On July 13, the Bureau of Labor Statistics (BLS) published the Consumer Price index for June of 2021. The results were not surprising to people who buy cars or drive them: used cars prices were through the roof (up 10.5% for the month) and gasoline prices were up 2.5% for the month. Overall, the all items index was at 5.4%. Other items were up around the board: food away from home was up 4.2%, beef was up 4.5%. Airline ticket were up 2.7% for the month after rising 7% in May. Used cars were off the chart (45.2% for 12 months), and new car prices were up 5.3% over 12 months. Motor vehicle insurance prices were up 11.2% over 12 months. And car and truck rental rose 87.7% year over year, which is really no big surprise considering the lockdown of 2020.
Prices are going up, but will they come back down?
Bureau of Labor Statistics (BLS)
To put this in perspective, this is a significant bump in inflation, the highest in almost 30 years. Fed Chair Jerome Powell testified in a House hearing on June 22, that inflation is transitory, and suggested it was due to the strong demand and weak supply from the reopening of the economy. In other words, what goes up, must come down. Maybe so, but when does it come down or does it? The question is, how much of this is sticky and will stay, versus slippery and be transitory?
Slippery. Oil, coincidently, is slippery. Oil prices spike, which triggers new development and production. A spike in oil will cause the shale producers to reactivate their rigs and increase supply. High oil prices portend higher production which portends lower prices. Oil price spikes tend to be transitory. Car rentals and airline tickets are pretty slippery: the demand is high, so the prices are high, and as supply increases, the prices come down.
Sticky. But there are sticky components of inflation. In fact, the Fed Reserve Bank of Cleveland has published an article on sticky inflation, and the St Louis Fed publishes a chart of sticky inflation, called appropriately, the ‘Sticky Price Consumer Price Index’:
Will these pricing changes be transient, or will they ‘stick’ around?
Federal Reserve Bank of Atlanta
Using the Fed’s study, we see some components are slippery (motor fuel, car rentals and fresh fruits and vegetables), while other are quite sticky, like rent, medical care services, education, and medical care. Labor costs are sticky as well. From a labor perspective, the main impetus of the fiscal and monetary authorities is to decrease unemployment and increase hiring. Thus, a comprehensive view of the overall inflation prediction will have to include a sticky labor component. In September, the increased Federal unemployment benefits go away, which should have a significant effect on the job market and labor costs.
The question of sticky versus slippery becomes important as we look forward to projecting future expenditures. Inflation is cropping up now, is it a temporary weed or something more durable? Past Fed studies indicate that CPI is not a simple number. Couple this with extraordinarily low interest rates and challenging returns and it creates a complicated picture. In the 1970s, we had ‘stagflation” – high unemployment and inflation. During that time, the Fed and the Administration made every attempt to deny the existence of any inflation. Policy makers have it in their own self-interest to check the perception of inflation.
Self-fulfilling prophecy? Inflation is dangerous because if the consumer believes prices are going up, they will buy now rather than later, increased demand effectively causing prices to rise. In the 70s, that is precisely what happened, and the inflation spiral was a self-fulfilling prophecy: People thought prices would go up and bought, which made prices go up. The inflation spiral is quite hard to break, and results in sticky inflation.
Bottom Line. Perhaps the Fed and the Administration are right: this inflation surge is temporary, caused by built-up demand from the pandemic. But the Fed has indicated that certain components of inflation are sticky and resistant to reversion. Perhaps planning for inflation and being pleasantly surprised is the best bet. As always, I’ll try to answer questions or share ideas. My email is llabrecque@sequoia-finanical.com. For a copy of our free e-book on IRAs, click here.