Thursday, June 10, 2021
Make that two consecutive months that CPI inflation has surprised meaningfully to the upside.
The U.S. Bureau of Labor Statistics released its May inflation report this morning, June 10, revealing that the headline Consumer Price Index (CPI) rose 0.6% month over month and 5% year over year. The core CPI, which strips out food and energy, rose 0.7% month over month, and 3.8% year over year. Given strong base effects from rolling off weak data from a year ago, we find the month over month data more informative. With that context, more volatile components that are heavily tied to the economic reopening had the largest effects on the monthly increases, most notably prices for used vehicles, airfare, and rental cars.
We continue to see strong evidence that supply chain bottlenecks paired with a rapid demand rebound are causing major price increases. The most visible example is in used car and truck prices, which surged 7.3% in May following a historic 10% rise in April. The supply of new vehicles is constrained in the near term because of semiconductor chip shortages, and as a result, used cars and trucks are being bid up in the secondary markets. The good news is that we expect these market imbalances to largely resolve themselves with time as supply, which has a longer ramp-up time than demand, recovers.
“The inflation outlook has rightfully been top of mind since last month’s blowout report,” explained LPL Financial Chief Market Strategist Ryan Detrick. “Under the hood, though, we think the picture is a bit more sanguine than the headlines would suggest, and still believe inflation will be relatively well-contained over the intermediate-to-long term.”
As seen in the LPL Chart of the Day, owners’ equivalent rent of primary residences, a measure of rents for non-rent-controlled residences in urban areas, has bounced off depressed levels. The move thus far, though, is likely best described as returning to the pre-pandemic trend rather than threatening to break away to new heights…for now. This measure is critical for future inflation prospects, as it is one of the largest components of CPI and is considered to be less volatile than other components. Movements observed in the series are, therefore, viewed as more structural in nature and thus have the potential to be “stickier.” At the moment, we do not believe that the rent component poses an imminent threat to the broader inflation picture, and is merely displaying an increasing willingness for consumers to rent following a massive shift in preference to own brought on by COVID-19.
Market-based measures of inflation expectations have also retreated from their fever pitch last month. 10-year breakeven inflation expectations, derived from the differences in nominal and real Treasury yields, have actually fallen since last month’s CPI report, not risen. And while we are hesitant to call that the peak in inflation expectations given ongoing bottlenecks in supply chains, there was a distinct air of a “buy the rumor, sell the news” dynamic to us.
Taken altogether, we believe the Federal Reserve (Fed) will view today’s inflation data generally as confirmation of its preexisting stance that the majority of excess inflationary pressures will be transitory. In a vacuum, despite the headline inflation beat, this likely does little to change the Fed’s timetable for tapering asset purchases, and the market reaction for now looks to be confirming that view. The coming months will be telling, though, as we are now entering the “show me” phase of the inflation debate where market participants will be increasingly anxious for the Fed to prove its assertion that higher inflation will be transitory.
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