What is the outlook for U.S inflation?

The CPI in US is tending to go up strongly.

Annual inflation has soared and there’s divided opinion about its longevity. How can we sift our way through this minefield and be sure to come up with the right answers?

There are numerous sources of uncertainty about the outlook for inflation, and clearly not just in the US. But it is the rise in US prices that is filling the most column inches given the predominance of the Fed in dictating the global financial cycle and, at least in part, the performance of asset prices.

One conundrum is why prices seem to have shot up so much more in the US than elsewhere. Another is the role that base effects have had, given that inflation was so low this time last year. A third uncertainty relates to the extent and longevity of supply-chain disruptions, which have pushed prices higher. Fourthly, it is unclear how long the post-pandemic demand surge will continue and so potentially pull prices higher. Yet another unknown is the tightness, or not, of the US labour market. For if it really is tight, and remains so, wage pressure could build and make the temporary rise in inflation more permanent. And finally, perhaps, there’s the much broader issue of the Fed’s very accommodative monetary policy. Of course, it has been accused of this for many years but inflation has not risen. Is the fact that prices are rising so smartly now party due to all the surplus cash that seems to be sloshing about?

“We could not possibly hope to answer all these questions in one small comment. The one aspect we want to concentrate on is whether the surge in inflation is down to certain specific components of the CPI that have risen sharply on the back of what seem to be both supply shortages and demand strength.”,  Head of Standard Bank G10 Strategy Steve Barrow said.

For example, the used car sector is one such area, and again this is not peculiar to the US as we are seeing it in other countries. Semiconductor shortages are reducing the output of new cars, and rising post-pandemic demand for cars is causing what Fed Chair Powell referred to last week as a “perfect storm” of rising price pressure. This is certainly true; used car and truck prices have risen by around 7% and 10% in the last two months. These are huge increases and there’s been pressure in other areas that we might expect to rebound quickly, like airfares, hotels and more.

Mr. Steve Barrow said that the impression we seem to be left with by Powell and others is that inflation is not a worry because, besides the base effects, the annual rise is elevated because a small number of CPI components are temporarily rising at a very fast rate. But there’s two issues here. One, obviously, is the assertion that the pressure in these sectors is temporary. This could prove to be incorrect. For instance, semiconductor shortages are expected to last for some time, possibly a year, or more, according to those in the industry. The second point, which is what we want to focus on, is whether this description of the CPI (and PCE prices) being pushed up by rapid rises in a small number of components is actually correct.

“One way to do this is to look at the dispersion of price changes month to month. If we do this with PCE prices, we see that the incidence of price increases is rising quite sharply. In other words, the breadth of price increases is rising. Currently around 80% of the components of PCE prices are rising; that’s up around 60% a few months ago and is actually around the highest that we’ve seen since 2011. In other words, price pressures seem more widespread that many might believe and that casts some doubt on how much inflation might fall back when demand and supply pressure eases in a few of these components that are seeing outsized gains right now”, Mr Steve Barrow emphasized.