Inflationary pressures had a significant impact on business profitability in 2018. A tight labor market drove wages higher, and regulatory changes contributed to double-digit increases for on-road shipping costs across the country. Meanwhile, tariffs led to many price increases, including on steel. All of these developments made it more expensive to conduct business and strained company profits last year.
In response to rising inflation, and in an effort to “normalize” interest rates relative to historic norms, the Federal Reserve Board increased the Federal Funds Rate four times in 2018. It is now early 2019, and the Federal Funds Rate is locked in a target range of 2.25% to 2.5%. Although tight labor-market conditions likely mean that wage inflation will persist in 2019, ITR believes other forms of inflationary pressures, such as commodity prices and shipping costs, will moderate over the course of the year. This in turn should allow the Fed to take a break from rate hikes.
As of the latest reading in February, the Producer Price Index (PPI), a measure of inflation for companies rather than consumers, was up 0.5% compared to February 2018. This is substantially lower than the peak value of 4.3% notched in July of last year by the PPI 1/12 rate-of-change. The sharp deceleration in the PPI growth rate over the past six months reflects easing inflationary pressures for businesses.
Furthermore, the US General Freight Trucking, Long Distance, Truckload Producer Price Index has also been slowing in its pace of growth. As of January, this Index was up 5.4% compared to January 2018, down noticeably from the 10.6% rate-of-change peak that occurred in October of 2018. Since the impact of the regulatory changes was largely confined to 2018, we expect this trend to persist over the course of 2019.
ITR Economics leading indicators point to a softening economy in 2019, which should provide the Fed with further impetus to take its foot off the gas pedal for additional rate hikes this year. The language the Fed uses to communicate its intentions to the outside world has already signaled a more temperate approach to interest policy in 2019.
With all this in mind, there are two key takeaways for decision makers.
First, inflationary pressure should ease over the course of 2019. You can react by either maintaining your current pricing with the goal of improving your margins, or by adopting a more aggressive (lower) pricing scheme to put pressure on your competitors and hopefully gain market share. Make sure to pay attention to any trade-related developments that emerge over the course of the year, as they could have a notable impact on the pricing environment.
Second, expect interest rates to stabilize this year after the increases that occurred in 2018. If you’d like to discuss what disinflation and stable interest rates could mean for your business this year, please reach out to us — we’re here to help!
