KEY DATA: CPI: +0.4%; Over-Year: +1.3%; Ex-Food and Energy: +0.4%; Over-Year: +1.7%/ Real Earnings: 0%; Over-Year: +3.3%/ HWOL: +1.7%
IN A NUTSHELL: “Inflation is making its way back toward the Fed’s target, but it is still not a major risk.”
WHAT IT MEANS: Once upon a time, inflation was something economists and even central bankers worried about. Not so much now that the Fed has announced it will allow inflation to run above target for an extended period. Nevertheless, we do need to follow the numbers. Consumer prices jumped again in August, led by the continued rebound in energy costs, as well as a surge in used car and clothing prices. In contrast, shelter expenses remained tame, food prices settled down and health care expenses, which had been exploding, took a breather. Price gains over the year are moving back toward the two percent level, though they still have a way to go. But who really cares about food, energy, housing or clothing? What really matters is the index for cakes, cupcakes and cookies. Those prices cratered in August and are down from their August 2019 level. I’m happy.
Inflation really matters when it starts restraining household spending power significantly. That is where real earnings, which adjusts for inflation, comes in. For consumers to buy more, their incomes have to rise faster than inflation. In August, that didn’t happen. Also, the increase in inflation-adjusted income, over the year, is decelerating as lower-wage workers get pulled back into the economy. This is a weighted average and the distribution of job gains across industries and professions makes a difference. Initially, those lower paid workers lost their jobs at a huge pace, raising the weighted average. Now that they are being rehired, they are lowering the average back towards its pre-pandemic level. But for the individual worker, not the economy on average, rising inflation is not good news, no matter what the Fed thinks.
The Conference Board’s Help Wanted OnLine index rose solidly in August after having skyrocketed in July. It is closing in on its all-time high set in January. Total payrolls may still be down by 11.5 million employees, but demand for workers is solid, indicating job gains should remain strong.
IMPLICATIONS: The Fed has made it clear that when it comes to its dual mandate, stable inflation is job three. First comes the unemployment rate, then comes something else, maybe equity prices, and lagging well behind is inflation. If it is too hot, so be it. And that is not a bad approach to take, given we have been in a too-low inflation environment for a long time. Inflation can ultimately be controlled if it is too high, but too low a rate creates the risk of falling into a deflationary environment. If that happened, the economy would be in real trouble. So, while we watch the inflation numbers out of habit, I suspect their value will be limited for a very long time, except for its impact on consumption. Given that wage gains have been limited for over a decade, it is hard to see why they would accelerate in this still very high unemployment rate environment. Rising inflation remains a negative indicator, but for consumption not for interest rates. Right now, workers are making more money, but by working longer, not by getting pay raises. With the Fed on hold for who knows how long, once the reopening process settles down, the outlook for consumption may not be as bright as many in the markets are currently planning for. But with the demand for labor still high, we may not see a significant moderation in total household spending until next year.