US Inflation - Step back, before you leap forward
20.05.2021 10:49 - La Financière de l'Echiquier
Markets are finding it difficult to know what to do. The April US employment report was much weaker than expected – despite numerous other factors, including measurement biases, that put a more positive spin on it – and seemed to provide a clearer outlook for monetary policy. However, last week's inflation figures shattered expectations. The consumer price index rose 4.2% year-on-year; this was its biggest jump since 2008, or the largest since 1996 if we include the core index (excluding food and energy), which rose by 3.0% year-on-year. This core indicator rose by 0.9% in April alone, well above the 0.3% forecast. In fact, it recorded its highest monthly change since September 1981. However, the monthly change in the core index includes neither the favourable base effect compared with spring 2020, reflected by the YoY change, nor the direct impact of commodity prices, which is included in overall inflation. This lends weight to a scenario of rapidly rising inflation, which had been given little credence by data published previously.
A more detailed analysis reduces the risk of over-interpretation. This sharp growth in prices in the United States is essentially focused on one sector: transportation. Price rises in this sector account for 50% of the monthly increase in consumer prices, and as much as 75% of that in the price of goods. Two segments are responsible for this surge: used vehicle prices rose by 10% last month (21% YoY), and those of hire cars by 16.2% (82.2% YoY). Shortages in the automotive industry, particularly of semiconductors, are drastically limiting the production of new vehicles. Private individuals and rental companies are therefore turning to the second-hand market, where supply is naturally limited despite soaring demand. Although these figures are not a big surprise – leading indicators have been pointing to these increases for several weeks – the sheer scale is still striking.
In light of this explanation, it is perhaps tempting to go along with the US Federal Reserve's view that the rise in inflation is due to transitory factors. This is probably the line that Jerome Powell will take at the next central bank meeting in June, citing hard-to-read employment figures. The risk of an inflationary spiral cannot be ruled out, though. Inflation was projected to rise sharply, yet it has far exceeded expectations. There are some structural components (such as housing) that still only show small rises in inflation figures, while leading indicators point to substantial increases to come. Furthermore, the potential for significant wage inflation cannot be ruled out, based on certain data: the proportion of people leaving their jobs voluntarily has risen above pre-crisis levels, signalling renewed confidence in the labour market. In addition, the numbers of SMEs with job openings are at record highs, creating significant leverage for wage negotiation.
The rise in inflation is not in itself a cause for concern. It reflects the strength of the economic recovery, and the Fed is in a position to address it. However, it is unlikely that the central bank will give an indication of any further tapering of asset purchases before the end of the summer. On reflection, though, markets should not be so concerned with the timing of the Fed's statement as with the extent of its monthly balance sheet reduction, and the pace (the length of time it will take to bring net asset purchases to zero) of future tapering. In a bid to buy time, the Fed may be forced to apply the brakes more sharply than investors anticipate – or at least just enough for the already relatively highly valued equity markets to be able to withstand without giving them too much of a jolt.
By Olivier de Berranger, CIO, and Enguerrand Artaz, Fund Manager, LFDE
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