INSIGHTS

On September 16, 2021

Inflation Mission: On Track

Tuesday's Consumer Price Index (CPI) report was a sign that we are indeed passing peak inflation, a first step toward fulfilling our (and the Fed’s) base case that inflation will prove transitory.

Mission: on track

However, as we have also argued, this does not mean a return to 2% CPI is imminent. With headline CPI at 5.3% and core at 4%, the descent should take time. In our view, headline CPI will likely end 2021 at ~4% and stay above 3% until mid-2022, before declining further into the end of 2022. For the Federal Reserve (Fed), this report amounts to “Mission: on track” rather than “Mission: accomplished.”

Trends point to deceleration

Inflation momentum appears to be fading. Since the second quarter, month-on-month price rises have decelerated in both core and headline CPI. This month’s figures (0.3% and 0.1% for headline and core, respectively) are quite similar to the pre-COVID-19 norm (Figure 1).

 Figure 1: Monthly momentum in CPI figures has been slowing

Source: Bureau of Labor Statistics, September 2021

It makes the second quarter CPI prints look increasingly anomalous, rather than the start of a new trend. Due to base effects, however, they will continue to influence every year-on-year CPI print until mid-2022.

Flexible inflation drivers finally appear to be reversing

Specific sectors, where prices were sensitive to developments relative to the pandemic, were generating what we believe were unsustainable gains in the second quarter. However, the tide finally might be turning.

There are five key sectors we are following where prices are still ~20% higher than they were a year ago, that collectively fell 1.3% in August (Table 1).

 Table 1: ‘Flexible’ CPI categories are potentially reversing

Source: Bureau of Labor Statistics, September 2021

Looking ahead, new cars in particular still might see pricing pressures given ongoing supply chain issues, but we anticipate these sectors will likely contribute less and less to inflation in coming months.

Meanwhile, the large “sticky” categories that we follow, such as owners’ equivalent rent and healthcare, have continued to show muted inflation pressures (Table 2).

Source: Bureau of Labor Statistics, September 2021

We still see little evidence that these sticky categories will meaningfully accelerate over the next 12 months, albeit we will not rule out the possibility. And even then, we expect the normalization in the “COVID-sensitive” sectors would overpower it.

Expect bumps in the road

Supply chains remain fragile, and we believe inflation figures will likely remain above 2% for some time. But our core thesis holds that above-target inflation cannot sustain indefinitely unless it is driven by large, sticky categories. Yesterday may have been a turning point, and as COVID-sensitive inflation dampens, overall inflation should gradually fall toward target.

Yesterday’s report will likely increase the market’s confidence that the Fed is correct to forecast transitory inflation. As such, we would view a tapering announcement at next week’s Federal Open Market Committee (FOMC) meeting as extremely unlikely. We see November as the first live meeting, assuming there is a strong September jobs report.

CRN: 2021-0915-9464 R

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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