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US CPI Preview: May 2023
The next set of inflation numbers are expected to further dispel the fallacy that the US remains in the grip of a major inflation problem - but will the Fed keep focusing on lagging price indicators?
May’s US CPI report is expected to reveal significant additional disinflation. My forecasts are as follows:
Headline CPI: 4.2% (vs 4.1% consensus, and 4.9% in April)
Core CPI: 5.4% (vs 5.3% consensus, and 5.5% in April)
Headline CPI ex-shelter: 2.3% (vs 3.4% in April)
Core CPI ex-shelter: 3.5% (vs 3.7% in April)
With the Fed continuing to articulate that they want clear evidence that inflation is headed to its 2% target before loosening its aggressive tightening, if May’s CPI report comes in as I forecast, this should give the Fed plenty of evidence — particularly on an ex-lagging shelter basis.
Though as opposed to recognising the clear disinflation that continues to take shape, the Fed may instead continue to focus its attention on the most lagging component of the price cycle, being services prices.
Given that services price growth is expected to still be broadly elevated in May, focusing on this sub-component of the CPI is likely to cause the Fed to increasingly overtighten — whether that is via the absolute level of rates, or the length of time that rates are kept at high levels.
The key thing to watch in May (and in June, where I currently expect further material disinflation to occur), is whether media, political and broader public opinion, will begin to put significant pressure on the Fed to loosen its aggressive tightening, as headline CPI inflation declines further from its June 2022 peak of 9.1%.
Wholesale used car prices tumble in May, but retail prices are expected to rise
While wholesale used car prices, as measured by the Manheim Used Vehicle Value Index (Manheim Index) fell significantly in May (-2.7% sa, -1.7% nsa), CPI used car & truck prices are expected to see another month of strong price growth.
This is on account of CPI used car & truck prices, which measure retail prices, tending to lag the wholesale prices of the Manheim Index by 2 months.
Though with the Manheim Index recording non-seasonally adjusted growth of 0.1% in April and -1.7% in May, CPI used car & truck prices are expected to follow this trend in June and July.
Used car price forecast expected to see durables prices return to YoY growth — but only just
With another month of very strong CPI used car & truck price growth forecast in May, this is expected to result in overall durables prices being driven materially higher — I forecast an increase of 0.7% in May.
This is expected to see CPI durables prices return to positive YoY growth — though only just. I forecast YoY CPI durables growth of 0.1% in May.
Wholesale food prices decline again — the 13th drop in 14 months — set to drive further CPI food at home moderation
For the 13th time in the last 14 months, the UN FAO Food Price Index registered a MoM decline, falling 2.7% in April. This takes its annual change to -21.4%.
Given the significant impact that wholesale food prices have on retail food prices, there’s understandably a strong correlation between the UN FAO Food Price Index, and CPI food at home prices, with the latter tending to lag the former by about 6 months.
Yet again, this historical relationship held true, with annual CPI food at home price growth beginning to moderate in September 2022, 6 months after the UN FAO Food Price Index peaked in March 2022.
I forecast a further moderation in the YoY growth rate of CPI food at home prices in May, to 5.7% (down from 7.1% in April).
Looking closely to see if this translates to further signs of CPI food away from home disinflation
While more exposed to a broader range of services related price pressures such as wages and rents, wholesale food prices also have a big impact on food away from home prices, which encompass services like restaurant dining.
So far, CPI food away from home prices have continued to record MoM growth that has generally been well above its historical average (across 2010-19) — though in April, MoM growth moderated significantly.
Given the ongoing decline in wholesale food prices, this will be an important category to watch in May, to see if a more enduring downshift in prices is revealed.
In the meantime, given that one month of significant price deceleration in April doesn’t make a trend, for May, I am conservatively forecasting a rebound in MoM growth to a level that would again be materially above its historical average.
