ITR Economics’ Connor Lokar on inflation trends through 2022

Our latest Vistage CEO Confidence Index survey revealed that 48% of small and midsize business CEOs expect the U.S. economy to worsen in the year ahead, an opinion driven by two main sources of uncertainty: inflation and the Russia-Ukraine war.

At a recent Vistage Executive Summitt, ITR Economics’ Connor Lokar sat down with Chief Research Officer Joe Galvin to discuss the Gordian knot at the intersection of the invasion and inflation and how that will impact rising costs, wage pricing and supply chain challenges through 2022.

Transcript:

Joe Galvin: I’m Joe Galvin. And this is The CEO Pulse. Inflation remains a major challenge for CEOs across the country. There’s no end in sight as every day in the headlines, we see more and more news about how inflation is impacting our ability to grow. Joining us today is Connor Lokar from ITR Economics. Connor is about to present here at the Denver Vistage Executive Summit, where he’ll share his insights on the economy overall to our community here in Denver. But I thought it’d be great if we could capture a few minutes of Connor’s time to give us an update on inflation.

Connor, what can we expect from inflation?

Connor Lokar: Well, inflation, it’s that dirty word, top of mind for most folks after 10 years and not talking about it, we’re talking about it is your last update with Alan back in January, some things have changed as we sit here in March 2022, or excuse me, April 2022; Ukraine has changed a few things. Inflation was poised to start to move into a disinflationary trend, which for folks that’s not necessarily pricing going down, but the pace at which prices are going up actually starting to ease. We’re not there yet. And unfortunately, we’ve had to change our expectations based on the events that we’ve seen in the last six to eight weeks. The net result is an upward revision of our CPI forecast. It was initially poised to peak at the start of the second quarter. And we’re going to start to see some easing inflationary pressure, now we’ve unfortunately had to kick that out now until the start of the third quarter.

So we basically bought ourselves another quarter of inflation, ongoing price pinches, which is going to be a challenge.

I think with the clients that we work with, what they’ve noticed for the first time in a long time, their employees are locked in on what that headline CPI figure is, 8.5% in March 2022, that’s making some comp conversations very difficult, because folks are, as everyone knows, they’re jumping for that 5-10% raise if they’re not keeping pace internally. So it’s going to mean labor stays tight. It means that labor cost continues to inflate here this year.

What we see is that, generally, inflation and employment trends are lagging indicators.

They’re responding to demand that’s already occurred, economic growth that’s already occurred, which means it’s going to take longer for them to respond to the slowing growth environment that’s starting right now.

So as we look to 2023, that’s when we’re really looking for normalization as it relates to the rates of inflation. Now, I don’t want to overpromise here. Normal inflation rates does not mean pre-COVID pricing. It means the pace at which prices go up starts to get into that more manageable 2.5-3.5% bandwidth as opposed to eight, nine approaching 10% is ultimately what we’re going to hit here in the second quarter. So we’re going to have to grit and bear it here through the short term before we get to normal as this demand-side starts to slow down.

Joe Galvin: The Russian invasion of Ukraine has driven energy prices up. And now they’ve come down a little bit. What’s your thought [about] where energy’s going to go as it connects to this broader inflation theme?

Connor Lokar: Yeah. I mean, energy inflation is really tough because everyone consumes it directly or indirectly. You feel it at the pump, you feel it on your utilities bills, but it doesn’t stop there. It’s diesel cost for farmers. It’s diesel cost for on-highway logistics, trucking, shipping. It flows through everything. So we notice that nickel pricing went up over 100%. But if you’re not consuming nickel, you might not notice and you might not care, but energy, it’s a different story. So we have upward revised our energy pricing forecast anticipating that oil — West Texas Intermediate in the U.S. —  is going to stay in that low a $100 per barrel bandwidth until such a point that we see some sort of resolution in this conflict, some normalization of energy flows. But until that point, we think that they stay higher for longer.

However, we are starting to see a meaningful supply-side response domestically. US fracking output is accelerating. In the first quarter, it averaged 13.5 points higher than the first quarter of last year.

So the domestic drillers, they’re starting to get to work, and they’re starting to push that production, which is going to keep a ceiling on prices.

We don’t think that they run away to 130, 40, $50 per barrel, which would be another fit 50% lift from where we’re at today. But we don’t think that they go markedly lower until whether it’s a ceasefire, victory, one way or another, until we see some moralization of energy flows and folks, if Russian oil makes its way back in or folks at least figure out where else they’re going to get it, we don’t see a ton of downside in price expectations.

