world discount rate (bank rate) is still way above the 1997-2020 average (lower chart). The implication is that world interest rates are likely entering a period of sustained decline, which will drive up asset markets (shares and property), as well as sustain growth. What will stop that decline is a renewed surge in inflation, which obviously can't be ruled out, but given anaemic global growth rates, that does seem unlikely. At least over the next year or two, though for various reasons, the underlying inflation rate will be higher than it's been over the last 30 years, meaning that world discount rates won't get back down to the 2009-2022 position.
S&P Global has released the provisional ("flash") estimates of the PMI indices for May. The PMI indices are among the earliest data points available for the state of the economy. The survey asks whether sales, employment, orders, etc are up or down on last month, but not by how much. S&P Global then produces country indices for manufacturing and non-manufacturing/services.
I take these time series, extreme adjust them, and add them together, each weighted by that country's weight in world GDP (using purchasing power parity, or PPP, exchange rates to value national currency real GDP).
The Big 5 are: the USA, the UK, the Euro Zone (European countries which use the euro currency), Japan and India. The big 8 adds China, Brazil, and Russia to this calculation.
The chart below shows the Big 5 and the Big 8 GDP-weighted PMI averages, with manufacturing and service PMIs averaged (= "whole economy"). Since we don't have "flash" PMI estimates for China, Brazil and Russia, Big 8 PMI is only available to April.
Clearly, the world economy is accelerating. Not only is the Big 5 PMI above the 50% "recession line" indicating that the economy is advancing, but it is also rising, i.e., the economy is accelerating.
The markets' conclusion that interest rates are likely to fall more slowly is correct. And it is also likely that inflation will fall more slowly, too.
In Australia, inflation continues to fall. The RBA won't be raising rates again, even though inflation is still above its long-term target of 2-3%, because its trend is so clearly down. Will they cut rates soon? Prolly not. Central Banks are by their nature conservative. They'd like a few months' more data before they start easing. It's clear enough that for Australia, the interest rate cycle has peaked.
Despite rents and insurance, the overall trend in CPI inflation is clearly down. There is no risk of inflation re-accelerating over the next couple of years. Time, maybe, for a Labor government to give some welfare uplift, and tax cuts, to the worst off?
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| Click on chart to see a clearer image (thank you Blogger!) |
I've just updated my CPI data bank (I've been distracted by a lot going on in my life, so I haven't updated it for a few months).
It's obvious that world inflation is continuing to fall. It will be interesting to see how sustained this decline is. World growth is low, but the reduction of supply chain constraints and the fall in commodity prices are also factors. But the Covid crash and Russia's invasion of Ukraine have reduced the appetite for globalisation. Everything else being equal, that will slow the decline in inflation.
The chart below shows the inflation rate for the big 8 countries/regions (US, UK, Euro zone, Japan, China, Russia, India, Brazil) compared with the percentage of countries (45 countries monitored) with inflation above 6%. The chart makes it clear that inflation cycles tend to be a global phenomenon. When the big 8 experience inflation, it tends to be experienced by most countries. Of course, there are some countries (Venezuela, Argentina, Turkey, for example) which have perennially high inflation.
The chart below shows the percentage of monitored economies where inflation is below 2%. It can be seen that this neared zero as inflation soared, but has risen steadily over the last few months. Obviously, this indicator is inversely related to global inflation rates.
The chart below shows a comparison between the US's Fed Funds rate (the Fed's discount rate) and the GDP-weighted average of world discount rates, covering countries with 72% of the world's GDP.
In my judgement, world discount rates have prolly peaked, though unless the world slowdown deepens, they're prolly not going to be cut rapidly. Central Banks will wait to see if inflation continues to decline. However, of the bigger economies, Brazil, Chile, China, Hungary and Poland have already started cutting their rates. Most of the rise over the last couple of months in the world discount rate has been because Turkey has pushed its discount rate up to 40%.
