October 08, 2021 | 13:53
This wasn’t a good week for the transitory-inflation crew. The big three energy prices—crude oil, natural gas, and regular gasoline—all crept higher and are trending near 7-year peaks. We already know from the previous week that key U.S. house price metrics were ripping at a record pace of around 20% y/y. In Canada, house prices appear to be reaccelerating (if that’s even possible), based on the latest Toronto data. And those who can’t afford to own won’t find many bargains in the rental market, as rents are quickly retracing last year’s dip. Neither will they get a break on their grocery bills. Though backing off a bit since June, the CRB foodstuffs index is still close to record highs. And, any hope that U.S. used vehicle prices would stage a hasty retreat after a massive increase was dashed in one fell swoop when the Manheim index popped 5.3% in September to new peaks. Increased demand arising from Hurricane Ida’s floods clashed head on with microchip shortages that are shrinking new vehicle inventories. The price hike might not show up in the CPI for a month or two, but used vehicles have already added about one percentage point to the annual CPI rate, and it doesn’t look like the pressure will ebb anytime soon.
Households are facing the fastest price increases in decades, with little relief in sight. Demand is hot, while supply is cold, a classic recipe for higher inflation. The growing imbalance is reflected in the latest ISM services report. The sub-indexes for business activity and new orders turned up and remain high, suggesting the economy is gaining momentum as the Delta wave crests. Meantime, respondents’ remarks about supply shortages and bottlenecks suggest that trying to meet this demand is getting more difficult. Delivery times are slowing, inventories are shrinking, and the backlog of orders continues to expand. The pressure to pass higher input costs to buyers is mounting. The prices paid index perked up to within 5 points of July’s 15-year peak, with all 18 industries paying more for supplies. If history is a guide, this flags a possible 2-ppts jump in CPI services (ex-rent) growth by early next year, a component that accounts for 29% of headline inflation. And don’t forget that residential rent accounts for another 31% of the CPI—and rents are almost certain to jump given the explosion in house prices. Nothing transitory here.
There's nothing transitory in labour markets, either, where worker shortages are fanning wages. Average hourly earnings popped 0.6% in September and 4.6% from a year ago. The six-month annualized rate of 6.0% is more than double the past-decade norm, and likely a better indicator of the direction for wage growth. Many new jobs were in lower paying sectors such as leisure and hospitality (at least before Delta hit), actually weighing on the average. We’ll need to wait for the Q3 productivity numbers to see if the rise in compensation is pressuring unit labour costs and profits. If so, the heat will be on companies to pass the increase to customers, many of whom are flush with savings to ease the pain. And the pressure will only build if the participation rate doesn’t pick up. It actually slipped in September and has hardly budged for more than a year, still 1.7 ppts below February 2020 levels. The BLS reports that 71,000 people who were unemployed in September (though not all may have collected UI or were in the now-expired emergency UI programs) left the labour force, contributing to the lower part rate.
Yet, investors haven’t thrown in the transitory towel. TIPS five-year forward inflation rates have been locked around the 2.3% range since the spring, only a couple of ticks above the past-decade mean. Their patience will be tested in the months ahead, though. There’s no doubt that businesses, notably many small ones, are under immense pressure to either absorb cost increases (that are persisting longer than expected) or to raise prices simply to survive. If they resort more to the latter, and if workers, in turn, try to compensate by seeking even larger wage increases, the transitory narrative will become a fairy tale.