KEY DATA: CPI: +0.6%; Over-Year: +5%; Ex-Food and Energy: +0.7%; Over-Year: +3.8%/ Hourly Earnings: +0.5%; Inflation Adjusted: -0.2%/ Claims: -9,000
IN A NUTSHELL: “Consumers are being battered by rising retail prices, while labor shortages and surging wages are hitting businesses hard, and there is little reason to think those trends will change anytime soon.”
WHAT IT MEANS: No good deed goes unpunished and that is the case with the rapid reopening of the economy. The upside is that growth is soaring. The downside is that consumer inflation is surging, and labor problems are pressuring businesses. Today’s data highlight those issues. Let’s start with the Consumer Price Index, which showed that retail prices jumped again in May. The solid increases were across the board. Only gasoline and fuel oil prices fell, and that could turnaround in the June report. Prices climbed for just about everything else except medical services, and thankfully cookies and cakes. The biggest gain was in used vehicles, which rose by over seven percent and have skyrocketed by nearly thirty percent since May 2020. The rise over the past year in all consumer prices was the second highest in thirty years and that was also true when food and energy were excluded.
The increasing costs of goods is not only hurting the consumer at the checkout line, be that online or in the store, but it is also eating into purchasing power. While hourly wages rose sharply in May, when adjusted for inflation, they were down. When you add the decline in weekly hours worked, it looks like income gains will be quite weak.
Business are being battered on two sides: Commodity costs are surging, and labor shortages, which are driving up wages, are cropping up across the economy. And it looks like things will get worse before they get better. New unemployment claims fell again last week and given the way the economy is reopening, they should continue to decline for weeks to come. But as solid as hirings have been, they cannot keep up with the rise in job openings, so firms are hanging onto their workers as tightly as possible. Thus, layoffs should continue to fall as will the unemployment rate. That said, it will take a very long to time before the rate, which is currently 5.8%, gets back to the 3.5% just before the pandemic hit.
IMPLICATIONS: Today’s data show what happens when demand suddenly surges while supply fails to keep up. The problems in the global supply chain are creating shortages and that is forcing up both producer and consumer prices. In a normal economy that is growing at trend, the pressure on costs would be elevated by not sky high. But we are not in a normal economy and the sudden ebbs and flows of growth have created outsized impacts. Firms love the jump in demand, but they don’t like the fact that they cannot get all the inputs they want, including labor, and therefore they are paying a lot more for their supplies and workers. On the other hand, the sudden surge in demand is allowing them to pass through those higher costs to end users. The result is the highest inflation in decades. Will the elevated inflation rates be temporary, as the Fed thinks or hopes? It depends upon what you mean by temporary. Inflation could easily remain above three percent for the next year, especially if the rest of the world recovers more rapidly. As I have noted before, the key will be inflation expectations. The Fed members seem to believe that expectations will remain well contained, even in the face of evidence that they are becoming unmoored. I expect the Fed will be accepting of inflation running well above its 2% average for an extended period, possibly all through 2022. The rate was almost always below the target for over a decade, so it will take quite a long period of high inflation to bring a medium-term average up to 2%. But that patience can only be sustained if expectations stay low, so investors should be watching not just the inflation rate but also the measure of inflation expectations. They should also recognize that the labor shortages will not magically disappear when the enhanced unemployment money runs out. Wage gains are not going to suddenly flatline. Thus, businesses will continue to be pressured by rising commodity and wage costs and it will be hard to make it up in volume. To maintain margins, firms may have to keep raising prices. But that will accelerate inflation further. Is wage-price inflation back? We shall see.