Supply-chain stress is easing...

At the Federal Open Market Committee's press conference last week, Federal Reserve Chairman Jerome Powell noted that supply-chain disruptions have been a major cause of global inflation growth. But now, he said, they're finally returning to normal.

Goods are flowing more freely around the world. Manufacturers can once more get their hands on necessary parts and materials.

This is another sign the economy is returning to pre-pandemic levels. And it means one thing: We'll see continued declines in inflation.

You see, prices for producers are finally falling. Raw-material costs have dropped... and so have the prices paid by customers.

This means inflation can keep declining. And that's good news for the stock market...

To see what Powell means, take a look at this chart of the New York Federal Reserve's Global Supply Chain Pressure Index ("GSCPI") versus the Consumer Price Index ("CPI").

You can see how supply-chain pressures drove inflation higher. As the GSCPI became stressed, it moved far above its baseline for normal activity – and costs exploded. But now, as the situation has begun to improve, consumer costs are coming back down...

This chart tells us economic activity is returning to normal. Countries and businesses everywhere are adapting to the changes brought about by COVID-19.

A big factor in all this is that costs for producers are coming down. Look at what the numbers are showing us...

The Producer Price Index ("PPI") is a measure of wholesale inflation. It looks at the prices businesses pay for goods and services before they get to consumers. As you can see, inflation for producers has been dropping rapidly...

The latest reading was the index's weakest year-over-year ("YoY") rise since March 2021. That's largely because shipping costs are easing...

Shipping costs climbed to historic highs in the second half of 2021 due to supply-chain stress. And they remained elevated through the first half of last year. Now, it looks like they're coming back down to pre-pandemic levels.

The Freightos Baltic Index ("FBX") – a major benchmark for global freight rates – has fallen 80% since its peak in late 2021. Take a look...

As you can see, pricing pressures are down significantly. That's important – because shipping costs are a key driver of inflation...

The International Monetary Fund estimates that when freight prices double, annual inflation rates increase by 0.7%. On the other hand, when freight rates are cut in half, inflation rates come down as well.

The decline in freight prices over the past year has fueled the dramatic drop in the PPI. Look at the relationship between the two indexes...

Even better, we should expect this to continue. Remember, as costs for producers fall, those savings get passed on to consumers – which means we could see more price stability throughout the economy.

But most important, the Fed knows all of this. Powell has noted that major inflation drivers are starting to cool. This could give the central bank the confidence it needs to pull back on its rate hikes – and even consider cutting rates toward the end of the year.

Very few of us were prepared for the economic impacts of the COVID-19 pandemic. Not many people expected such huge supply-chain stress and the inflation that followed. But throughout history, we've adapted and overcome.

That's what's happening now. The economy is returning to normal. As inflation eases, the Fed can stop tinkering. And as investor confidence grows, folks will put more money back to work in risk assets like stocks... which will underpin the S&P 500 Index over the long term.

Good investing,

C. Scott Garliss and Kevin Sanford

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