U.S. U.S. U.S.

U.S. January inflation : A painful reality check

Macro
CD
Christopher Dembik

Head of Macro Analysis

Summary:  U.S. January consumer price index (CPI) is higher than expected, at 7.5 % year-over-year versus expected 7.3 % and prior 7.0%. Inflation is now broad-based. This is a painful reality check for the transitory camp. Inflation is not only caused by used cars - the usual excuse of sell-side analysts. A large part of inflation is structural, in our view. It will take much more than a 50bps interest hike by the U.S. Federal Reserve (Fed) to push inflation downward. Expect the rate-hike cycle to be very aggressive in the short term. We would not want to be in Jerome Powell’s shoes now.


Driving forces : On a year-over-year basis, the main factors driving inflation higher are unchanged : used cars (+40.5 %), gasoline (+40.0%), gas utilities (+23.9%), meat/fish/eggs (+12 ;2 %), new cars (+12.2 %) and electricity (+10.7 %). Excluding volatile components (such as energy), inflation remains uncomfortably high at 6 % year-over-year versus prior 5.5 %. This shows a large chunk of inflation is not transitory but structural (wage-price spiral and supply chains bottlenecks, for instance). Supply chain disruptions are likely to last longer than forecasted. The line of ships waiting to enter the Los Angeles and Long Beach port complex remains elevated. They collectively account for roughly 40 % of United States-bound import volumes. According to Sea Intelligence, the punctuality of containerships, which is an indicator to measure port congestion, stands at 12 % (against 23 % in Europe, for comparison). Bottlenecks might only ease when new containerships arrive in the market, from 2023 onwards. This means that global cost transportation will remain a headache for businesses all this year again. U.S. home prices are another concern, in our view. Shelter inflation is exploding. Homeownership is the least affordable since 2008. Based on data from the Atlanta Fed, the median American household now needs a third of its income to cover mortgage payments on median-priced homes. This might fuel social discontent and populism going into the next election.

Inflation warning for U.S. consumers : Persistent high inflation is erasing wage increases, especially for the lowest quintile income. This will slowdown GDP growth. There are already early signs that inflation is hitting the purchasing power and consumption. U.S. December retail sales disappointed (minus 1.9 % versus expected minus 0.1 %). The drop is partially explained by the Omicron wave but also by less buying due to high prices. The control group – which is used for GDP calculation purposes – came well below the estimate of 0.1%, at minus 3.1%. We agree one data point does not make a trend. But if January retail sales are out down again next week (release on 16 February), it will be time to start worrying about the strength of the U.S. consumer and to revise downward GDP forecasts for 2022.

What to expect ? U.S. rate futures now see a 50 % chance of a 50 basis points interest rate hike in March, from 30 % before the CPI release. If the probability rises in the coming weeks well above 50 basis points, it will be complicated for the Fed not to deliver. Expect next week’s release of the January producing price index (PPI) to constitute another strong incentive to act fast and strong at the March FOMC meeting. The likelihood inflationary pressures ease in the short term is low. We expect CPI to climb to 8 % in February or in March. The Fed has certainly been too complacent regarding the evolution of inflation. It cannot wait any longer to contain it. If the Fed does not meet expectations, the immediate risk is to cause a quicker tightening in financial conditions. This would be a nightmare for the Fed. The market currently forecasts that the Fed will tighten more than the Bank of England (BoE) from now to September. Until now, the BoE was considered as the most aggressive central bank from developed markets. The adjustment to a world without quantitative easing and low nominal interest rates will be painful for the U.S. bond market in the coming weeks and months. The new normal means more volatility and higher cost of financing. Not all the market participants are ready for that.

We plotted on the above chart U.S. CPI, ISM manufacturing prices index and a gauge for commodity prices produced by the Hamburg Institute of International Economics. Despite the recent easing in the ISM manufacturing prices index, there are several other factors pushing inflation higher. Commodity prices are one of them. This is explained both by high demand (conjunctural) and by the lack of investment in fossil energy infrastructures before the pandemic (structural). Other factors pushing U.S. inflation above the rooftop are wage-price spiral and home prices, for instance. 

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