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Tilney Smith & Williamson’s Casali comments on US October CPI inflation data

Daniel Casali, Chief Investment Strategist at Tilney Smith & Williamson, the wealth management and professional services group, comments on US October CPI inflation data:

US October headline CPI inflation rose 6.2% from a year ago, the highest rate in nearly 40 years and exceeds both the 5.8% consensus expectations from Reuters and 5.4% in September. Excluding food and energy, this so-called core CPI inflation measure rose 4.6%, beating a consensus forecast of 4.3% and 4.0% in September.

The key message from the data release is that underlying inflationary pressures continue to grow in the US. For instance, last month’s data showed that three categories (shelter, used cars and transportation prices) accounted for 58% of the rise in October core (ex-food and energy) CPI inflation. Looking forward, alternative data sources may provide a timely read of the trajectory of these pandemic-affected CPI components. It could be argued that lagging government CPI statistics have yet to capture the full extent of recent price rises from other data providers.

First, Apartment List, a website that captures more than 5 million US rental properties, reported that national October rents rose 0.9% in the month of October. While that increase has slowed from a peak monthly gain of 2.4% last July, rents are still up 15.8% from a year ago and the trend is up. Rents are rising, as landlords may view the opening-up of the economy as an opportunity to recoup lost revenue and particularly as accommodation seems tight. In the second quarter of 2021, the rental vacancy rate for apartments was 5.3%, well below the historical peak of 8.0% in 2009-10 after the Global Financial Crisis. Rapidly rising house prices may also encourage prospective homebuyers to delay getting on the housing ladder or moving on the hope that prices could cool later. Potentially, this could raise current demand for rentals.

Moreover, consumers expect to pay higher rents. The October New York Survey of Consumer Expectations showed that median 1-year forward annual rent inflation rose at a record rate of 10.0%. On balance, there appears room for shelter CPI inflation (including rents) of 3.5% in October to catch up with prevailing Apartment List rents and rent expectations.

Second, supply-chain disruption continues to be a factor in auto output and is likely to exert upside to overall inflation. The Manheim measure of used car prices in October rose 38.2% from a year ago and 9.2% for the month, the biggest monthly increase on record from data that goes back to 1995. Used cars prices are rising as there is a shortage of chips utilised in new car production and this has constrained supply. As supply chains get back to full strength it is likely these bottlenecks will eventually ease.

Third, given that daily passenger numbers in US airports are now currently running at 2.2m (as of 7 November), not far off the pre-pandemic run rate of 2.4m in mid-February 2020, there is reason to believe that airfares (included in transportation services CPI) will rise further now that concerns over the Delta strain of covid have eased somewhat.

While it is still too early to determine whether the recent uptick in US inflation is transitory or structural, the prevailing elevated CPI inflation rate increases the risk that it will lead to an upward wage and inflation spiral, where firms pass on higher labour costs to consumers. Given the sharp recovery seen in non-farm payrolls, workers appear to be in a favourable position to demand higher wages. For example, the quits rate (resignations per month/total employment) is running at multi-decade highs, indicating that workers are willing to leave jobs as they may expect to be better paid in a new role. Historically, the quits rate has led the Employment Cost Index (a broad measure of salary rates and benefits) up and suggests that wage rates are set to accelerate in the months ahead.

For markets, given strengthening economic growth and healthy gains in company earnings, the macro backdrop is still favourable for equities over long-duration nominal bonds for now. Nevertheless, uncertainty created by whether inflation is transitory or structural could lead to greater equity and bond volatility over the coming quarters.

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