Inflation will decrease, but not enough

Amid epidemic-related lockdowns, supply chain disruptions, and speculation, U.S. inflation has risen sharply. This jump should be made easier gradually as these distractions diminish over time.

Nevertheless, this reduced inflation could still be much higher to protect consumers who have been adversely affected by coronavirus-induced economic disruption.

Pre-epidemic inflation

Prior to Covid-1, in 2019, inflation was stable at around 2%. Although the consumer has shown signs of weakness, the negative effects of the US Federal Reserve inflation have been offset by financial stimulus.

Consumer vulnerabilities manifest themselves in strong price increases of essentials compared to their consideration partners. In the five years ending December 2019, prices such as food, rent and medical services rose faster than luxury items such as clothing, entertainment and autos.

Monetary policy contributes to the increase in housing costs by increasing the concentration of ownership of housing assets. This, in turn, has weakened the purchasing power of the consumer: as the price of essential commodities has risen, it has kept it low for consideration.

US Consumer Price Index (CPI), 12-month percentage change

Covid-1 of Inflation – Increased Fuel

In the midst of the epidemic, inflation has skyrocketed across all sectors. Disruption of supply chain and lockdown effects were the primary culprits, but as different waves of infection continued to burn, paint-up demand, pressure on production and distribution, and higher, speculative-driven product prices pushed up inflation.

US inflation before and after Covid-1 Pre

December 2019 (YoY) Growing five years
December 2019
December 2020 (YoY) January 2020 to July 2021
Inflation heading 2.3% 9% 1.3% 5.4%
Food and drink 1.7% 6% 9.9% 6.6%
Rent of primary accommodation 7.7% 20% 2.3% 3.6%
Health care 4.6% 16% 1.8% 2.7%
Clothing -1.2% -3% -4.1% -0.7
Entertainment 1.5% 5% 0.9% 3.3%
New car 0.1% 0% 1.9% 7.4%
Used car -0.7% -5% 10% 42.1%
Household furniture 1% 1% 3.2% 5.4%

Source: US Bureau of Labor Statistics

Gradual normalization?

Currently the U.S. headline inflation rate is 5.3% per year. Inflation should return to its long-term average of 2% as excess demand declines, the distribution network adapts to the new normal, and ongoing consumer weakness has its impact on prices.

After all, the demand for paint-up is naturally temporary. When the economy reopens, the lockdown ends, and work-from-home (WFH) -related items are needed when workers return to the office or settle in their remote system, it will reduce the ward upward pressure on inflation.

Indeed, the data suggest that consumer demand growth has already peaked. The growth of retail sales is seen in April 2021. Growth in auto sales also seems to have normalized by mid-2020.

Retail and food service sales (YoY)

Source: U.S. Census Bureau, Earth Road Capital

Supply chains are also becoming fully operational again. Such as ISM Manufacturing PMI sub-index such as supplier delivery time and order backlog seem to have reached their high-water mark as raw material inventory has run out. Thus, the pressure on the supply chain is decreasing.

Moreover, since the consumer as a whole has not been financially strong since the epidemic, consumer demand should remain weak. This should form an additional drag on inflation.

Supplier delivery, slowness (Index)

Charts that provide supplier slowness
Source: ISM (Supply Management Institute), the capital of dirt roads

Based on these factors, we can expect a slowdown in US inflation.

Similar trends follow, for example, in Canada, Germany, the United Kingdom, and Japan. Covid-1 – The sudden rise in related inflation is now moderate and returning to the long-term trend line in most sectors. There are exceptions to ensuring oil and housing in some markets as a result of some monetary policy and speculation.

The outlook for inflation

Overall, consumer demand and low interest rates will be the main drivers of inflation. Ongoing consumer weakness should bring down inflation and require more Fed support. The impact of other, event-specific inflation drivers is likely to diminish as the economy adapts to new realities.

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All posts are the author’s opinion. As such, they should not be construed as investment advice, or the opinions expressed must not reflect the views of the CFA Institute or the author’s employer.

Image Credit: © Getty Images / RBFried

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Dhruv Goyal, CFA

Dhruv Goyal, CFA, founder of Mud Road Capital. He specializes in global macro research, and sovereign bond and currency investing. He has more than 15 years of experience in the industry and has previously worked with Nationwide Insurance, the Wisconsin Alumni Research Foundation, and CUNA Mutual Group in the United States. He holds an MBA from the University of Wisconsin-Madison and is a CFA charterholder.

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