Lower gasoline prices expected to see CPI energy commodities decline by over 20% YoY
According to U.S. Energy Information Administration data, regular all formulations gasoline prices declined in May, somewhat reversing the large gain of over 5% that was seen in April. While this may seem surprising in light of oil prices that have remained pressured, this marks the first time that monthly average gasoline prices have declined in 2023.
With the CPI energy commodities index closely correlated to gasoline prices, with the large 8.0% MoM increase in energy commodities prices from May 2022 rolling out of the YoY calculation, I expect the annual decline in the CPI energy commodities index to exceed 20% in May.
Market rents continue to moderate — Apartment List Rent Index down to just 0.9% YoY
A critical component of the CPI equation is shelter, with owners’ equivalent rent (OER) and rent of primary residence composing 33.0% of the CPI in April. They compose an even larger proportion of the core CPI — 41.4% in April.
Though as opposed to providing up-to-date insights into the changing state of rental prices, the CPI’s rent based measures significantly lag spot market rents. The reason for this, is that the bulk of the CPI’s rental sample consists of rents under a fixed lease agreement. With the most common lease agreement being 12 months in length, it can take a significant length of time for rents to be reviewed and moved in-line with current market rates.
During times when spot market rents are undergoing huge shifts — as happened in 2021 and 2022 — the lagging nature of OER and RPR means that they can significantly distort the CPI versus underlying price trends.
For this reason, it’s important to look at market based indicators of rental prices, and analyse the CPI on a spot market rent adjusted or ex-shelter basis (which is detailed later in this report).
In terms of spot market rents, an important indicator, the Apartment List Rent Index, has continued to record an ongoing moderation in its annual growth rate. After peaking at 18.3% in November 2021, annual growth was just 0.9% in May 2023.
As the gap between OER and RPR has significantly converged, additional moderation in OER and RPR is expected
With spot market rents having seen their growth rates decelerate, and the CPI’s lagging OER and RPR measures recording high MoM growth as more of the rental sample saw their rates adjusted in-line with the prior surge in spot market rents, the bulk of the gap that opened up between Apartment List’s spot market rental index, and the CPI’s OER and RPR, has now converged.
As the spot and CPI rent indexes have converged, there has been a shift to a gradual moderation in the MoM growth rate of OER and RPR. Given the ongoing moderation in annual spot market rental growth, this is a trend that I forecast to continue in May, with a modest deceleration expected from the MoM growth rates recorded in April.
The generally gradual nature of MoM shifts higher or lower in OER and RPR occurs for the same reason that they are lagging — as only a small proportion of the rental sample has their rents updated in a given month, this has the effect of “smoothing” price changes, making them more gradual and less volatile versus underlying spot market rents.
Looking for a continued moderation in motor vehicle maintenance prices
After motor vehicle maintenance prices saw enormous growth over 2022, resulting in peak annual growth of 14.2% in January 2023, monthly price growth began to moderate in February. While monthly price growth remained above its historical average in March and April, it was much less so than the levels that were seen from June 2022 to January 2023. I forecast a continuation of this more recent trend in May.
After a record month in April, will personal services price growth moderate in May?
In contrast to motor vehicle maintenance prices, which have shown signs of disinflating, the other personal services category, which includes items like legal services and haircuts, saw its highest ever MoM growth in April, in data that dates back to 2010.
While I am forecasting monthly price growth that is less strong in May, given that MoM growth has tended to be materially above its historical average in recent months, I am still forecasting another month of relatively very strong price growth.
The price trend that has been seen in other personal services does an excellent job of highlighting the contrast between more leading durables prices, which peaked all the way back in February 2022, whereas other personal services prices are recording their sharpest monthly growth now — more than a year after the durables price surge began to taper.
Putting it all together
Forecasting MoM growth of 0.4%, core growth of 0.5%
Putting it all together, I expect headline CPI growth to come in at 0.4% MoM.
While slightly above its historical average, the overall trend since 2H22 does not present a concerning trend, with very high monthly inflation prints having largely dissipated.
