September 17, 2021 | 13:07
Peak Inflation? Don’t Count Your Chickens…
…until they’re on the grocery shelves. Markets and policymakers breathed a sigh of relief on the benign U.S. CPI result for August. This week’s highlight economic report produced a rare downside surprise on core, nudging up just 0.1% m/m and clipping the 12-month underlying inflation rate by 3 ticks. However, before popping the champagne (alcoholic beverages: up 2.6% y/y), note that the more “moderate” core inflation rate still stands at 4%, a pace not previously seen in nearly 30 years. And, both the 3- and 6-month trends remain piping hot at 5.4% and 6.8%, respectively. Even so, that inconvenient fact didn’t stop some from suggesting that inflation is “rolling over”, or at least past the peak. In turn, bonds staged a brief rally, before yields backed up on a run of decent U.S. data, which included solid regional factory reports for September, and moderate gains for industrial production and retail sales in August.
While markets relaxed after the cooler CPI, count us as firmly in the less-calm camp. Indeed, the latest consensus survey for the U.S. economy (conducted this week) puts us at the very high end of the inflation forecasts for 2021/22. We look for headline CPI inflation to average 4.4% this year (consensus 4.3%) and ease only slightly next year to 3.8% (consensus 3.1%). For the Fed’s key core PCE deflator, we expect it to average around 3% this year and next, while the consensus looks for it to fade below that pace in 2022. Even our high-side calls would still represent a big deceleration from the current hot pace of 5.3% y/y on headline CPI and 3.6% for core PCE. The main message today is that such a big deceleration is simply no done deal.
True, the first stage of higher inflation is now behind us. Think of the extreme base effects and the reopening bounces as being the booster rocket that is now falling away. Those two factors, along with relentless supply chain pressures, flung headline U.S. inflation into the 5% orbit. While some of this was anticipated, we’ll just point out that the consensus call on headline U.S. CPI at the start of the year—i.e., the collective wisdom of Wall Street and beyond—was for an average increase of 2.0% for 2021. Instead, the great minds are now expecting 4.3%—whoops. By definition, much of the initial rocket boost was a surprise, whether it was the fast comeback in oil prices, the sprint in autos (including the used car moonshot), or the snapback in airfares. And, in turn, we could easily be surprised again in the year ahead.
Where might that next surprise come from? Well, the potential second stage rockets are all staring us in the face.
One strong argument that the calmer crowd had in its favour was that the sudden upswing in inflation was mostly just a U.S. story, at least in the developed world. In mid-summer, there was a very neat pattern among headline CPI rates, stepping down the staircase from (roughly) 5% in the U.S., 4% in Canada, 3% in the Euro Area, 2% in the U.K., 1% in China and zero in Japan. However, there are signs that the neat pattern is about to be jumbled. First, the U.K. broke out with a big uptick in its top-line inflation rate in August, jumping to 3.2% y/y, as a special factor (the “Eat Out to Help Out” subsidy) fell out of the calculation. Some said that this artificially boosted the inflation rate; on the contrary, the subsidy had been artificially containing inflation, and the new 3%+ reading is in fact a truer picture of British inflation reality. Second, Canada also is risking a breakout, with headline CPI popping to an 18-year high of 4.1% last month, with some measures of core inflation touching 30-year highs above 3%.
Finally, note that many smaller economies are printing above 3% inflation, including Australia, New Zealand, Norway, not to mention well above 5% in all the BRIMs (Brazil, Russia, India and Mexico). Still, emerging market inflation is not yet problematic, averaging just under 5%, which is close to both the pre-pandemic trend and the median pace of the past 25 years. However, there are pockets of concern—Turkey is running just below 20% y/y—and a sustained upswing in food and energy would hit these economies especially hard (given a larger weighting for these components).
In sum, we view this not as the beginning of the end of the inflation risk, but more like the end of the beginning. Oh, and by the way, chicken prices have popped 7.2% y/y in the U.S. and 9.8% y/y in Canada; the latter is testing a 25-year high.
In the wake of this week’s uncomfortably hot Canadian CPI result, a certain “National Newspaper” editorialized that “Despite the headlines, inflation is not Enemy No. 1”. In the midst of a pandemic, few would argue with that statement. But to back up its contention, it wheeled out some quotes from “top economists”, indicating that “things are likely as hot as they will get on the inflation front”. Lo and behold, we happened to be one of the two said economists, with our deeply penetrating insight that inflation “may be close to the peak”. Of course, omitted from the quote was the second part of the sentence—“with the emphasis on may”. Technically, next month’s reading could take one more step higher, as base effects remain challenging. But, more importantly, beyond that it all comes down to the strength of the three second-stage boosters listed above, which equally apply to Canada’s price picture.
Suffice it to say, if you are looking for soothing words on inflation, probably best not to approach us—similar to the U.S., our calls are at the high end of consensus, with headline Canadian CPI to average roughly 3% this year and next. Canada has not seen a single year with an average inflation rate of 3% or higher since 1991, let alone two years in succession. How do you like them apples (up 6.8% y/y)?