Inflation emerging in the US

Inflation emerging in the US

Inflation and inflationary pressures are emerging in the U.S. economy. A plethora of measures from the real economy, the financial markets, and numerous surveys all show inflation starting to bubble up. While it is unlikely that broad-based inflation rates will rise significantly above 3% for an extended period of time, it is likely that the economy this year will break out of the less than 2% range experienced since the end of the recession. We are now factoring in new information (the recent increase of oil prices in particular) to revise on the upside our US inflation scenario to 2.8% y/y on average compared with 2.3% y/y before

Real economy points toward higher prices alongside higher capacity utilization

Measures of inflation in the real economy have recently risen significantly.

No single measure will rise in a straight line every month of course, but the number of measures indicating rising prices is striking:

  • The Personal Consumption Expenditures (PCE) Price Index and the PCE core index, which excludes the volatile food and energy components, have both risen 60 basis points (bps) since August including a 30 bps increase from February to March. Perhaps more importantly the PCE core is now rising at 1.8% y/y, bumping up right next to the Fed’s target of 2% for this measure.
  • Consumer and Producer Prices, including their core components, have also risen sharply over the past year, and all four measures are now above 2% y/y.
  • Housing prices in the past 12 months have risen at an average y/y rate between 5.6% (NAR existing median sales price) and 6.1% (Case-Shiller, 20 cities SA). And since the end of the recession, 6.9% and 6.2% respectively, far outpacing wage gains of only 2.3% over the same period.
  • Some essential commodity prices are on the rise.  Lumber prices have risen 60% since last August when it became clear that the administration was about to impose a 21% tariff on Canadian softwood. Steel prices, such as those on Midwest Hot-Rolled Coil, have been pressured by tariffs and have risen 35% since January. Commodity indexes such as the S&P GSCI Commodity Index have risen 18.7% y/y.
  • US retail gasoline prices have almost increased by 20% y/y in June.
  • Freight rates, which lead other prices and the economy in general have risen a steep 12.8% y/y as measured by the Cass Freight Expenditures Index
  • Wages are being pressured by a number of indicators in the tight labor market, including a job openings/unemployed ratio of 1, a high quits rate, and aggressive hiring plans expressed in the National Federation of Independent Business (NFIB) survey. As a result the Employment Cost Index (ECI) Wages and Salary component rose at an annualized rate of 3.7% in Q1-18, the most in 11 years.

Chart 1  CPI and PCE headline and core rate