Is 5 Percent US Inflation the “New Normal”?

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Is 5 Percent US Inflation the “New Normal”?

Just one “Data” topic, but an important one: today’s Consumer Price Index report.

We’ll start with the easy bit: explaining why CPI is still running over 5 percent:

  • Headline number: +5.4 percent annual inflation (note: highest reading since July 2008)
  • Core (ex food and energy): +4.0 pct (note: lower than June 2021’s 4.4 pct reading)
  • Meat, Poultry, fish, and egg (i.e., proteins): +10.5 pct annual inflation
  • Energy commodities: +41.7 pct annual inflation
  • Used vehicles: +24.4 pct annual inflation
  • Headline inflation less Proteins, Energy and Used Cars: 2.7 percent
  • Core inflation less Used Vehicles: 2.9 pct

Takeaway: even when you exclude the most inflationary pieces of the CPI calculation, prices are rising faster (2.7 – 2.9 pct) than the Federal Reserve’s 2.0 percent target. Not to be cute, but only vegans who don’t own a car and have no plans to buy a used vehicle are seeing sub-3 percent inflation.

Moving on to the part of the report that gives us the most pause, Shelter is the most important category to consider, at 33 percent of headline and 41 pct of core inflation. The correlation calculation between headline CPI and Shelter since 1970 shows an 80 percent r-squared. Energy only has a 48 pct r-squared, highlighting how important the Shelter component has been to driving overall inflation in the modern era.

The following chart shows Shelter inflation (red) along with its 2 major subcomponents, Owners’ Equivalent Rent (70 pct of Shelter, in blue) and Rent (23 pct, in black) back to January 2000. It highlights just how volatile this component has been over the last 2 decades. Two peaks at +4 percent inflation (2002, 2007), a deep trough (2010), a slow grind higher (2011 – 2016), and the most recent and quick move higher (the double from February to September 2021).

Takeaway: given the US housing market’s continued strength, it is reasonable to assume Shelter inflation will return to at least its pre-pandemic peak of 3.6 percent (2016 levels) if not get close to the 4 pct levels of 2002 and 2007. The sharp-eyed reader will rightly note that Shelter inflation on its own did not drag overall inflation higher in the late 2010s, and that’s true because there was so little inflation outside of Shelter at the time. Now, the situation is different, of course, as the first point above shows.

Finally, let’s touch on food inflation; September’s reading of 4.6 percent was below the headline 5.4 pct level, but that’s still an outsized comp for an essential product and a new post-pandemic high (old high in June 2020, 4.3 pct.)

This chart shows CPI Food inflation back to 2000, and we’ve broken up the time series into 3 phases.

  • The first we call “cyclical” inflation, from 2000 – 2013, because it clearly moves in line with economic growth.
  • The second is “stable” food inflation, from 2014 – 2020, when price increases trended around 2 percent.
  • The third, where we are today, looks very much like structural inflation. The spike higher at the start of the pandemic is understandable; with restaurants closed the supply chain struggled to adapt. That wore off as lockdowns eased, but food inflation has come roaring back since May 2021, when it was 2.1 percent.

Takeaway: food prices directly inform consumers’ inflation expectations. Even if the Federal Reserve can’t directly address supply chain issues, food inflation is still their problem. Ditto for the Federal government, by the way.

Final thought: since the commentary here has been a bit frightful, we’ll end on a more reassuring historical note. The chart below shows annual CPI headline inflation back to 1960.

  • Yes, there was one period of rising inflation, and everyone knows when that was: 1960 to 1980.
  • Since 1982, however, the US economy has been unable to replicate the sort of structural inflation that grinds its way ever higher over decades. In the 1980s and 1990s, inflation trended around 3.5 percent. It was even lower over the last 20 years, right around 2 percent.

So yes, the 5 percent “we are here” marker on the far right side of the graph looks ominous. But … To believe the American economy has suddenly entered a new inflation regime one must shut the door on 40 years of economic history and venture off into the unknown. Capital markets implicitly know this, which is why we have a 1.5 percent 10-year Treasury yield and an equity market trading at 21x forward earnings. It will take a lot, and by that we mean several quarters if not a few years, of hot inflation data to alter market perceptions. Enough time, in other words, to reposition portfolios to a new inflation reality should it actually come to pass.


CPI report: