The recent surge in domestic prices continued as consumer prices increased by 0.9% on a monthly basis and by 5.4% on a year-ago basis, according to Labor Department data released on Tuesday.
The gains continue to be driven by a cluster of items — energy, transportation and commodities.
While the increase in prices requires close monitoring by policymakers, the gains continue to be driven by a cluster of items — energy, transportation (used car prices) and commodities — whose prices are linked to the near collapse in the economy last year.
In addition, the increase in the CPI does not signal that the economy is overheating. Rather, it is still a function of the shock to the economy induced by the pandemic and the unique constraints around supply chains.
So what does that look like? In June, the increase in transportation was responsible for 46.7% of the monthly CPI, with used vehicles responsible for 33.3% alone. Rent of shelter, which we will be focusing on as a source of sticky inflation, was responsible for 17.7% of the increase.
Energy contributed to 11.5% of the increase, and lodging away from home 7.5%. Lodging prices away from home have almost returned to pre-pandemic levels — yes, that means prices are up, but they are still below where they were before the pandemic. This gain in hotel costs implies that the worst is likely in the rearview mirror for that sector.
If one is a middle-market firm manager, central banker or investor, this is a good starting point for a rational conversation around inflation risk and any prospective policy changes.
While it is too early to call a peak in the top-line Consumer Price Index — we continue to believe that will occur in the fall — prices look as if an apex is forming as the economy moves away from the pandemic-induced shock.
Yes, inflation has firmed, and over the next few months a prospective increase in owners’ equivalent rents and housing may cause a strong bout of indigestion among central bankers and policymakers. But the primary drivers of inflation continue to be clustered in a few areas that are prone to volatility and are likely to abate.
Behind the price increases
The CPI is clearly experiencing a multi-month period of volatility primarily driven by three factors:
- A 21.2% increase in transportation on a year-ago basis — 21.6% private and 17.3% public.
- An 8.8%% yearly increase in commodity prices, including a 13.7% rise in durables and a 6.8% increase in non-durables.
- A 24.9% annual increase in energy, which is down from 28.8% in May.
This portion of the data bears out the 3.6% monthly increase in transportation and the 10.5% increase in the cost of used cars and trucks. Inside the index, the weight of price increases attributed to transportation is 16.55%, commodities 38.28% and energy 7.07%.
Away from those three areas, pricing has firmed but not at the alarming pace that the top-line numbers might suggest.
Service prices, which account for 61.72% of the index, advanced 0.4% on the month and are up 3.2% on the year. Housing, which accounts for 41.76% of the index, increased 0.4% in June and is up 3.1% from a year ago.
The owners’ equivalent rent, which is closely watched by policymakers and plays a role in the formation of medium- to long-term inflation expectations, had a 23.71% advance — 0.3% on the month and 2.3% on a year-ago basis.
The cost of medical care, which carries an 8.67% weight in the index, actually declined by 0.1% in June and is up 0.4% from a year ago. Education and communication costs, which have a 6.61% weight in the index, increased 0.1% and are up 2.1% over the past year.
Food and beverage prices, as always, remain volatile, increasing by 0.8% on the month and by 2.4% on a year-ago basis. Food and beverage prices are assigned a 14.89% weighting in the CPI basket of goods and services.
Policy takeaway
The talk around the Federal Reserve tapering its asset purchases will take on an added urgency and may get a bit noisier as rents firm and perhaps rise a bit.
The top-line increase in prices will result in a more meaningful discussion on a possible rate hike in late 2022 versus 2023 on the back of a quarter of stronger-than-anticipated increases in consumer prices.
Our sense is that the Fed will continue to look through top-line increases and focus on the composition of CPI and its transitory nature. But we continue to expect a robust discussion around the withdrawal of accommodation to the housing market when it comes to the $40 billion in monthly purchases of mortgage-backed securities.
That being said, the bond market barely registered a reaction Tuesday morning following the stronger-than-anticipated increase in costs, with the 10-year Treasury trading between 1.34% and 1.38%.
We take that as an expectation among professional investors that there is little medium- to long-term risk to the economic outlook linked to inflation despite the short-term noise as the economy emerges from the pandemic.
What’s next?
Looking ahead, we anticipate that policymakers and investors will closely focus on the prices of housing and oil. It is hard to make the case that rents and housing will not firm further and quite possibly rise. This type of inflation tends to be sticky and plays an important role in forming medium- to long-term inflation expectations.
Just as important is the price of oil. The OPEC economies have been able to clear the oversupply that prevailed last year in global markets. That has pushed oil prices higher — West Texas Intermediate is trading near $74 per barrel and Brent crude at $75.
The OPEC economies of Saudi Arabia and United Arab Emirates are currently engaged in a discussion around how much to increase supply as the global economy reopens after the reduction in supply over the past year.
Those two factors will weigh heavily on inflation and the domestic policy response. Stay tuned because this is going to get much more interesting throughout the year and well into next year.
For more information on how the coronavirus pandemic is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.
