The U.S. Supply Chain Index in July was back above neutral for the first time in nearly three years on the back of the continuing strong rebounds in inventories and capacity utilization.
With most of the COVID-19 concerns behind us and the renormalization of supply-chain linkages around the world, we should expect substantial relief coming from the supply-induced components of inflation, which account for about 35% of the year-over-year inflation according to our estimate.
Our index, however, does not capture the issues surrounding the housing deficit, which will be a sticky component of inflation moving forward. On top of that, the labor market remains tight as labor supply is slow to come back to its pre-pandemic level, reflected by the stagnated labor force participation rate in recent months.
That should keep the Fed on its course to raising rates again later this year to combat elevated inflation, which is still far from the long-term target of 2%. While our base case shows inflation will continue to retreat as supply-chain disruptions fade, we expect the annual inflation rate will likely stay around 3% by the end of 2023 and remain above the 2% target rate for a while.
Besides easing inflation pressures, the improvement in the supply chain index suggests a boost in spending as goods and services become more available. We expect spending to rise materially in the second half of the year as consumers head toward the holiday season.
Inside the index, other components, such as delivery time and prices paid, also improved in July, although they remained under neutral levels. Freight traffic was also near neutral, partly due to lower demand and the strong gains in transportation and warehousing employment in recent months.