Inflation held its ground yesterday at 5.4%, the same as last month’s post-2008 high and broadly in line with market expectations. Core inflation did, however, soften slightly from 4.5% to 4.3%.
On a month-on-month basis, CPI rose 0.5%. Undeniably sizable, but notably the slowest increase since February, as some outsized gains in recent months begin to normalize.
Volatile items still responsible for the overshoot
As is becoming déjà vu (see Instant Insights: Still peaking and Instant Insights: Peak CPI), inflation was once again dominated by ‘volatile’ rather than ‘sticky’ categories, underpinning our view that the weight of evidence still indicates that this is a transitory spell. In our view, it is unlikely that inflation will continue to overshoot beyond next year.
The report even provided evidence that some volatile price items have normalized. Used cars, the major driver of inflation over the last two months, showed signs of stalling out, rising just 0.2% in July, after having risen 30% over Q2.
Furthermore, the Manheim used car index (a leading indicator of used car prices) shows auction prices have fallen over the past two months, which will potentially feed through to consumer prices, reversing the impact on CPI. New car pricing remained firm (up 1.7%) given supply constraints around semiconductor production, but recent production schedules suggest new car inventories may be finally starting to climb, further indicative of supply conditions normalizing.
Leisure spending is strong, but may moderate after the summer
Hotel prices were very strong, rising 7% in July and 24% pa. Last week, hotel occupancy reached 94% of 2019 levels (Figure 1), despite a tepid recovery in business travel, implying that leisure is dominating as consumers make the most of summer amid a largely reopened domestic economy. Indeed, hotel occupancy in tourist hotspots like Florida and South Carolina is well above 2019 levels.
Figure 1: Hotel prices back at pre-crisis trends, continued parabolic growth potentially unlikely1
This, however, indicates pricing pressures may fade into the fall. The spread of the Delta variant may also lead to consumers booking marginally fewer upcoming vacations.
There is a high hurdle for inflation to continue rising at the current pace
Although the CPI story has been very similar over the last three months, the current trend looks increasingly unsustainable to us.
For current trends to continue pushing CPI above 5%, over the next year hotel prices would need to rise another 24%, used cars another 41%, or car rentals another 74%. All of these look highly unlikely in our view.
Realistically, for persistent inflation to take hold, we would need to finally see it in the major ‘sticky’ categories, such as owner’s equivalent rent (weighted at 24% of the index), which saw a moderate 0.3% increase in July for the third straight month, consistent with its 2016-2019 trend (Figure 2).
Figure 2: 'Sticky' inflation components still show muted growth2
Another ‘sticky’ category, medical inflation, was also once again subdued, at ~1%, and potential policy changes in the upcoming reconciliation bill may help limit any increases.
The Delta variant could, however, be inflationary
The spread of the Delta COVID-19 variant across the globe has once again added some uncertainty.
In Asia, governments have begun implementing some restrictions, which may exacerbate challenges across global supply chains. To the extent that consumer demand remains elevated in the US, this could create further inflationary pressure.
In our view, this would still result in ‘transitory’ inflation, which we expect to last into Q2 2022 (see Instant Insights: Some like it hot). In coming months, we continue to expect to see inflation slowing closer to 3% in mid-2022 and 2% in 2023.
Expect the Fed to be unmoved
We do not expect this to cause the Fed to change course despite the discord between hawkish regional Presidents and the rest of the committee (see Instant Insights: Tug of war). We expect the Fed to announce its plan to ‘taper’ its asset purchases in Q4 this year, and carry out tapering over the subsequent 8 to 12 months.