The February consumer price index provided an unpleasant preview of coming attractions in the U.S. economy as top-line inflation soared by 0.8% on the month, pushing the year-ago reading to 7.9%, the fastest rate in 40 years.
The price shock that is now cascading throughout the domestic and global economies will push top-line year-over-year inflation to 10% or more.
It is important to note that the February estimation of inflation released by the Bureau of Labor Statistics on Thursday was completed before the Russian invasion of Ukraine and the broad economic sanctions that followed.
The price shock that is now cascading throughout the domestic and global economies will be captured in the coming months and in our estimation will push top-line year-over-year inflation to 10% or more.
This implies that the pain threshold for firms and households over inflation has yet to be pushed to its limit.
As the economy approaches that threshold, expect the collective howl from the public and commercial community to only increase as both the economy and policymakers venture into uncharted terrain.
The interplay between rising prices and demand destruction will present an unusually difficult policy puzzle to solve amid a price shock that will take some time to ebb.
While demand destruction will ease inflation on the margin, that will mean little to firms facing order cancellations and households experiencing a loss of purchasing power.
The decline in inflation-adjusted average hourly earnings of 2.6% cannot be explained away, and consumers will be in little mood to forgive further deterioration in real income and the loss of discretionary spending.
While we think it is certain that the Federal Reserve will hike its policy rate by 25 basis points at its meeting next Wednesday—the same day when investors widely expect Russia to default on its $117 million in bond payments due that day—we expect no further forward-looking indications on its strategy for drawing down the balance sheet or a realistic forecast on growth, employment and inflation.
Conditions are simply too volatile to put forward a coherent forecast at this time, and everything must be placed in a context of “revisions to come.”
The data
Beneath the headline number, inflation climbed by 0.6% when energy was excluded; by 0.5% excluding food, energy and shelter; and by 0.5% for service prices. The cost of housing climbed by 0.5% on the month and is up by 5.9% on a year-ago basis.
The cost of shelter rose by 0.5% on the month and is up by 4.7% on the year, while the policy-sensitive owner’s equivalent rent series climbed by 4.3% over the past year and is up by 0.4% on the month. This will require a response by the fiscal authority to create the conditions for an increase in supply to meet robust demand for housing irrespective of the external shock that will affect the economy through the energy channel.
The price of commodities increased by 1.3%, while food prices advanced by 1% on the month. Food at home increased by 1.4%; cereals and bakery products by 1.1%; meats, poultry, and fish by 1.2%; and dairy and related products by 1.9%. Watch this space closely in the coming months. Russia and Ukraine are responsible for roughly 25% of global grain exports.
The price of imported foodstuffs will increase noticeably because of rising energy costs and the curtailment of supply as the war continues. In addition, by late spring or early summer there will most likely be a food crisis in the Middle East and sub-Saharan Africa as grain exports contract significantly.
Overall transportation costs increased by 1.9% on the month, while the cost of new vehicles advanced by 0.3% and the price of used cars and trucks declined by 0.2%.
Medical care advanced at a modest 0.2% rate, recreation costs increased by 0.7%, and education and communications costs were flat on the month. Apparel prices increased by 0.7%.
The takeaway
The February inflation report foreshadows what will be a difficult period of price increases in just about all aspects of the American households’ market basket. What makes this worse is that the price shock will be held hostage to external events and policy decisions that have little to do with economic fundamentals. Rather, war and its consequences have returned to the U.S. economy and households are going to bear the burden of that adjustment.
