U.S. Industrial Sectors: Inflation Outlook for the Next Six Months

Rating

Industry Sector

Energy:

Down

Petroleum Products – Crude oil prices have broken past $100/barrel and have climbed as high as $105 on news of the Colombian border skirmishes and lower-than-expected inventories. Additional factors affecting the high price of oil are the weakness of the U.S. dollar and OPEC's most recent decision to not to increase production. Based on market fundamentals, however, we expect the crude oil price to fall to around $85/barrel by the end of the year.

Up

Natural Gas –Healthy demand should continue to place pressure on pricing, even in the face of an economic downturn. The rising cost of coal, a cold winter, and the lower level of LNG imports have all contributed to the rise of natural gas prices, and the supply balance will remain tight in the near term..

Stable

Wages: While recent job reports and unemployment claims point to more slack in labor markets, inflationary pressures will prevent any deceleration in wage growth over the next six months.

Stable

Benefits: Growth in benefit costs will continue to decelerate, as contributions to benefit trusts fall in response to weakening profits. In addition, employers continue to shift health expenses not only to individuals, but to unions in an effort to contain costs in 2008

Up

Iron and Steel: Carbon steel prices exploded in January and February, and more increases are in store through the second quarter. Most product prices are up 40% or more in the past two months, and total increases will exceed 50%. International prices are quickly playing catch-up, so imports are not a bargain. High prices will persist into the third quarter, then decline rapidly during the fourth quarter and across the first half of 2009.

Up

Nonferrous Metals: A surge in speculative buying has pushed prices up dramatically since the start of the year. Physical markets remain tight, but a lackluster outlook for consumption outside of China and rising production make this recent spike look unsupportable on a fundamental basis, even in the immediate near term. Look for LME prices to correct in the second or third quarter. Downstream prices, however, are likely to continue moving higher a bit longer.

Up

Chemicals and Allied Products: Additional strength in energy prices is providing chemical producers with further cost-induced justifications for upward pricing moves. While slowing U.S. end-markets will increase domestic buyer resistance, reasonably good end-markets worldwide will allow many announced increases to stick, at least partially.

Stable

Building Materials: Weak housing construction will hurt materials tied to residential markets, including lumber and wallboard. Despite a slowdown in nonresidential construction, cement and construction steel prices are staying inflated because of lower imports linked to a depreciating dollar. Asphalt prices are also strong, as oil prices continue to soar.

Down

Electronic Components: A slowing economy and slackening demand will ensure that prices continue to decline. Both the producer price indices and the average selling prices for semiconductors and electronic components will see significant softness over the next six months. If, as expected, the economy resumes growth in the second half of this year, then prices may slow their decline, but outright increases are nowhere in the future.

Machinery and Equipment:

Stable

Electrical– Corporate America is rethinking its capital spending programs in the face of weakening final demand, downward pressure on profit margins, and surging energy prices. At the same time, the recovery in nonresidential construction is fast running out of steam. With this as a backdrop, domestic demand for industrial electrical equipment is likely to soften over the near term. Energy-related projects are expected to proceed apace, while export markets should continue to provide some solace. But with domestic demand in retreat, escalation rates will remain tame.

Stable

Non-Electrical– With domestic demand softening, a buyers' market will emerge over the near term. Bucking the trend, record farm income and skyrocketing oil prices will continue to bolster spending on agricultural machinery and allow energy investment programs to proceed. A weak dollar and generally favorable rest-of-world end-market prospects bode well for U.S. exports of non-electrical machinery.

Down

Transportation Equipment–The prospects for light vehicles have soured in the face of the freefall in housing, a deteriorating employment picture, tighter credit, and sky-high energy prices. We are not expecting any fire sales, but given the mood of the market, holding the line on prices will be near impossible. Therefore, incentives and rebates should remain in play. The weakening economy will also take its toll on trucks, trailers, and railroad equipment. Last year saw more capacity and traffic, a situation that will not improve soon.

Stable

Transportation and Logistics: Despite weak demand, rates for railroad, trucking, and air freight have been driven higher in the first quarter of 2008 because of sky-high fuel prices. But demand for transportation services is lower, and expected to remain sluggish throughout 2008. Furthermore, fuel prices should ease over the next six months, eliminating any upward pressure on rates.

Up

Paper and Packaging: Prices continue to strengthen moderately, but steadily. Despite weaker demand, supplies are extremely well managed, with additional mill closures and lower imports as the U.S. dollar weakens. .