US core data suggests we may have reached peak inflation

The inflationary tiger that policy makers feared would be unleashed on the world's developed economies may have already retreated back to its lair. US core inflation, which tracks changes in prices that consumers pay for a basket of goods, rose by 0.3% in July, missing economist expectations of a 0.4% increase and was below June’s 0.9% increase.

The data suggests we may have reached peak inflation. These figures also tentatively imply that we might be close to the peak of the economic acceleration we had since the beginning of 2021 on the back of vaccination efforts and the reopening of economies.

If data continues in this direction, it will also further validate our ‘Japanification’ theory. In the short-term, we contended that the pandemic recovery would trigger a rapid acceleration in both growth and inflation – a reflationary spike – before we return to a period of economic growth normalisation which will imply less fiscal and monetary support.

Only time will tell, but we continue to view this spike as one of many temporary bursts in price inflation against the backdrop of a lower-growth, low-rate environment. For tactical and flexible investors, these temporary shifts represent fertile opportunities to unearth alpha across a range of asset classes, by shifting out of cyclical sectors, in favour of quality growth ones.

US consumer prices rose at a more moderate pace in July, up 0.5% from June, with the core measure coming in somewhat lower than expected at 0.3% month-on-month.

As in previous months, the majority of the increase can be ascribed to Covid-sensitive goods and services, which still face a range of supply disruptions and bottlenecks. Given that consumers appear relatively less price sensitive for the moment, retailers have been able to pass on higher input costs. Though with excess savings declining and the reopening-led surge in demand abating, we expect spending habits to normalise in coming months.

Some price measures, such as those for airfares and used cars, which had seen outsized gains recently, have settled back into a normal range. Signs of growing price pressures in food and shelter bear watching however. Overall, the July CPI report shows signs of normalisation, which should give the Fed further confidence in the transitory nature of inflation and thus have limited if any impact on the central bank’s policy path.”

The market is obsessed over when, not if, the Fed will start tapering its asset purchase program and normalise monetary policy. The economy is running gang busters and yesterday’s announcement of a $1trn bipartisan infrastructure bill just adds fuel to that fire. Of the 11 voting members, two of the most hawkish want to taper as soon as September whilst the uber doves want to push into 2022, at the earliest. Perhaps we will get greater clarity in a few weeks at Jackson Hole.

One factor in that decision is inflation, which just came in at 0.5% for July versus a prior reading of 0.9% and expectations for 0.5%. The year-on-year number was 5.4% versus consensus expectations for 5.3%. The big question is whether inflation has now peaked or prove longer lasting. Earlier this week the New York Fed’s July consumer expectations survey suggested rent expectations were up by 9.8%. The extent to which that number becomes self-fulfilling could have a large impact on this debate going forward. The index for rent rose 0.2% although lodging away from home continued to rise sharply, increasing 6% in July after rising 7% in June. The shelter index rose 0.4% in July, accounting for over half of the monthly increase in inflation when excluding food and energy.

Another factor impacting the decision to taper is the unemployment rate. Given prior comments on social policy, and the elevated unemployment rate amongst those socio-economic groups hardest hit by the virus (relative to the aggregate number) I would put Fed Chair Jerome Powell on the dovish end of the spectrum, which shouldn’t hurt his chances for re-appointment either. Then again, with Senator Elizabeth Warren on a war path for a Lael Brainard shoe-in, if you liked Jerome Powell’s easy money policy… you’ll love Brainard who would let the economy run even hotter.

The CPI data broke the 5-month streak that saw CPI continuously beat preceding releases. This momentum slowdown could confirm the Fed’s view that the recent spike is transitory, although we maintain that it is too early for either side of this inflation debate to claim victorious. There are still 60% of CPI categories that saw prices jumping above 3% year-on-year.

It is important to note that despite this month’s print, the timeline for the Fed’s tapering is unlikely to be pushed out. Output gap is still projected to be closed by the end of this year, and inflation is still projected to end this year above target. Macroeconomic conditions are better this year than the Fed’s first tapering experiment in 2013 and 2014.