Checking In on Inflation’s August Slowdown

The Consumer Price Index (CPI) inflation rate moderated again in August, slowing to 5.3% y/y from July’s 5.4%—and to just 0.3% m/m versus July’s 0.5%.^[i] That month-over-month rate is quite notable, in our view, as it is equal to the average monthly inflation rate since data begin in 1947—making this a return to normal in many senses of the term. A quick look under the hood shows many of the categories that drove faster inflation earlier this summer and spring are also moderating significantly. In our view, this all provides more evidence that while math might keep the annual inflation rate high for a while longer, price pressures in the here and now are easing considerably. We never thought inflation was likely to prove a market risk this year, but the latest data should help defang fears further.

When discussing inflation, we don’t typically focus on month-over-month changes. They are quite volatile—especially in individual categories—and the year-over-year inflation rates help smooth out that bumpiness and make the trends easier to see. Plus, public policy officials and the Fed focus on annual inflation rates. But in recent months, we have made month-over-month changes in CPI the centerpiece of our analysis, as events from a year or more ago are still skewing the year-over-year rate higher. We are referring, of course, to the sharp, temporary deflation that accompanied lockdowns in March, April and May 2020, which dragged down the denominator in the year-over-year calculations this spring. In our view, the effect lingered into the summer, as prices took a bit of time to rebound last year. Therefore, focusing on the monthly inflation rate removed that backward-looking skew and enabled us to zero in on the present.

In doing so, we found that most of 2021’s price pressures were coming from the categories affected directly by reopening: travel and leisure, automobiles, transportation services, food and energy. Some of these stemmed primarily from the unleashing of pent-up demand as people were finally able to travel and dine out again (e.g., airfares, hotels and fuel). Others received an assist from shortages, as resurgent demand coincided with supply chain kinks (e.g., food, automobiles and rental car prices). Used car prices, which jumped 31.4% between February and July, were at the nexus of all these factors.^[ii] Reopening spurred demand for cars, but the global semiconductor shortage drove a shortage of new vehicles. That forced shoppers to turn to the used car market at the exact moment rental car companies were scrambling to rebuild their fleets after selling off inventory to shore up their finances during last year’s lockdowns. It was a perfect, if temporary, storm.

Most of these factors continued waning in August. After slowing from 10.5% m/m in June to 0.2% in July, used car prices actually fell -1.5% in August.^[iii] Hotel costs, which rose 6.8% in July, fell -3.3%.^[iv] Car rental prices, down -4.6% in July, fell another -8.5%.^[v] Food prices were a mixed bag, with most meat up and several other delicious goodies down, but the category overall moderated from 0.7% in July to 0.4%.^[vi] The only category that got demonstrably worse was energy, which accelerated from 1.6% in July to 2.0% as gasoline prices jumped 2.8%.^[vii] Hurricanes may see that stretch into next month’s prices, too, but that isn’t likely to last, either.

Because food and energy prices are subject to temporary disruptions that often have little to do with domestic economic conditions or money supply, analysts often cut through the noise by looking at “core” inflation—prices excluding food and energy. Core CPI, which topped out at 0.9% m/m in April, rose just 0.1% in August—below its own long-term average of 0.3%.[viii] Now, we aren’t arguing that outside of food and energy there was no inflation, which is a line of logic that is getting a lot of laughs on Twitter. Anyone with Excel and a spot of cleverness can manufacture their own inflation index that magically comes out to zero. But below-average core inflation does suggest strongly that the factors driving prices higher earlier this year are now firmly in the rearview.

This is not inherently bullish for stocks—inflation doesn’t have a preset market impact. However, for months, pundits have tried to argue rising stocks are ignoring inflation, storing up trouble once reality sets in. That is always a dangerous stance, in our view, considering markets are arguably the best discounters of widely known information on Earth. It strains credulity to think any sufficiently liquid market would ignore one of the biggest economic stories on the planet. In our view, stocks’ rise and bond yields’ simultaneous fall wasn’t blind stupidity, but rather the market’s way of signaling that while inflation was spiking in the near term, it was quite likely to moderate within a reasonable period of time. In other words, stocks and bonds were previewing what the data are now showing. That, friends, is called climbing the wall of worry.