United States
Over the last few years, the idea that markets would be encouraged by an 8.5% CPI print would seem ridiculous. However, it may finally be peak CPI.
Nonetheless, a continued increase in “sticky” CPI components this month confirms to us that inflation will likely remain well above-target for the foreseeable future.
Falling commodity prices help CPI fall
As we projected last month, commodity market retracements eased pressure on the CPI index. Energy CPI was -4.6% month-on-month, taking airfares down with it (at -7.8% month-on-month). Food inflation was the exception, remaining relatively high at 1.1% month-on-month, although further commodity price falls bode well for next month. Easing supply chain issues also resulted in goods categories, like appliances and used cars, declining (Table 1).
Table 1: Commodity price falls were the major reason CPI slowed1
| Sticky | Flexible | Non-Core | ||||||
|---|---|---|---|---|---|---|---|---|
| Health services | Owners' Equivalent Rent | Education and Commuication | Airfare | Used Cars | Apparel | Food | Energy | |
| 12 month Average | 0.3% | 0.4% | 0.1% | 2.7% | 1.8% | 0.4% | 0.7% | 2.3% |
| Feb-22 | 0.1% | 0.4% | 0.1% | 5.2% | -0.2% | 0.7% | 1.0% | 3.5% |
| Mar-22 | 0.6% | 0.4% | -0.1% | 10.7% | -3.8% | 0.6% | 1.0% | 11.0% |
| Apr-22 | 0.5% | 0.5% | 0.2% | 18.6% | -0.4% | -0.8% | 0.9% | -2.7% |
| May-22 | 0.4% | 0.6% | 0.2% | 12.6% | 1.8% | 0.7% | 1.2% | 3.9% |
| Jun-22 | 0.7% | 0.7% | 0.2% | -1.83% | 1.6% | 0.8% | 1.0% | 7.5% |
| Jul-22 | 0.4% | 0.6% | -0.1% | -7.8% | -0.4% | -0.1% | 1.1% | -4.6% |
Gasoline prices may have peaked, in which case CPI most likely has too
If gasoline prices remain at their current levels, the contribution to CPI will fall over the coming months, to just 1% from ~2.5% by December (Figure 1).
Figure 1: Gasoline's contribution to CPI would fall if gas prices remain at current levels2
We see this as a distinct possibility as refining margins are normalizing and consumers have adapted, which has moderated demand. Of course, it depends on global developments in commodity markets, but if gasoline prices have peaked, so has CPI in our view.
Easing supply chains was also positive
During the earnings season, several chip producers recently stated that inventories are normalizing after years of shortages and demand has softened, easing pricing pressures (although the auto sector appears to be the main exception for now).
Easing supply chain issues have helped. The cost to move a container from Shanghai to Los Angeles has fallen ~45% from its peak last summer, although shipping costs are still triple the pre-COVID norm (Figure 2).
Figure 2: Shipping costs indicate supply chain distruptions are easing3
"Sticky" inflation sectors are still rising — and will keep inflation high
As we have long stressed, the key categories to watch to understand long-term CPI trends are sticky services categories. Our “big three” are: shelter, education, and health care (collectively ~50% of core CPI).
All three are still rising (Figure 3). Although they may not rise much further, they are structurally unlikely to slow down significantly any time soon. In our view, they will keep CPI above 3% by end-2023.
Figure 3: Our big three sticky CPI categories are still running hot4
The shelter component of CPI (primarily rental categories) continues to be high, given low apartment vacancies (well below pre-pandemic). We expect it to run above 5% (year-one-year) for at least six months. Medical services CPI has been impacted as hospitals face pricing pressure, although health insurance CPI may see some relief during Q4.
Peak inflation is likely here, but it will be sticky
We believe the worst of energy and supply chain inflation is behind us. However, the persistence of sticky categories will likely help keep inflation in the 5.5% to 6% range by the end of the year, mirroring trends across the globe.
The print will also take some pressure off the Federal Reserve, which faced rising calls for a third consecutive 75bp hike after an unexpected bumper jobs report last week. At present, we still think a 50bp hike is a more sensible base case, although the next FOMC meeting is not until September, leaving plenty more data to come in the meantime.
Sticky inflation means the Fed’s tightening cycle will continue, but most likely at a slower pace. As such, further volatility feels inevitable, but with the worst potentially behind us, we believe it is a good time for investors to size up the most compelling opportunities in credit.
