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Do Falling Gas Prices Signal An End To U.S. Inflation Spiral?

·5 min read

After hitting multi-decade highs in recent months, erstwhile stubbornly high inflation in the U.S. has begun to ease and is showing signs of returning to somewhat normal levels before long.

In August, the headline inflation fell to 8.1%, higher than expected but lower than the four-decade 8.5% peak it hit in June, with volatile food and energy prices, or core CPI, the brunt of that–at 6% higher than last year.

The Biden Administration is now increasingly confident that inflation will fall even further thanks to falling oil and gas prices. According to a survey Monday from the New York Federal Reserve, U.S. inflation is expected to average 5.7% for the whole of 2023 and contract to 2.8% three years out thanks to falling gas prices.

To be fair, energy is only part of what’s been causing runaway inflation that has been plaguing the United States in the current year with widespread supply chain snarl ups, surging demand, high production costs, a global pandemic and swathes of government bailouts also to blame.

Those soaring oil and gas prices have been taking a toll on many industries from transportation to manufacturing, so the reversal of the oil price trajectory has a knock-on effect, as well.   

According to AAA.the national average for unleaded gas has dropped all summer, to an average of $3.71 per gallon Monday, a 26% decline from its mid-June peak at $5.01. Meanwhile, the gas price index fell by 7.7% in the month, helping to overcome increases in the costs of food and housing.

Those numbers have come at a time when the Fed is using aggressive interest rate hikes to battle inflation that is still running close to a more than 40-year high. The central bank is widely expected to approve a third consecutive 0.75 percentage point increase when it meets again next week.

In a rather extreme view, contrarian fund manager Cathy Wood of ARK Invest (NYSEARCA:ARKK) is predicting that deflation, rather than inflation, will rule the U.S. markets going forward.

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The innovation-themed asset manager believes that Jerome Powell and the Federal Reserve are miscalculating the outlook on inflation by increasing rates at such a steep pace, tweeting out: “Powell is using Volcker’s sledgehammer and, I believe, making a mistake. The Fed is basing monetary policy decisions on lagging indicators: employment and core inflation. Leading inflation indicators like gold and copper are flagging the risk of deflation. Even the oil price has dropped more than 35% from its peak, erasing most of the gain this year.

Back in February, Wood told a webinar that advances in technology would likely push productivity rates higher, outweighing any gains in wages.

“We have a very strong point of view that productivity gains we will witness over the next five to 10 years will be astonishing. We think productivity will increase 5%-plus, and we won’t have an inflation problem,” she said.

ARK Invest is famous for betting on high-valuation, high-growth stocks that soared during the early stages of the pandemic. Indeed, the ARKK portfolio appears vulnerable to further declines in tech valuations due to its overweighting of high-multiple stocks.

Unfortunately, Wood’s contrarian approach has not exactly delivered stellar results this year, with her ARK Innovation ETF down 53.5% YTD. Four innovative tech-based funds that have outperformed ARKK in 2022 are: ALPS Disruptive Technologies ETF (DTEC), Innovator Loup Frontier Tech ETF (LOUP), Main Thematic Innovation ETF (TMAT) and Future Tech ETF (BTEK).

Whether it’s inflation or deflation, falling gas prices might not translate to a lower cost of living for the average American. Where consumers expect inflation pressures to ease somewhat, they mostly believe that the cost of living will continue to escalate.

Indeed, median expectations for household spending over the next year rose 1 percentage point to 7.8% in August, with those holding a high school education or less and a group largely composed of lower earners less confident about the outlook.

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To make matters more complicated, respondents are saying that credit is harder to come by. With a series high 57.8% saying that it’s either harder or much harder, the New York Fed reported. Further, people are becoming less confident about making their debt repayments in time, with a good 12.2% of respondents expecting to miss a minimum debt payment over the next three months , a 1.4 percentage point gain and the highest reading since May 2020.

And in the meantime, high-volatility is here to stay.

From an investment standpoint, the energy sector continues to be among the most volatile in the U.S. stock market.

Last week, financial participants observed a cool off in market volatility as the major averages ended in the green. Traditional S&P VIX Index (VIX) readings also were reduced on the week by 14% to $22.79. PriceVol, a proprietary risk indicator generated by ASYMmetric ETFs, records an average daily drop in weekly realized volatility from 6.6 to 6.2. Volatility is an integral part to how investors evaluate the marketplace, and PriceVol is an instrument that is able to measure the complete landscape of the volatility reflected in the S&P 500.

ASYMmetric S&P 500 ETF (NYSEARCA:ASPY) is a fund that was developed from the PriceVol instrument. ASPY works as a quantitative long/short hedging strategy that seeks to offer investors a backstop against bear market selloffs by being net short, while also seeking to capture the majority of bull market gains, by being net long.

From a sector vantage point, the Energy (XLE) sector observed the highest level of volatility with a realized volatility level of 6.7. On the opposite end of the spectrum, the Real Estate (XLRE) sector experienced the lowest level of realized volatility at 2.4.

By Alex Kimani for Oilprice.com

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