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Financial Industry Insights from Advisors Asset Management
On June 15, 2021
Peak CPI?
“It’s deja vu all over again.” – Yogi Berra
Last week’s inflation report is eerily reminiscent of last month’s (you can read our thoughts on the May 12 read in The Inflation Debate Rages On).
Supply chains and economic reopening create a perfect storm
Headline inflation, as measured by the Consumer Price Index (CPI), rose 0.6% month-on-month to hit 5% year-on-year, the fastest since 2008. Core CPI also substantially beat expectations at 3.8%, the fastest since 1992.
We are currently in a perfect storm: new car production is being impaired by chip shortages and rental car companies are holding off from selling their fleet of used cars as consumers are rushing into leisure spending post-vaccination.
As with last month, used car prices surged, rising another 7.3% (up nearly 30% from last year). Car rental prices rose 12% and have risen 45% in just the past three months. Elsewhere, airfare and apparel prices also rose significantly, benefitting from the continued economic reopening.
Gains like this simply cannot be sustained, in our view. The two auto categories account for less than 4% of the index but drove 40% of this month’s increase in CPI and certain signs indicate that conditions are normalizing. For example, a large U.S. auto maker announced last week that it is restarting several factories.
Still no real signs of persistent inflation
The stickier “shelter” and “healthcare” components of CPI still show little sign of accelerating.
Medical services prices declined 0.1% as health insurance profits began to normalize. Meanwhile, rents rose just 0.2% while owner’s equivalent rent has been bouncing between 0.2% and 0.3%. The rental categories account for a third of CPI, and together are up just 2%, roughly half the pre-pandemic run-rate. We anticipate a long, slow recovery in shelter inflation, which would weigh on the index as “base effects” fade.
Figure 1: Inflation is currently limited to transitory categories
Source: FRED, June 2021
As we have now passed the one-year anniversary of the most severe pandemic-related market shocks, we are now about to begin passing the worst of the COVID-related base effects.
As such, we expect CPI to begin to decelerate from here as these supply chains repair, the reopening rush fades, workers re-enter the labor force, and consumer spending on durable goods normalizes.
Categories such as used car prices likely cannot rise 10% per month ad infinitum. Furthermore, some commodity prices have seen a pullback following recent gains, making it very difficult for 5% inflation to be sustained. Indeed, over the next three months, monthly inflation would need to accelerate further to eclipse the 5% mark on a year-on-year basis.
That said, we expect the descent in CPI to be slow. Returning to below 3% inflation will likely take until several months into 2022.
Figure 2: Has CPI reached the peak?
Source: FRED, Insight calculations, June 2021. The light blue line assumes month-on-month of 0.18% in line with 3-year linear pre-COVID trend. Light green line implies month-on-month inflation of 0.4% month-on-month inflation gradually falling to 0.25% month-on-month in line with recent trends. Opinions expressed herein are as of June 10, 2021 and are subject to change without notice. Insight assumes no responsibility to update such information or to notify of any changes.
The dotted blue line indicates the expected path of monthly inflation assuming we return to three-year pre-COVID CPI trends. The dotted green line is a risk case, indicating the potential path of inflation assuming used cars, rental cars and air fare prices continue to rise for the next few months (which we view as unrealistic). We find that even if the volatile CPI elements continue accelerating (all else being equal), overall inflation would still fall over the next several months as headwinds from base effects kick in.
“Buy the dips” still the playbook
Absent signs of persistent inflation, large inflation prints such as these have the potential to unnerve markets.
We believe patience and level-headedness should reward investors in the end. While we anticipate tapering in 2022 and an initial rate hike in 2023, we believe the Federal Reserve will stick to its guns in describing inflation as “transitory” and do not expect a shift from its accommodative policy stance in the near term.
CRN: 2021-0603-9235 R
The opinions and views of this commentary are that of Insight Investment and are not necessarily that of Advisors Asset Management.
This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit http://www.aamlive.com/.
Please note: any forecasts or opinions expressed herein are Insight Investment's own as of June 10, 2021 and subject to change without notice. Information herein may contain, include or is based upon forward-looking statements within the meaning of the federal securities laws, specifically Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements include all statements, other than statements of historical fact, that address future activities, events or developments, including without limitation, business or investment strategy or measures to implement strategy, competitive strengths, goals expansion and growth of our business, plans, prospects and references to future or success. You can identify these statements by the fact that they do not relate strictly to historical or current facts. Words such as ‘anticipate,’ ‘estimate,’ ‘expect,’ ‘project,’ ‘intend,’ ‘plan,’ ‘believe,’ and other similar words are intended to identify these forward-looking statements. Forward-looking statements can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. Many such factors will be important in determining our actual future results or outcomes. Consequently, no forward-looking statement can be guaranteed. Actual results or outcomes may vary materially. Given these uncertainties, you should not place undue reliance on these forward-looking statements.
The Consumer Price Index (CPI) is released by the Bureau of Labor Statistics as a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.
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