Market outlook: Inflation and supply chain issues easing

As we prepare to start the fourth quarter of 2022, it is my pleasure to report that the U.S. economy is not in a recession—at least not yet.

The official data for the third quarter will stream out in a few weeks; however, I have seen enough already to be confident the U.S. economy is not yet contracting. Undoubtedly, the pace of economic growth this past summer remained well below the long-term trend, but we currently live in an environment where slower economic growth is actually a good thing.

That's because slower economic growth is necessary to bring down prices, and so far this dynamic is unfolding favorably. The rate of inflation in the U.S. is decelerating and should continue to abate. I believe this to be true because commodity prices are sharply lower in recent weeks, and the value of the U.S. dollar is higher. This means that prices paid for goods in the U.S. should continue to move downward. The downside to this is that we are now exporting inflation to our trading partners, and this may in turn have negative future consequences. But for now, the rate of inflation in the U.S. is slowing.

A significant exception to this downtrend in overall consumer prices is the ongoing uptrend in prices paid in the services sector, particularly the price for rent. Unfortunately, this rent situation will take some time to correct, but we can take solace in the fact that many other price trends are showing improvement.

Another positive factor I can share is that the labor market is gradually moving toward a healthier equilibrium. Last month, the labor force participation rate ticked higher while the number of job openings ticked lower, and the headline jobs number registered a moderate pace of growth. When you combine all of these factors, it indicates that the gap between the number of open jobs and the number of workers is closing, and a smaller gap will reduce the upward pressure on wages. This will in turn put downward pressure on inflation.

The inflation hawks at the Fed will see that we are off to a good start, but it is still way too early to declare "mission accomplished." The decisions of the Fed notwithstanding, the macroeconomic environment as described by these three components—GDP growth, the inflation rate and the labor market equilibrium—will determine whether the U.S. economy enters an official recession.

And if we do enter an official, broad-based recession, will it be short and shallow or something more severe? At the present time, the probabilities of a soft landing are still fairly good, but like I say, it is still very early.

Therefore, let us not get too carried away just because the current trends are mostly favorable, and please do not think I am trying to oversell the happy talk. There are still a number of formidable hurdles in our path to a robust state of economic health. These hurdles include adapting to significantly higher interest rates; a pending energy crisis in Europe, which will have global implications; heightened geopolitical tensions; and a challenging global supply chain situation.

Speaking of the global supply chain, I have one more positive trend I will report. Every month, the Federal Reserve Bank of New York compiles and reports its Global Supply Chain Pressure Index. I know, I know… You have never heard of GSCPI. That's likely due to the fact that it has a name only an economist could love. And to make the matter even funnier, the GSCPI units are "standard deviations from average value." (Don't ever let anyone tell you economists have no sense of humor.) I will admit this is the first time I have ever discussed this indicator in any of my columns.

But as soon as you have stopped chuckling, take a look at the chart. The line clearly shows that the situation with the world's supply chain hit a historically bad peak in December of last year, but the trend has improved so far this year and is clearly heading in the right direction.

According to the New York Fed: "Global supply chain pressures decreased in August. … The August decline was quite broad-based, with decreases in delivery times recorded for all the countries in the sample. The GSCPI's year-to-date movements suggest that although global supply chain pressures have been decreasing, they remain at historically high levels."

I am not sure when the New York Fed started to report on this index, but I can tell you that it has data back to September 1997. And at the risk of throwing shade on some industrious economists, I will say that until 2020, this was one of the least interesting data series for me personally that I can imagine. Most years it tended to register incremental improvement in the global supply chain, which was exactly what one would expect as technology, communications and global trade networks steadily improved.

But in 2020, this index suddenly became extremely interesting. The pandemic has permanently altered the way we all do business, and the subsequent geopolitical events will affect all of us for years to come. And any strike by railroad workers would result in pressures on the U.S. supply chain to rise again. I am starting to think the GSCPI is emerging as a relevant and interesting economic indicator after all.

Every owner and manager of an American manufacturing entity, especially those in the plastics industry, has an acute awareness of the relationship between prices and supply chain issues. The well-known Producer Price Index adds some depth and texture to that knowledge. But during the past three years, logistical problems, such as the supply chain, are where most of the negative, unintended consequences of the economic shutdown have come back to bite us. The GSCPI will improve our understanding of the important relationship between prices and supply chain pressures.