Inflation beat expectations last week, with data for April revealing a stunning 0.9% increase in the core consumer price index (which strips out volatile food and energy prices) over March. This was the single largest monthly increase since the early 1980s when inflation was a much bigger concern than today. But on the other hand, such an increase shouldn’t be all too surprising, especially in light of last week’s jobs report in which apparent labor shortages in some low-wage industries led to employers raising wages. The economy is still evolving at unprecedented rates and in untypical ways, and as such, data releases require extra care in interpretation.
The latest CPI data shows a clear “reflation” move occurring in some of the more COVID-sensitive sectors. Below we chart changes in prices of these components by their implied impact on core CPI overall, multiplying the rate of change by their weighting in the basket of goods sampled. For example, nearly one-third of the 3-point rise in Core CPI over the past year is attributable to the prices for used cars alone. These three sectors make up a mere 6.5% weighting in core CPI, but imposed a major impact on the inflation trend.
Used auto prices surged as a global shortage of semiconductors forced car manufacturers to slow production and close some lines. Friday’s industrial production data showed that U.S. production of new automobiles was at a mere 9 million unit annualized pace, over 2 million units below the pre-pandemic, five-year average. Robust consumer demand shifted to used cars and trucks, pushing used auto prices up an astounding 21% over the past year, about half of which occurred in April alone.
Strong demand for durable goods during the pandemic, including used automobiles, is continuing, and pressuring prices. Almost half of April’s monthly inflation was due to the rising prices of durable goods. Generous fiscal and monetary policy support has kept financing rates low while bolstering household incomes. The result has been both record levels of personal savings and a sharp drop in new debt delinquencies. The dry powder to finance auto purchases has been building over the past year and may be a significant reason why used car prices are rising at this unprecedented rate.
Other items that saw large price increases were lodging away from home, largely hotels and motels, and public transportation, largely airline fares. Prices rising in these two sectors reflect the easing of COVID-related restrictions as the health crisis improves, allowing more mobility and travel. While year-over-year comparisons capture major base effects from last year’s weak baseline of activity, fortified household balance sheets play a role, as households have the wherewithal to spend more freely.
April’s price increases may not be concerning yet. As semiconductor production ramps up again, auto production should resume, easing supply constraints, although the timeline remains uncertain.
Price increases in reopening sectors are, in fact, encouraging and signal a burgeoning recovery. The Federal Reserve re-framed its inflation target last year, allowing it to tolerate conditions where an inflation miss below 2% in one year means a rise above 2% in the next year.
The Fed’s Vice Chairman Richard Clarida indicated as much in comments last week following the CPI release:
"Readings on inflation on a year-over-year basis have recently increased and are likely to rise somewhat further before moderating later this year. Over the next few months, 12-month measures of inflation are expected to move above our 2 percent longer-run goal, largely reflecting, I believe, transitory factors such as a run of year-over-year comparisons with depressed service-sector prices recorded last spring as well as the emergence of some supply bottlenecks that may limit how quickly production can rebound in certain sectors. However, under my baseline outlook, these one-time increases in prices are likely to have only transitory effects on underlying inflation, and I expect inflation to return to — or perhaps run somewhat above — our 2 percent longer-run goal in 2022 and 2023. This outcome would be entirely consistent with the new framework the Federal Reserve unanimously adopted in August 2020 and began to implement at our September 2020 Federal Open Market Committee (FOMC) meeting."
Indexing the inflation rate to what would be consistent with the Fed’s 2% target — and adjusting for the difference between core CPI and the Fed’s preferred core personal consumption expenditures price index — the price level in April is exactly where they want it to be. Should the pace of increases remain above 2%, the Fed may begin discussing policy tightening. However, as much of the recent increase is temporary due to rapid shifts in an economy emerging from the aftereffects of the pandemic, and with inflation expectations still firmly anchored, runaway inflation should not be a major concern.
The Week Ahead …
The data deluge slows next week, as manufacturing indexes give clues to May activity. The New York Fed’s Empire State manufacturing index and Philadelphia Fed’s manufacturing index released on Monday and Thursday, respectively, are among the first major data releases to May, typically useful prognosticators for other business sentiment reports. Both indicated rising demand in April reports. Elsewhere, the Fed plans to release the minutes for its April 27-28 meeting. Minutes typically reveal internal debate among members not otherwise available in Fed statements. Discussion will likely involve interpretations around chances of higher inflation, though the center of the committee continues to hold a “wait and see” approach.