Inflation: it was the weather wot did it

Britain’s obsession with the weather has drifted across the Atlantic (seemingly along with half its stock market).

The Fed has no mandate to wade into climate policymaking, Jay Powell acknowledged again this week, moments after blaming an “unseasonably warm” January for a bout of higher-than-expected inflation.

Preliminary data from the National Oceanic and Atmospheric Administration suggest the first two months of 2023 “may be close to the warmest on record” for that period in data going back to 1895, according to the US Energy Information Administration. As Powell alluded to in his testimony to Congress, data on US employment, consumer spending, manufacturing production, and inflation bear this out.

The first indication that things were heating up economically came early last month, with January’s blockbuster jobs report. The US added some 517,000 nonfarm jobs in the first month of the year, nearly double December’s total and close to triple the consensus forecast. Why? Strikes, seasonal factors and you guessed it, the weather, said Morgan Stanley.

Sunny skies accounted for 126,000 of the jobs added in January, according to the bank’s analysis, which drew on research into the effects of weather on employment by the Federal Reserve Bank of San Francisco. 

But one swallow does not make a summer. The San Francisco wonks found that in winter, “when warmer-than-usual weather increases employment in a given month, the effect reverses over the following three months, leading to zero cumulative effects over a four-month period”. 

Inflation doves with an eye on February’s jobs numbers, out on Friday, will be hoping this holds true. James Knightley, ING’s chief international economist, has “pencilled in” a 200,000 jobs gain for last month but admits he has “little confidence in that forecast given the seasonal adjustment factors and unusual weather patterns”. 

Just over a week after the release of the jobs numbers came the latest consumer price index report (up 6.4 per cent annually versus a 6.2 per cent forecast) and the Fed’s favoured core personal consumption expenditures index (4.7 per cent versus a 4.3 per cent forecast). “It could be that progress has stalled,” said Fed governor Christopher Waller, “or it’s possible that the numbers released last month were a blip, perhaps associated with unusually favorable weather”.

Manufacturing output was meanwhile blowing with the wind, according to a Bank of America note from mid-February:

Components of industrial production have been subject to excessive volatility from unseasonably cold weather in December, which may have held back production and hours, and warm weather in January, which may have supported both a modest rebound in manufacturing production (+1.0% m/m) and a sharp 9.9% decline in utilities output.

Retail sales boomed unambiguously, rising 3 per cent over December’s figures for one of the biggest monthly increases of the past 20 years. Here’s a chart from State Street showing almost half (!) of all US retail sales in 2021 and 2022 occurred in the first month of both years. Warmer weather almost certainly fuelled a similar shopping bonanza in early 2023. 

It also helped stave off a sharp slowdown in Europe, where muted demand sent prices for crucial natural gas tumbling over the usually bitter winter months, averting a widely-expected collapse in both production and consumption.

JPMorgan notes “a general sense of complacency” emerging in the European natural gas market, however, thanks in part to the “the extra cushion in storage created by an incredibly mild winter”:

Ultimately, the market seems primed for asymmetric upside price moves – be it as a result of geopolitics, an upside surprise in Chinese demand in 2H23, or weather.

Higher temperatures could even end up boosting natural gas prices further down the line, the bank reckons:

Over the past several years, droughts – reducing hydro power generation and increasing natural gas burn throughout the globe – have been prevalent. Additionally, warmer temperatures overall have supported an increase in natural gas consumption in Europe – be it from low river levels preventing coal shipments, warm river temperatures suppressing nuclear power generation, or an outright increase in baseload cooling demand.

Back in the here and now it should go without saying that the weather was far from the only factor that influenced inflation and economic activity in Europe and the US. Add to that list China’s economic reopening, buoyant global liquidity, a secular shortage of workers, robust consumer savings etc. etc. 

But the weather clearly matters when it comes to price stability, even if its precise effects remain hard to quantify. Climate forecasting is “arbitrary and capricious” in nature, senator Tim Scott reminded Powell on Tuesday. Financial modelling, on the other hand, is a famously exact science.