Investors spent another week kicking around the inflation debate, just as they’ve done for much of the summer. June’s Consumer Price Index (CPI) and core CPI both came in hot, just like the prior month, which propelled rising consumer prices to the national nightly news circuit. Are current inflationary pressures transitory or stickier? That’s basically what drove trading through the week and will likely remain a focus in the weeks ahead.
We believe inflationary pressures are transitory. Over the next quarter or two we’ll likely see prices cool as supply chains normalize and consumers pull back or delay spending in response to high prices for certain goods. Another ingredient needed for lasting inflationary periods is sustained wage increases. We estimate there are still 12.5 million workers who can be brought back into the workforce, which means there should be plenty of slack left to keep wage pressures contained.
As inflationary pressures recede in the months ahead, we think the economy continues growing with strength. Longer term, we believe productivity advances (logistics, engineering, robotics, automation) over the past several years should help GDP expand, even at full employment, and keep inflation at bay. Now, let’s tie this all into fresh data (recall, there was quite a bit) and look to the week ahead.
WALL STREET WRAP
CPI Stays Hot: CPI notched its highest rate increase in nearly 13 years, surprising to the upside on Tuesday and capturing the trading narrative through the week. Overall, June CPI rose 5.4 percent year-over-year and 0.9 percent month-over-month. Core CPI, excluding food and energy, was 4.5 percent — the highest since 1991.
Once again, it’s worth peeling back these numbers because there’s a little more bark to CPI’s bite. Used cars once again did most of the heavy lifting, accounting for roughly one-third of the overall rise in prices. Other categories that rose are tied to reopening-sensitive categories (where demand is snapping back the fastest), such as lodging, airfare and food away from home.
If we look at the central tendency of rising prices, which strips out outliers on both ends of the distribution curve, the Cleveland Federal Reserve’s calculation of median CPI currently resides at 2.2 percent — quite modest. In other words, most of the stuff we buy isn’t rising at 5.4 percent.
Small Business Owner Confidence Rising: The NFIB small business optimism index came in strong — rising to 102.5 in June from 99.6 in May — the highest level since October of 2020. This had all the hallmarks of a great report as companies anticipate higher sales and earnings, and a record percentage of respondents indicated they planned to hire more workers in the coming months.
Another record high reading: A net 11 percent of business owners are planning inventory investment in the coming months — the old high was 4 percent in 1974. This bodes well for production but could pressure inflation as many businesses seek to purchase goods/inventories at the same time. Job openings remain difficult to fill, as the survey for this component remains near record levels. At the same time, a record number of respondents said they planned to increase worker compensation.
Industrial Production a Bit Below Expectations: Industrial production in June was a bit weaker than expected, up 0.4 percent versus expectations of 0.6 percent. Manufacturing was the weakest sector, declining 0.1 percent, but it represents 75 percent of the production index. The decline in manufacturing was driven by a 6.6 percent drop in motor vehicles and parts, but that decline in production is being driven by a semiconductor shortage in the auto industry (hence why used car prices are rising).
Despite the drop, the manufacturing outlook remains strong. The New York Fed’s Empire manufacturing survey hit a record, and the Philadelphia Fed’s survey remained strong, as well. Manufacturing capacity was at 75.4 percent, which means there’s room to ramp up production. During the last two economic cycles, capacity was at least 80 percent before we got into the “later” stages of the cycle.
Inflation Nicks Sentiment: U.S. consumer sentiment fell to a six-month low in July, falling to 80.8 in the first half of the month compared to 85.5 in June. Consumer complaints about rising prices on homes, autos and household durable goods hit an all-time high. While this is being framed as a disappointing result, we see a silver lining here for the inflation trend.
Clearly, consumers are noticing higher prices. However, rather than rushing in to make purchases and lock in prices, people are waiting. High prices are likely constraining demand a bit, which should allow supply chains time to catch up. Case in point: lumber.
The price of lumber skyrocketed to an all-time high of $1,688 on May 7 and has since crashed back down, finishing last week at $536. Consumers are viewing the bout with inflation as passing and are willing to wait. According to the University of Michigan survey, one-year inflation expectations rose to 4.8 percent, but the five-year outlook is at 2.9 percent.
While higher prices are likely constraining demand a bit, overall, consumers continue to spend at a healthy rate. Retail sales rose 0.6 percent in June and were especially strong at restaurants, bars and clothing/accessories stores.
THE WEEK AHEAD
A Quieter Week: After a busy week for economic data, this week will be lighter. The focus will be on a few housing metrics, including builder sentiment, housing starts and existing home sales. June leading economic indicators are due Thursday, while Markit PMIs in the U.S. and abroad will be released Friday. U.S. corporate earnings will continue to roll out this week, as well. In the eurozone, the Governing Council of the European Central Bank will hold its first monetary meeting since announcing its “2 percent symmetrical” inflation target.
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