Friday, July 1, 2022
Goods versus Services
Before we think about the new world order that global inflation may enter, let’s start with the good news within the United States. The Federal Reserve’s (Fed) preferred measure of inflation, the core PCE deflator, is slowing on a year-over-year basis. As shown in the LPL Chart of the Day, the May core PCE deflator rose 4.7% from a year ago. The annual growth rate slowed for the third consecutive month after reaching a high of 5.3% year-over-year in February. “Inflation is still stubbornly high and far above the Fed’s long run target of 2%, but the deceleration is encouraging,” explained Jeffrey Roach, Chief Economist at LPL Financial.
Price conditions in the U.S. are best understood by breaking out goods inflation from services inflation, and the rate of inflation seems to be cooling for durable goods.
Auto prices continue to moderate as growth rates for motor vehicles and parts slowed for the fourth consecutive month. Used auto prices rose at the slowest pace since May 2020 and as supply bottlenecks improve, the car market should begin to revert to pre-COVID-19 behavior.
Recreational goods and vehicle prices were flat from a year ago, as high gas prices are slowing demand for recreational vehicles.
However, a major concern for the Fed is that the surge in travel-related demand is pushing services inflation up. Consumer prices for housing, restaurant, and accommodation services are reaching new highs as consumers release pent up demand for travel and housing costs react to the recent hot real estate market.
Overall, this is a positive report for investors as the core year-over-year growth rate has consistently fallen since February. This inflation report gives some salve to policy makers after what seemed to be unanchored inflation expectations in the previous week’s Consumer Confidence Report. According to the Conference Board, inflation expectations 12 months hence rose to 8%, a record high but conflicting with the University of Michigan report as well as the inflation rate implied by Treasury Inflation-Protected Securities (TIPS).
Could Inflation be Entering a New World Order?
With all the talk on inflation rates decelerating, in actuality, inflation may not reach the preferred target in the near term.
Consumers may have to live in a new world order where inflation consistently runs hotter than the previous decade. At least, that’s what global central bankers warned at the ECB conference in Portugal.
Reshoring production, newer health protocols, and tight labor markets could keep inflation rates above the 2% long run average for the near term.
Policy makers must come to grips with a real possibility that inflation rates will not come down to their preferred targets for many years. The latest inflation report is a juggernaut for the Federal Reserve as they use blunt instruments to slow aggregate demand during a time when inflation is also irritated by supply shocks. For more on the current environment, be sure to watch our latest Econ Market Minute, where Chief Economist Jeffrey Roach gives more economic insights.
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