At a time when Federal Reserve officials are working hard to fight inflation, a key question is becoming increasingly important: will commodity prices continue to fall?

The fall in prices for various products, from clothing to used cars, was the main driver of inflation falling faster than expected in the second half of 2023. Since then, the rate of decline in commodity prices has slowed, leading to higher inflation data for the first few months of 2024.

Core commodity prices have declined, but are still at a high level

Whether the supply chain has fully recovered from disruptions related to the COVID-19 pandemic and geopolitical conflict, policymakers are divided on the outlook. Federal Reserve Chairman Powell said last week that “we can get more” improvements to lower prices. Some of his colleagues seemed skeptical about it.

Scott Anderson, chief US economist on capital markets at Bank of Montreal, said: “The real uncertainty about the outlook for inflation is on the commodity side.” “This will continue to keep the Federal Reserve cautious.”

At the policy meeting from April 30 to May 1, Federal Reserve officials kept the benchmark interest rate unchanged at a 23-year high and hinted that interest rate cuts would begin later than previously anticipated after disappointing first-quarter inflation data.

The minutes of the meeting released on Wednesday emphasized the importance of progress on commodities. The minutes showed, “Although supply chain improvements have supported the fight against inflation in commodity prices over the past year, participants commented that the pace of such improvements is expected to be more gradual and may slow the progress of inflation.”

Car prices

The consumer price index (CPI), which excludes food and energy, rose for the first time in nine months in February, partly due to rising used car prices. New and used car prices have been falling since then, and some economists expect this trend to continue given weak demand and increased supply due to high interest rates.

Another category that has significant weight in the CPI is clothing. The price of clothing has been rising over the past three months. The monthly increase in April alone was the biggest since June 2020.

Meanwhile, the price of household goods has declined steadily over the past year, reversing the rapid rise when consumers invested heavily in home improvement during the pandemic. In those times of high demand and tight supply, logistics often couldn't keep up, and delivery was delayed for several months.

Now, these factors seem to have largely normalized: the New York Federal Reserve's Global Supply Chain Stress Index (which brings together 27 variables to measure factors ranging from cross-border transportation costs to national manufacturing data) eased over the past year after soaring to record levels at the end of 2021.

Supply chain pressure has largely normalized

Despite this, many Wall Streeters are optimistic that core commodity prices may continue to fall in the coming months as the supply side of the economy continues to improve and demand pressure eases. Although the CPI index has declined 1.6% since peaking in May 2023, it has risen 14.3% since February 2020.

Morgan Stanley economist Alan Zentner believes that in the personal consumer spending price index, which is the inflation indicator favored by the Federal Reserve, there are only three categories that have caused the recent slowdown in commodity deflation: clothing, video tapes, and computer software.

In a mid-year outlook report released earlier this week, Morgan Stanley's research team said: “There is no evidence that the economy is accelerating across the board. This looks more like a temporary adjustment in relative prices.”

Anna Wong, chief economist at Bloomberg in the US, said, “We believe that core commodities will continue to hold back inflation throughout the summer and become a key driver in controlling inflation. But then this power will begin to wane. To continue curbing inflation, housing and core services other than housing must take the baton, because in view of this year's low base effect, year-on-year inflation in core commodities is likely to increase inflation in 2025.”

Federal Reserve officials want to believe this trend will continue. Powell said on May 14 that we can still see “the last part of the supply chain has actually been sorted out,” and he pointed out that the investigation of the company “still indicates that there is a shortage.” The Federal Reserve's Philip Jefferson said on Monday that he will keep a close eye on upcoming data to see how much more help the supply side can provide.

Others, however, sounded less optimistic. Atlanta Federal Reserve Chairman Bostic said on Tuesday that he “no longer hears too much news about supply chain issues,” while Cleveland Federal Reserve Chairman Meister said on May 16, “We are unlikely to get help with inflation from the supply side as we did last year.”

At the meeting earlier this month, officials also pointed to upside risks: “Some participants indicated that geopolitical events or other factors could lead to more serious supply bottlenecks or higher transportation costs, which could put upward pressure on prices,” the minutes said.

Neil Dutta, head of the US economy at Renaissance Macro, said that there is still more room for commodity deflation to continue. He expects clothing prices to fall in the next few months due to weak inflation-adjusted sales. “The deflation of new car prices has only just begun,” he said in a report earlier this week.

“The slowdown in core commodity inflation is not over,” Duta said. This is worth emphasizing, because one of the main reasons behind the hawkish claims is that the commodity's smooth flow has come to an end. I'm not sure.”