Commodity Prices: Oil Up, Most Other Inflation Forces Topped

The headline commodity price worry is the rise in oil and energy prices: 57.2% for WTI and 28.7% for gasoline since the beginning of the year. And gasoline prices look to be headed higher while rubber prices have soared 62.8% this year.

With any luck, however, that isn't the whole story. There seem to be other factors which will mitigate the effect that these gains will have on overall consumer price inflation.

The first is that factory sector pricing depends both on overall demand growth, which is easing, and the overall rise in costs of which commodity prices account for 25% or less. The other 75% is labor costs, and the employment cost index for factory workers is up 1.2% so far this year versus a 1.8% gain last year, a 3.4% rise in 2005 and a 4.8% rise during 2004.

The second is that for the economy overall, the dependence on oil is roughly half what it was in the early 1970s due to conservation and improved efficiencies in production techniques. And, in total, U.S. demand growth has slowed as well as the growth in the Fed's monetization of that growth. Year to year growth in the monetary base through October was 2.5% versus a 3.9% rise last year and a 4.3% 2005 increase.

Finally, other commodity prices have topped or have been declining. The housing market's weakness has dropped lumber prices 5% so far this year after a 15% decline last year, and a 4% decline in 2004. In addition, steel scrap prices have been roughly flat this year after strong gains in years prior. Zinc prices are 31% lower so far this year and have retraced most of a strong gain at the end of 2006. Similarly, aluminum prices have fallen 12% this year and have retraced the strong gains during the latter part of 2006.

In conclusion, inflation worries have affected the consumer's psychology greatly. The worries have been enough to drop consumer sentiment by nearly one quarter since the highs early this year. This would seem to guarantee some near term slowing in consumer spending. The mitigating factors sighted above, with that luck, will prevent a protracted decline.

The OECD trend restored leading indicators are now indicating an outright slowing rather than a moderating for growth. These signals have been gradually shifting toward the more pessimistic. Japan’s signal is now quite dour. The US and Europe are showing almost the same degree of slowdown in the new numbers. The table is arrayed with some six month calculations since that is the OECD’s preferred way of assessing its data. No matter how you slice this month the outlook is for weakening.

Another indicator that all is not well in Japan was released today. The seasonally unadjusted diffusion index of consumer confidence for a two or more person household was 42.8% in October, compared with 44.1% in September and 48.2% in October, 2006. A value below 50% means that the majority of the participants in the survey have a negative view of the outlook. While the decline in October is significant, it should be noted that since June, 1982, when the series began, there have been few times when the level of the index was above 50% as can be seen in the first chart. Japanese consumers have not been particularly optimistic over the past twenty-five years. Monthly data for confidence are available only since December 2004.

The index is based on the average of four sentiment indexes: Overall Livelihood, Income Growth, Employment and Willingness to Buy. The year to year changes in each of these indexes are shown in the second chart. As shown there, the year to year changes have been declining from their early 2006 peak and, since early 2007, have become negative. The declines in the Employment and Willingness to Buy indexes have been particularly sharp.