Inflation: What the April CPI Jump Might Mean for Fed Policy | Lord Abbett
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Economic Insights

While the larger than expected increase in the U.S. consumer price index took markets by surprise, the U.S. Federal Reserve likely will remain focused on labor costs.

Read time: 2 minutes

Consumer prices in April rose much more than expected according to a U.S. Bureau of Labor Statistics report released May 12, with the headline consumer price index (CPI) rising 0.8% versus expectations of a 0.2% increase, and core CPI, which excludes food and energy prices, up 0.9% versus 0.3%.

As much as the larger than expected numbers took Wall Street by surprise, we believe they are still consistent with the U.S. Federal Reserve’s (Fed) views that a “level” adjustment higher is to be expected as the economy progresses towards full reopening and that base effects1 will result in a temporary surge above the central bank’s 2% inflation target.

 

Figure 1. April Sees a Bigger-than-Expected Increase in Consumer Prices
Percent change in components of the monthly U.S. consumer price index (CPI), January 2009-April 2021

Source: U.S. Bureau of Labor Statistics. Data compiled May 12, 2021. YOY=Year-over-year. Core CPI excludes food and energy prices. For illustrative purposes only.

 

Larger than expected price increases in April were caused by huge increases in a couple of items: used cars (+10%!) and airline fares (+10.2%), and small ones in many others. While rent inflation is picking up as the economy recovers, it is still tracking slightly below the pre-shutdown trend. This is important because rents are one of the most cyclical components of inflation and are a large enough component of the consumption basket to influence headline outcomes.

Watching the Trends
A little over a year into the pandemic, relative prices have adjusted as would be expected; very strong demand for core consumer commodities has caused inflation to accelerate sharply for those items and much weaker spending on core consumer services has caused that portion of core inflation to decelerate. That is clear from two-year trends of annualized inflation rates that smooth out base effects from the combination of the sharp price declines that took place during the shutdown in March–April 2020 and adjustments higher taking place now.

 

Figure 2. Commodity, Service Inflation Trends Have Diverge
Two-year annualized percentage changes in the monthly U.S. consumer price index (CPI) and indicated components of the index, January 2015–April 2021

Source: U.S. Bureau of Labor Statistics. Data compiled May 12, 2021. For illustrative purposes only.

 

As shown above, core goods price inflation (blue-green line) has moved sharply higher as household income has risen due to large fiscal transfers and shortages for certain items have developed along the supply chain. But this has been accompanied by lower inflation in core services (blue line) as consumers have avoided spending on things that could expose them to infection by virtue of their being consumed in social settings. Overall, however, CPI increases, whether headline (green line) or core (yellow-green line) are still in line with the pre-COVID trend.

Fed Policy Implications

The pandemic is an unprecedented event and the price adjustments that take place as the economy grows into its “new normal” are, to some extent, unpredictable. From the above, it seems likely that core service inflation will pick up as more people are vaccinated and infection risk recedes while core goods price inflation will slow as supply increases and spending adjusts to a lower trend level.

But the kind of inflation the Fed cares about won’t pick up unless labor costs increase and keep accelerating. Where the labor market settles as growth slows later his year and spending patterns normalize is what the Fed will be watching closely as it determines when to begin the process of removing accommodation. or now, in our view, the central bank need not change its guidance.

 

1The “base effect” relates to inflation in the corresponding period of the previous year; if the inflation rate was too low in the corresponding period, even a smaller rise in a price index will arithmetically give a high rate of inflation to the current period. 

The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy.

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

This article may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

The U.S. Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care. It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein. If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in the preceding commentary are as of the date of publication and are subject to change. Additionally, the opinions may not represent the opinions of the firm as a whole. The document is not intended for use as forecast, research, or investment advice concerning any particular investment or the markets in general, and it is not intended to be legal advice or tax advice. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information.

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