2022 Theme: Inflation Day, USA! What Does The Latest CPI Print Mean?
This past Tuesday was the release of the monthly US CPI report. As usual these days, it was a big day for financial markets and the broader economy.
We were initially hoping for a rather "boring" report whereby inflation would still be elevated but also show signs of diminishing via both demand (higher prices) and supply (less availability of credit) channels and we could try and focus our analytical fire elsewhere.
Our hopes were completely dashed.
When the CPI number actually came out it reminded everyone why we say that "US inflation is the new jobs number" and this data is the single most important data point determining the direction of US financial markets.
The highlights from the report itself:
US CPI rose 8.3% year-over-year vs 8.1% expected but slowed (very slightly) from last months's multi-decade high.
Removing volatile food and energy prices, so-called "core" CPI still rose 6.2%, which surpassed expectations for a 6% gain.
Inflation breadth grew considerably. This means that the number of average prices rising grew considerably. i.e.: more stuff is becoming more expensive.
In essence, the takeaway is that headline inflation fell (slightly) but core did not and so investors remained very concerned because inflation is both elevated and seems increasingly entrenched.
No bueno.
The (3) deeper insights from this new data:
The first is that the breadth point is really concerning.
When inflation was first high a lot of people pointed out that there were very few components of the CPI index that were contributing to the rise.
This was true!
However it is no longer the case. As high inflation has persisted month after month it has slowly bled into other industries, products and economic sectors.
Today's high fertilizer costs become tomorrow's high corn prices which eventually becomes a more expensive steak.
"Of the 95 CPI components we can track back to 1998 (which cover 98% of the CPI) 63% show year-over-year price gains of 6% or more in April, which is the highest share on record.”
You can see how unusual this is here:
The reason this development is so concerning is simply that the more breadth there is in the inflationary pulse, the more stubborn the cycle of price rises is becoming and the harder it will be to bring under control.
This raises the probability of a Fed mistake and the highly correlated possibility of recession which, for self evident reasons, was worrying for investors.
The second insight is that goods inflation is moderating but services inflation is taking over. It has now risen four months straight.
This is also very concerning because, once again, it demonstrates that inflation is successfully taking hold in a) new and b) very important part of the economy.
And the service sector inflation is five times (5x!!!) the weight of the goods component in US CPI.
You can see that the long anticipated decline in goods inflation has finally occurred but, in tragic fashion, this reversal has been almost simultaneously offset by a rise in services-based inflation.
This is the ultimate "out of the frying pan and into the fire" economic scenario.
Finally, the third interesting aspect from this report is that the CPI shelter component is rising and doing so steadily.
We have argued for nearly a year that, slowly but surely, the ultra low interest rates and financing would continue to fuel large increases in house prices that would, eventually flow into shelter inflation.
Some of our old work is here. The last chart (No. 4) is the key.
Typically, shelter inflation has what economists term "a lag" but today's higher purchase price will eventually become tomorrow's rent and it is important to remember that, for a lot of people, rent is super important.
In 2021, 36% of Americans households rented according to the latest available data.
The reason this is important is two fold:
On the one hand, many Americans will be adding higher rent to the already lengthy list of adjustments they have made to their cost of living. This will further hurt real incomes.
On the other, the "lag effect" we mentioned above is likely to keep inflation elevated, no matter what the Fed or economy does going forward.
Why?
Because shelter is just under a third of the CPI basket. And it is 40% of core CPI.
And the lag will mean that, even if many other prices come down, the costs of shelter will continue to rise for many Americans.
Here is the relevant chart:
In conclusion, along with grains, rents are heading up and will almost certainly continue to do so. If you rent this is a problem, if you are a homeowner, or a landlord, it will be to your benefit.
Even with mortgages breaking above 5.3% for a 30 year fixed, the costs of housing won't necessarily be coming down, rather the pace of increases has been what has changed.
What has come down is the stock market. Will that continue?
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