US inflation: the story is different than it appears at first glance

On a monthly basis, headline inflation rose 0.470% versus the previous month and 0.550% for the core rate. Certainly some very hot prints when viewed from afar. But a closer look at the numbers tells a slightly different story.

Senior Vice President, Portfolio Strategist and Portfolio Manager
at Natixis Advisors

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The headlines will read that this was the sharpest spike in inflation since 1982.  Headline Consumer Price Inflation (CPI) in the US rose 7.0% versus same time a year ago while the core rate, which excludes food and energy prices, rose 5.5% over that same period.  On a monthly basis, headline inflation rose 0.470% versus the previous month and 0.550% for the core rate.  Certainly some very hot prints when viewed from afar.  But a closer look at the numbers tells a slightly different story.

First of all, what matters most with these economic prints?  It’s where they come in relative to what’s expected.  And in the days running up to this number, a 7% handle had certainly been expected.  In fact, some of the ‘whispers’ running through the market were calling for an even hotter print.  So this data point could constitute a small win versus expectations. 

But more importantly, pulling back the layers tells a slightly better than expected story.  A few line items within the report stand out:  apparel was strong, registering an increase of 1.717% versus the prior month.  The transportation components were hot as well:  Used Cars and Trucks rose 3.518% versus the previous month, new vehicles were up 0.977% and motor vehicles, parts and equipment rose 1.591% versus previous month. 

The US imports almost 90% of all its apparel that it consumes. This line item has supply chain related issues written all over it.  And the auto related issues?  We all know the semiconductor chip shortage story and the knock on effect it is having on both new and used autos.  The point here – the usual culprits are at play, keeping prices elevated. 

Transitory or not, the pandemic continues to wreak havoc on price levels.  Another important point:  shelter prices.  The shelter component of the CPI has been a concern given its large weighting in the inflation basket and the recent surge witnessed in housing prices.  After a spike back in September of 2021, the rents component of the inflation basket, which has held steady at an elevated level, moderated modestly this month, a move that was certainly not expected and has yet to continue its upward trend that many have predicted.   

The song remains the same.  Stripping out pandemic affected services and vehicle related issues, inflation continues to remain contained albeit at higher levels.  We are set to enter a period where base effects will begin to kick in as well.  Year on year comparisons will be very difficult to match given the base effect impacts.  This will start to make those year on year comps very challenged and likely lead to a softening in the numbers.  Just simple math at work. 

But even as those base effects begin to challenge the inflation prints, tightening financial conditions are likely to start helping as well.  The markets have priced almost 4 rate hikes for the Fed by end of 2022 and 3 more by end of 2023.  In addition, tapering has been accelerated and the talk of balance sheet run off is now front and center with some pundits calling for outright sales of those assets purchased later in the year.  March has all but made a rate by the Fed a foregone conclusion.  June is not far behind either. 

But combine this with base effects, COVID related improvements in supply chains and labor markets, the Fed’s tough talk on inflation, balance sheet management and some modest fiscal tightening and we very well could see inflation prints beginning to soften to a pace that some are not expecting.  Plenty of hawkish takes abound right now regarding monetary policy and inflation. And while the Fed continues to talk tough, they are also trying to buy time and let the economy normalize and the data show persistent inflation before moving to a more aggressive tightening campaign highlighted with rate hikes.  Remember, it’s what’s priced into markets currently that matters.  And there’s a lot of hawkishness baked in at current levels.  Maybe too much. 

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US inflation: the story is different than it appears at first glance