Such a conclusion is made particularly true when one recognises that the average YoY change in the CPI across 2010-19 was 1.8%, below the 2% inflation target.
Monthly growth in the core CPI is expected to be 0.5% in May, well above its historical average. While recent trends in the core inflation picture appear to be ominous, this is the danger that comes with focusing on “core” inflation measures, for they are particularly lagging.
There’s two key reasons for this:
1) “core” measures largely IGNORE the second key phase of the disinflation cycle by excluding food & energy prices (which as discussed above, are either disinflating or are already sharply YoY negative).
2) by excluding food & energy prices, “core” measures have a higher weighting to LAGGING shelter costs and services prices.
The combined impact of these two factors, is that focusing on “core” inflation will promote a LAGGED response to inflation — both as it rises, and as it falls.
This is illustrated via the chart below, which shows that nondurables prices have been the second key phase of the current disinflation cycle (after durables prices), whilst services prices have been the most lagging.
Note that the lagging nature of services prices that can be seen in the below chart, comes despite mechanically lagging shelter costs being excluded from the adjusted services price numbers below.
Forecasting YoY growth of 4.2%, core growth of 5.4%
Given the major deceleration that has been seen in monthly headline CPI growth since 2H22, annual headline CPI inflation has moderated for 10 consecutive months.
I expect an eleventh month of moderation to take place in May, with annual growth forecast to fall to 4.2% — a significant moderation from the 4.9% recorded in April.
This is slightly above the consensus forecast of 4.1%.
Moving to the core CPI, here we can clearly see its lagging nature, with the Fed’s lackadaisical approach to inflation in 2021 supported by the much lower inflation readings being presented by the core CPI. While headline CPI inflation reached 5% by May 2021, it didn’t do so on a core basis until December 2021.
Now the reverse is happening, with headline inflation falling quickly, and the core CPI remaining elevated, which is now contributing to the Fed’s overly aggressive inflation fight.
I forecast annual core CPI growth of 5.4% in May, which is relatively little changed from the levels that have been recorded since January. As is the case with my headline CPI forecast, my core CPI forecast is slightly above the consensus expectation, which is 5.3%.
Forecasting MoM ex-shelter growth of 0.3%, core ex-shelter of 0.5%
Given the aforementioned lagging nature of rents in the CPI, which are recording annual growth rates that are well in excess of spot market based measures like the Apartment List Rent Index, it is important to also analyse the CPI on an ex-shelter basis.
On such a basis, I expect monthly CPI growth to be largely in-line with its historical average in May, recording growth of 0.3%. On this metric, which I would argue is currently a far better “underlying” measure of inflation than either the core CPI or core PCE Price Index, the deceleration that has occurred in monthly price growth since 2H22, is even more clear to see.
While the more lagging core CPI on an ex-shelter basis continues to show elevated inflation pressures, the trend since 2H22 is also much less concerning than the standard core CPI suggests.
Over 40% of the expected MoM growth of 0.5% in May stems from durables prices, which as earlier detailed, are driven by CPI used car and truck prices, which are expected to moderate significantly/turn negative over the months ahead.
Forecasting YoY ex-shelter growth of just 2.3%, core ex-shelter of 3.5%
With high monthly growth from May 2022 rolling out of the YoY equation, annual CPI ex-shelter inflation is forecast to be just 2.3% in May.
With the Fed continuing to state that it wants to see significant evidence of a material decline in inflation back towards its 2% target before loosening its aggressive tightening, you’d think that this would be it. Though as opposed to taking their cues from this measure — which is currently a more accurate measure of underlying inflation — the Fed is more likely to instead focus it attention on the most lagging component of inflation, being services prices.
Perhaps they will take more notice of CPI ex-shelter next month, which I currently forecast to fall to just 0.9% in June.
Despite its lagging nature, core CPI ex-shelter has also moderated significantly since September 2022. In May, I expect YoY core CPI ex-shelter growth to come in at 3.5%, down from 6.7% in September 2022.
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