One, focus on the inflation risk of drought in the United States
(1) How bad is the current drought in the United States?
The west and Midwest have been hit by a severe drought this year, with the West worst hit. In nine western states, including California, Arizona, Nevada, Montana and Washington, 95.6 percent of the region is currently in drought (up from 54.9 percent last year) and 64.6 percent is in extreme or exceptional drought (up from 4.5 percent last year). Amid widespread drought and lack of rainfall, water levels in major lakes and reservoirs in the Colorado River Basin have plummeted. Lake Powell, the nation’s second-largest reservoir, saw unregulated inflows in June at 30% of normal levels and is now at its lowest level in more than 50 years. And lake Mead, the nation’s largest reservoir, has fallen to its lowest level since 1937, meaning less water will be available in parts of Arizona, Nevada, California and even northern Mexico.
The prolonged heat and drought have
also brought secondary disasters such as wildfires. As of July 31, there were 87 major wildfires remaining in the United States, most of them concentrated in the West. In Oregon, for example, the third largest wildfire on record has burned more than 410,000 acres. The largest active fire in California, the Dixie Fire, has burned nearly 220,000 acres about 15 miles northeast of the town of Paradise.
(ii) What are the effects of high temperature and drought weather on crop production?
Soil moisture in most states in the Midwest and West of the United States is currently low due to high temperatures and drought. The U.S. Department of Agriculture estimates that soil moisture is currently deficient in much of the Western and Midwestern United States (Figure 3). In Washington state, for example, 99 percent of the area had insufficient topsoil moisture, compared with an average of 44.4 percent over the past five years. The same is true in Montana (97 percent), North Dakota (97 percent), Wyoming (79 percent), Minnesota (81 percent), Iowa (53 percent), and Other states.
Those states happen to be major agricultural regions in the United States, and high temperatures and dry weather and a lack of irrigation water have hampered crop production and earing, threatening to significantly reduce U.S. crop production this year. Iowa, Nebraska, and Minnesota’s corn and soybean producing areas, the western region in northern states such as Idaho, North Dakota and Montana is the grain of barley, North Dakota, south Dakota, Minnesota and Iowa is oats, North Dakota, south Dakota and Montana is hard red spring wheat (American production’s second largest wheat varieties) of producing. With crops such as corn, soybeans, oats and barley flowering and heading from July to August, and hard red spring wheat heading and harvesting from June to September, high temperatures and dry weather and a lack of irrigation are likely to reduce U.S. crop yields significantly this year. Durum wheat is expected to be down 46 percent from last year, other spring wheat is down 41 percent, and all wheat is down 4.4 percent, according to the latest usda forecast. Barley production is down 31% from last year, and oat production is down 37%.
(iii) Sustained increases in food prices may put additional pressure on US inflation in the second half of the year
Expectations of crop losses and speculation that the drought could cause will push up prices. From the historical experience, the impact of drought on grain prices is more through the expectation of grain production reduction and price speculation. In other words, when a drought occurs, prices start to rise in anticipation and speculation that production will decline, rather than waiting for actual production to fall to reflect supply and demand. U.S. wheat prices are more closely related to the intensity of frequent U.S. droughts than to actual yields. For example, during the 2012 drought in the United States, the actual wheat production increased that year, but wheat prices rose sharply.
A sustained rise in food prices will put upward pressure on food inflation, and in the context of this year’s drought in the US, the additional inflationary risk posed by higher food prices should be considered. When grain prices rise sharply, food inflation pressures in the US are high. In 2012, the drought in the United States caused food prices to rise sharply, with food contributing 2-3 percentage points to inflation. Us food prices have risen sharply this year, with wheat, corn and soyabeans up 10.8 per cent, 39.6 per cent and 18.4 per cent since the end of last year. Meanwhile, food and beverage prices in the PCE price index have also started to accelerate month-on-month inflation since the end of last year. The low level of food inflationary pressure in the first half of the year was partly due to the high base of food prices in the first half of last year. As the high base effects fade in the second half of this year, a sustained rise in food prices due to the drought could put additional pressure on US inflation in the second half of the year.
