Sticking With The Transitory Inflation Story

Scott Anderson
Chief Economist
Bank of the West

Consumer inflation continued to surprise on the high-side in May. Both the headline and core consumer inflation measures have been above economists’ consensus forecasts for three consecutive months now as surging household demand, low inventories, supply chain disruptions, and rising inputs costs from a scarcity of raw materials and labor supply led to broad-based price increases of the likes we haven’t seen since 2008 on the headline number and 1992 on the core-CPI measure.

A Whiff Of Inflation With That Robust Q2 Growth

Core consumer price inflation, a measure more closely followed by the Fed for signs of underlying inflation pressures because it excludes volatile food and energy prices, has been running “hot” and well-above the headline number for two consecutive months now. Core-CPI prices increased at a sharp 9.2% annualized pace in May and over the past two months has average a 10.4% annualized pace. This is a rare occurrence in recent years, and a possible sign (though we remain skeptical) that underlying inflation dynamics in the U.S. economy could be shifting to a higher equilibrium pace longer-term.

Unsustainable Core Consumer Price Increases

Incorporating the latest historical readings on consumer prices, we revised up our near-term consumer inflation forecasts for the balance of 2021. Second quarter CPI inflation year-on-year is expected to average a high 4.6% from a year ago, and remain at a still elevated 4.3% from a year ago in the second half of 2021.

A “Hot” High Price Summer

On a sequential basis, however, we already believe consumer inflation has peaked. I think this partly explains the bond market’s puzzling reaction to May’s “hot” consumer inflation data. The 10-Year Treasury yield slipped 10 basis points yesterday after the new inflation data was digested by the markets. Annualized CPI inflation in the second quarter is forecast at a sizzling 7.5% annualized pace, but is expected to moderate to 3.7% annualized in the third quarter, and drop to a more tolerable 2.5% annualized pace by the fourth quarter. By the second half of 2022, year-on-year consumer inflation is expected to be back near 2.0%.

The University of Michigan Consume sentiment survey for June, showed a sizable pull-back in one year ahead and five to ten year ahead inflation expectations to 4.0% and 2.8% respectively. While still elevated compared to last year’s levels, the pull-back is consistent with our transitory inflation forecasts.

Raw Material Price Pressures Eased Last Month

Moreover, at the earliest stages of production (raw materials), price pressures already appear to be easing. Headline grabbing commodity categories such as lumber, copper, and agriculture commodities, that had huge price increases over the past year, saw price declines last month. As we eye next week’s FOMC meeting, we expect little change in the FOMC’s dovish statement or median fed funds interest rate projections. We do see an upward revision to 2021 GDP growth and inflation forecasts from the FOMC, but little change in the projections for 2022 and beyond.

To learn more, check out this week’s U.S. Outlook Report.


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