In Instant Insights: Peak CPI?, we noted that inflation’s ‘base effect’ would be strongest in May, as COVID spread across the US a year earlier. However, CPI surprised again to the upside in June, rising by an unexpectedly brisk 0.9% on the monthly basis and 5.4% year-on-year. However, ‘transitory’ inflation drivers are still the culprits.
Inflation still driven by transitory drivers
Volatile price items – particularly airfares, lodging, rental cars and used cars – together contributed 0.43% to the 0.9% headline CPI figure, even though they account for just 5% of the index.
For signs of persistent inflation, we are watching ‘stickier’ items, such as rents and owner-equivalent rents. They rose a trend-like 0.25%, while medical service prices, another bellwether of persistent inflation, was unchanged.
So, although a high CPI print, this report does little to indicate that inflation will be persistent rather than transitory.
Used car prices accelerate yet again, but may finally hit the brakes
Used cars alone contributed 0.33% to CPI, making it a major driver of CPI for the third month in a row.
However, the Manheim Index, the gold standard in used car prices and a good leading indicator of used car CPI, has been moderating significantly over the last two months and even declined in June. We expect this to feed over into official CPI data in coming months. All else equal, this will bring CPI down.
Figure 1: CPI could begin to moderate as leading used car inflation indicator reverses1
Expect the Fed to stick to its roadmap
We continue to believe we are in the process of seeing the peak in inflation and expect the Federal Reserve will continue to largely remain on the same page.
As such, we expect Chairman Jay Powell will continue to argue that inflation data should be taken with a grain of salt. While more hawkish regional Presidents may feel emboldened, we do not believe this will shift the thinking of the center of the committee.
This report does not change our forecast, and we anticipate the beginning of tapering by year-end with a first-rate increase occurring in 2023. We expect this to continue to be a constructive environment for credit markets overall.