Two, PCE price index with the month-on-month pull split
Year-on-year, the PCE price index in June was 4%, unchanged from May. The main additional factors were motor vehicles and their parts, transportation services, entertainment services, food services and accommodation, which added about 0.19 percentage points to the PCE price index in June. Gasoline and other energy products, other non-durable goods (pharmaceuticals), health services, financial services and insurance combined to drag PCE down an additional 0.22 percentage point from a year ago.
On a month-on-month basis, the June PCE was 0.5% month-on-month, unchanged from May. The main extras were food and beverages, gasoline and other energy products, transportation services, food services and accommodation, which combined added 0.19 percentage points to the PCE price index. Recreational goods and recreational vehicles, other non-durable goods (games/toys/pet products, etc.), medical services, financial services and insurance, and home operations and maintenance (domestic/moving services, etc.) accounted for an additional drag of about 0.19 percentage points.
3. Review of PCE data in June
(1) The core PCE price index rose slightly year-on-year, reaching a new high since July 1991
On a year-over-year basis, the PCE price index was in line with the Bloomberg consensus, while the core PCE price index was slightly below the Bloomberg consensus. Us June PCE Price Index 4% yoy, last 4%, Expected 4%; The core PCE price index was 3.5% yoy, compared with 3.4% last and 3.7% expected, the highest since July 1991.
Commodity prices rose by 5.2% year on year, compared with 5.4% last year, pulling the PCE price index by about 1.77 percentage points. The increase in the price of durable goods continued to expand, while the increase in the price of non-durable goods eased slightly. Durables prices 7.2% yoY vs. 6.9% last; Non-durable goods prices were 4.1% y/Y, compared with 4.5% last.
Among durable goods, the year-on-year price increases of motor vehicles and their parts (14.8%) and furniture and household equipment (5.8%) were 1.1 and 0.2 percentage points higher than the previous month, respectively. The supply constraints of the automobile industry chain continued to support the increase of automobile prices, while the price increase of furniture and home appliances continued to expand due to the shortage of wood and the postpartum cycle. Prices of sports equipment, guns and ammunition, and recreational vehicles fell 0.3 percentage points from a year ago, while prices of recreational goods and recreational vehicles (2.2 percent) fell 0.3 percentage points from a year ago. Lower price increases for jewelry, watches and medical equipment for treatment dragged down other durable goods (0.9 percent) by 0.6 percentage points. Among non-durable goods, food and beverage prices (0.9 percent), clothing and shoes prices (4.7 percent), gasoline and other energy prices (43.4 percent), and other non-durable goods prices (0 percent) decreased by 0.2 percentage points, 0.5 percentage points, 9.8 percentage points, and 0.4 percentage points, respectively.
Service prices rose by 3.3% year-on-year, compared with 3.2% last year, pulling PCE price index by about 2.21 percentage points year-on-year. Prices of housing (2.7 percent), transportation services (7 percent), entertainment services (3.4 percent), and food services and accommodation (4.5 percent) increased 0.2, 1, 0.8 and 1 percentage points from the previous month. Prices of medical services (2.7 percent) and financial services and insurance (3.9 percent) fell 0.3 and 0.8 percentage points from the previous month.
On a month-on-month basis, the U.S. PCE price index rose 0.5% in June, compared with 0.5% last month. The core PCE price index rose 0.4% from 0.5%.
Commodity prices rose 0.7% month-on-month, compared with 0.8% last, driving PCE up 0.26 percentage points month-on-month. Durables prices rose 1% month-on-month, down 1.8 percentage points month-on-month. The main drag was furniture and household equipment (0.6% vs. 1.1% last), recreational goods and recreational transportation (-0.5% vs. 0.7% last), and other durables (-0.8% vs. 1.1% last, mainly jewelry and watches/medical equipment for treatment). Non-durable goods prices rose 0.6% month-on-month, up 0.5 percentage points from the previous month, driven mainly by food and beverage prices (0.8% vs. 0.3% last), gasoline and other energy products (2.5% vs. -0.6% last); Clothing and shoe prices fell (0.8% vs. 1.2%).