Joe Galvin: Supply chain is another part of this. We saw the supply chain beginning to heal, then maybe not so much. How does supply chain and the challenges there contribute to the overall inflation picture?

Connor Lokar: Huge. I mean, folks want to oversimplify inflation a little bit and say it’s only supply chain or it’s only all the currency creation in the fiscal stimulus. It’s really both. And supply chain’s been, I think, an equal component to that. And so supply chain wise, again, it’s we don’t source a ton from that part of the world, from Ukraine or Russia, but other countries do. And if they can’t get their wheat from Ukraine or Russia or anything else, they have to go back into the global marketplace, maybe competing with us where we source or actually sourcing from the United States. So they’re bidding up that global environment.

So this additional supply chain tightening is going to intensify that inflation. Also, China is starting to lock down very aggressively, which from a supply chain perspective, I think, is more relevant or will be in the next quarter than what we’re actually seeing in this Ukraine-Russia conflict right now. That is going to cause some serious. Some of the port numbers that we’re seeing in terms of backups along China right now is worse than actually what we saw in 2020. So that’s actually going to create some ongoing tightening where again, a quarter ago, we were poised to start improving on both supply chain and inflation right now, but that’s not going to happen, unfortunately.

Joe Galvin: The headlines tell us a lot of reasons why inflation is or isn’t. Can you give us some of the core reasons why inflation has surged? And again, how that’s going to imply, how it’s going to come down as we get to the second part of the year?

Connor Lokar: Sure. I mean, it’s a three-headed monster. It’s demand, it is supply chain breakdown, and it is stimulus. And we overstimulate it into supply chains that we essentially broke globally with the lockdowns in 2020.

And you can lock the consumer at home for 90 days and then give them 2 trillion bucks and send them on their way. And they’ll start spending right away. If you put manufacturers on their heels, put them into bunker mode, drawing down inventories, furloughing employees, you can’t bring that back online like a light switch.

So at the same time that we had done unprecedented supply chain damage, inventory drawdowns, we also pushed consecutively unprecedented fiscal stimulus support to induce demand.

And so all those conditions that gave us such a red hot 2021 from both a demand and an inflation perspective and a tight supply chain environment, all those conditions are fading in 2022. Demand is decelerating. It will continue to decelerate month by month by month, every step of the way here in 2022 and into 2023. So demand coming back to the pack is going to be more meaningful in our mind to inflation normalization.

We’re not just going to snap our fingers and get a 30% increase in global supply and productive capabilities. It’s going to be moderate capability and capacity increases, but it’s really going to be demand slowing to the point where that actually starts to make some headway.

The narrative’s really been for every step forward on the supply side of the economy, it’s been eight steps forward for demand. Demand is going to decelerate. And then that’s going to allow supply side to get its head above water, which should accommodate some loose things, supply chain conditions, lead time compression and ultimately pricing normalization as it relates to inflation rates.

Joe Galvin: So from a strategic planning perspective, we can assume that we’re close to the peak of where inflation is. It’ll slowly abate. And as we get into the second half of this year, more importantly, and the next year, we should see a more rationalization of inflation as we plan over the next period in the growth cycle.

Connor Lokar: Exactly. I think businesses right now, I think you have the cover to take price maybe one more time here in the second quarter that you probably otherwise wouldn’t have. That’s why we were advising our clients to move early first quarter of this year to get that final price because as this demand slows, price sensitivity is going to go up.

Folks aren’t just going to be indiscriminate buyers. They’re going to be more cautious shoppers.

They’re going to be looking around, they’re going to be quoting more, they’re going to be seeking a little bit more. So now we have little bit of cover to take some extra price because you’re going to have to because your costs are also going to be going up. And then second half of this year is where you’re probably going to want to back off on price, because that sensitivity is going to be going up, competitor product availability is also going to be increasing at that point in time and you can really bid yourself out of work as we start to get into the slowing portion of the business cycle.

Joe Galvin: Great. Connor, thank you so much for your insights. ITR is such a great partner of the Vistage community. I know the folks here in Denver are so excited to hear what you have to say. And I thank you for your time. I’m Joe Galvin for The CEO Pulse.

Related resources

The CEO Pulse: Inflation Resource Center

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