Headline CPI came in slightly higher than expected today at 5.4% (versus 5.3%) while core inflation was in line at 4%. This essentially displays a stabilization of CPI, but stubbornly at an elevated level.
On a monthly basis, things look more benign, core inflation has been rising at a 0.2% for the last three months, essentially in line with its 0.18% pre-COVID trend.
As we look through this report, we cannot help but be reminded of one of our favorite Clint Eastwood Westerns.
The Good: Flexible categories still moderating
In the ‘flexible’ CPI categories, used car prices fell for a second straight month, down 0.7%. Rental car prices fell another 2.9% while airfare was down 1.7% and hotels 0.6%. In our view, it now looks safe to say we have passed the worst of the reopening surge in prices.
The Bad: Supply chain pricing pressures persist
New vehicle prices rose 1.3%, furniture 2.4%, and appliances 1.2%. Overall, durable goods inflation is running north of 7% year on year.
Similarly, globally supply issues in energy markets have led to accelerating inflation in those categories. Gasoline prices are now up over 40% versus a year ago, and natural gas service prices rose 2.7%, now up over 20% this year.
Energy inflation may nonetheless be relatively muted in the US, as it is a net exporter of natural gas. It will likely be a larger inflation story in Europe and Japan, which are both net importers. US domestic oil supply may also improve as the Baker Hughes rig count has doubled over the past year, which will potentially lead to higher production.
The ‘to be determined’: are ‘sticky’ categories set to rise?
As we have stressed in previous Instant Insights, we are focusing heavily on ‘sticky’ price categories for signs of persistent rather than transitory inflation.
Every inflation print this year has been muted within the sticky categories. However, for the first time, today’s report provided some conflicting signals on this front.
Healthcare inflation remained largely nonexistent — medical services prices fell 0.1% and are up less than 1% from a year ago. Education services inflation is also muted.
We do, however, notice a more notable pick-up in shelter — the largest CPI category. Rents rose 0.5% month-on-month while owners’ equivalent rent rose 0.4%. This is the fastest monthly rise in rents since 2016 and owners’ equivalent rent since 2006.
Importantly, these trends are less concerning on an annual basis, with rents and owners’ equivalent rents at 2.4% and 2.9% respectively, well below pre-COVID trends.
Also, crucially, one month does not make a trend. The figures have potentially been mildly distorted by ending mortgage forbearances, but we will stay laser-focused on these categories to see if a trend does emerge.
A persistent rise in these sticky categories could make for an ugly scenario for the Fed, which currently remains intent on leaving policy rates alone until 2023 (see Instant Insights: Wall of cash meets wall of worry).
Inflation will remain elevated, but still likely transitory
Overall, this report is consistent with our expectations. As the summer reopening rush fades into the fall, we believe it is difficult to see inflation rise meaningfully from here.
Continuing supply chain disruption will mean that inflation will potentially stay elevated for longer — in our view above 3% through Q2 2022. The large sticky categories will determine the ongoing run-rate thereafter.
The jury is certainly still on out on how the sticky categories will perform, and it remains the key metric to watch.
For the Fed, everything now appears set for a ‘taper’ announcement at its November meeting. In our view, there is little chance it will commit to any policy path beyond that, as it waits for more data before it decides on lift-off earlier than its current trajectory of Q1 2023.