Service prices rose 0.4% month-on-month, compared with the previous 0.4%, pulling PCE up 0.26 percentage points month-on-month. Prices of food services and accommodation rose by 1.3% (last value 0.5%), housing by 0.3% (last value 0.3%), and transport services by 2.1% (last value 0.6%), respectively, contributing 0.08, 0.05 and 0.05 percentage points to the PCE price index month-on-month. Prices for medical services fell 0.1 percent, while those for recreation services rose 0.6 percent and those for financial services and insurance rose 0.1 percent.
(2) Salary remuneration led to a small increase in total personal income
In June, total personal income in America (on a quarterly basis) was about $20.4 trillion, up 0.1% from the previous month and 2.3% from a year earlier. Personal disposable income was about 18.0 trillion yuan, basically unchanged from the previous month and up 0.8% year on year. Increases in employee compensation, operating income and personal asset income in June offset declines in transfer payment income and rental income, resulting in a small increase in total personal income month-on-month.
On a month-on-month basis, employee compensation rose 0.7%, contributing to a 0.4 percentage point increase in total personal income. Business income increased by 1.1%, contributing to a 0.1 percentage point increase in total personal income. Asset income rose 0.5%, contributing 0.1 percentage points to total personal income. A 2 per cent drop in transfer payment revenue dragged down total revenue by 0.4 percentage points. A 0.3 per cent drop in rental income dragged down total personal income by 0.01 percentage point month-on-month.
Year-on-year, employee compensation increased by 9.5%, contributing 5.4 percentage points to total revenue. Operating income increased by 19.9%, contributing 1.6 percentage points to total personal income; Rental income increased by 1.9%, contributing 0.1 percentage points to total personal income. Asset income rose 2.3 percent, contributing 0.3 percentage points to total personal income year-on-year. Transfer payment revenue fell 17.5%, dragging down the total revenue by 4.3 percentage points year-on-year.
(3) Consumption expenditure on services increased month-on-month, while consumption expenditure on goods decreased month-on-month
Us personal consumption expenditure (qPI) was $15.8 trillion in June, up 1% month-on-month and 13.6% year-over-year.
Service consumption followed commodity consumption and became the active energy to promote the growth of personal consumption expenditure in the United States. Consumer spending on goods increased by 0.5% (-2.1% last) in June, contributing to the 0.19 percentage point increase in personal consumption expenditure month-on-month, while consumer spending on services increased by 1.2% (1% last), contributing to the 0.81 percentage point increase in personal consumption expenditure month-on-month. Among commodities, consumption spending on durable goods such as motor vehicles and their parts, recreational goods and recreational transportation vehicles fell significantly, while consumption spending on non-durable goods such as clothing and shoes, gasoline and other energy products increased. In services, the reopening of the society led to consumption expenditures on transportation services, food services, accommodation and entertainment services increasing by 4.8%, 3% and 2.2% respectively, while consumption expenditures on other services increased slightly.
Year-on-year, commodity consumption expenditure increased by 16.1% (23.3% last), and personal consumption expenditure increased by 5.5 percentage points. Among goods, spending on durable goods rose 21.3 percent, with spending on motor vehicles up 27.2 percent, furniture up 14 percent and household equipment up 14 percent. Spending on non-durable goods rose 13.3%, with spending on clothing and shoes up 26.2%, gasoline and other energy items up 62.3%. Consumer spending on services grew by 12.2% year-on-year (17.7% last), driving personal consumption expenditure to increase by 8.1 percentage points year-on-year. Among them, spending on services related to travel and social improvement, such as transportation consumption, entertainment consumption, food service and accommodation consumption increased by 31.2%, 27.9% and 40.1%, respectively, year-on-year.