Daniel Casali, Chief Investment Strategist, Tilney Smith & Williamson, gives his take on today’s announcement that US CPI inflation for May has hit 5%,
What happened?
US May headline CPI inflation rose 5.0% from a year ago, up from 4.2% in April and is higher than consensus expectations of 4.7%. Excluding food and energy, this so-called core CPI inflation measure rose 3.8% versus 3.0% in April and the consensus forecast of 3.5%.
What does it mean?
While underlying core CPI inflation continues to trend up, it is still early to determine whether it is transitory or structural. The upward trajectory in consumer prices over the last couple of months has been boosted by a low base from last year. Moreover, higher inflation has been narrowly focused: in May, 68% of the annual increase in core CPI inflation came from just three categories (shelter, used car prices and transportation services). Even so, looking at these CPI groups individually, there remains upward pressure on consumer prices, at least in the short term.
First, shelter CPI prices (which account for around 42% of the entire core CPI basket and encompass rents) are set to accelerate from here. Landlords may view the opening-up of the economy as an opportunity to raise rental prices. Apartment List, an online marketplace for over 5 million US flat listings, showed that its national rent price index rose 5.3% from a year ago in May. Given that the annual shelter CPI component rose 2.2% in May, there is room to catch up with prevailing Apartment List rents.
Second, Manheim, an established US wholesale vehicle auction operation since 1945, reported that used car/truck prices are currently rising by around 50% per year, the fastest pace on record from data that go back to 2011. Nevertheless, the CPI component for used car prices in May rose by 29.7% from a year ago and lags the surge already seen in the Manheim data.
Used car prices are rising sharply as there is a supply shortage of new vehicles entering the market brought about by the pandemic. Not only was auto production curtailed during the lockdowns last year, but a surge in working from home and e-commerce has created soaring demand for semiconductors, which are increasingly used in the manufacture of cars and trucks. Given the shortage of chips, new auto production has been held back and has forced car rental companies to buy used cars, as they can’t get the new cars they need. In turn, this is contributing to an uptick in core CPI inflation through the used car CPI component.
Third, transportation services CPI (includes airfares and motor vehicle insurance and repairs) rose 11.3% in May from a year ago. As lockdowns are lifted and vaccines are distributed to the population, it has unleashed pent-up demand from holidaymakers. The latest data from the Transportation Security Administration show that daily air passenger numbers are running at 2.0m, back to a level last seen in March 2020 when the pandemic first broke out in the US and lockdowns were imposed, and is well up from a low of just 0.1m in April 2020. Airline could well raise prices further to recoup lost revenues during the pandemic.
The bottom line is that provided the US economy continues to open up, supply bottlenecks remain acute and policy remains accommodative, then the tail risk of higher future (and potentially, structural) inflation has increased. Even so, the Fed believes inflation to be transitory and has not indicated that it is set to tighten monetary policy. For the moment, this macro backdrop remains favourable for equities over long-duration nominal bonds.
