Four points about yesterday’s US Consumer Price Inflation report:
#1: While the headline/core +5.4/+4.5 percent annual inflation numbers were above economists’ expectations, the same transitory factors as previous months drove those numbers:
- Gasoline prices are up +45 percent versus last year because, well, there wasn’t as much demand then as now. This contributed 1.7 points of the 5.4 percent headline inflation rate.
- Used vehicle prices have been increasing because of America’s post-pandemic suburbanization and a lack of new vehicle inventory due to chip shortages. June’s 45 percent increase in used car and truck prices was worth 1.4 points of headline inflation and 1.8 points of core inflation last month.
Takeaway: exclude gasoline and used vehicle inflation and the headline/core CPI June numbers are +2.3/+2.7 percent. History says those are valid asterisks to June’s inflation data:
- From 2010 to 2019, average annual CPI inflation was 3 percent for gasoline and 0.9 percent for used vehicles. The current readings are much higher but for entirely understandable reasons.
- We’ve been highlighting that the Manheim Used Vehicle Price Index is rolling over, so we’re close to/at “peak used car”.
- As for gasoline, an oil shock would obviously push gasoline price inflation higher but in that scenario we’d be worried about a lot more than CPI reports.
#2: Related to today’s CPI report, yesterday’s NY Fed Survey of Consumer Expectations showed that Americans are expecting 5 percent-ish inflation over the next year. The exact number from the SCE was 4.8 percent, but respondents’ expectations of 3-year forward inflation is just 3.5 percent. Pre-pandemic (January 2020) those estimates were just 2.5 percent expected 1- and 3-year forward inflation.
That got us to wondering: are US consumers becoming more price-conscious? Put another way, are they “walking the walk” of inflation worries, or just “talking the talk”?
After a short trip to an online synonym dictionary’s entry for “cheap” and some trial and error on Google Trends looking for popular searches related to budget shopping, we found these (all charts show the last 5 years of data):
US Google search volumes for “cheap” are down 18 percent from January 2020.
US search interest in “sale” picked up markedly during the pandemic but is off 11 percent from last year at this time:
US searches for “low cost” and “bargain” are also below last year’s levels:
Takeaway: we occasionally hear concerns about impending “stagflation” (high inflation, low economic growth), but as long as consumers are relatively price insensitive (as this data shows) it is hard to see that scenario developing. Readers who lived through the 1970s clipping coupons and collecting books of S&H green stamps know what we mean.
#3: Housing inflation is the most important issue to watch going forward. Owners’ Equivalent Rent (OER) is the primary measure here, and at 24 percent of headline and 30 percent of core CPI no other component matters more. Reminder: OER is based on a consumer survey which asks and tracks answers to the question “what would your house rent for?” and is not directly related to actual home price appreciation.
This chart (2000 – present) shows that OER (red line) has made an inflationary turn in the last 2 months, going from 2.0 percent in Q1 to 2.3 percent in June. It also highlights that OER inflation is usually a tailwind that keeps core inflation (black line) higher than it otherwise would be. The red line is usually higher than the black line except for the period around the Great Recession.
Takeaway: OER/home price inflation will almost certainly increase in the coming months given the state of the US housing market and this, not used cars or gasoline, will be the issue to watch. Housing inflation was a key cause of the late-1970s US inflation some investors worry is about to make a return appearance. The OER calculation is sufficiently different from how the CPI was calculated back then to make this statistically impossible. But even OER saw +4 percent inflation in the 2000s housing boom, so if other structural inflation does appear in coming years it could mean that CPI runs +3-4 percent for longer than the Fed may like.
#4: Two other odds-and-ends items to wrap up:
First, Chair Powell is testifying in front of Congress the next 2 days. He has thus far been able to avoid Chair Bernanke’s May 2013 verbal faux pas regarding the tapering of bond purchases. Given today’s inflation print, however, we expect he will face repeated questioning on when the Federal Reserve will start to reduce the scale of quantitative easing.
Second, today’s CPI report did have a noticeable effect on Fed Funds Futures prices/odds of a 2022 rate hike:
- The December 2022 contract went from discounting Fed Funds of 0.29 percent to 0.33 percent today.
- That may not sound like much but put in the context of the last few days it is significant.
- Back on Thursday, Futures were pricing in 0.25 percent Fed Funds – about 50/50 odds of a 2022 rate hike.
- At today’s pricing, our estimate is that the current odds of a rate hike stand at 88 percent.
Takeaway: last night we showed that US equity markets were too focused on the upcoming earnings season and not enough on macroeconomic issues. Between today’s inflation report and the next 2 days of Chair Powell’s testimony, the pendulum of market attention may start to swing back the other way.