July Inflation Update: 9.1%

Yesterday the Bureau of Labor Statistics issued the June CPI numbers.

We are now running at an annual inflation rate of 9.1%, up from 8.6% last month. This is the largest 12-month increase since November 1981. The BLS defined the increase as broad-based, with energy, shelter and food being the biggest contributors.

Energy

The energy index rose 7.5% overall after rising 3.9% in May. gasoline 11.2%, natural gas at 8.2%. Electricity index also rose 1.7%. The energy index overall rose 41.6% for the year, with gas rising

Shelter

The shelter index increased 0.6% in June, as it did in May. Rent index rose 0.8%, and owner’s equivalent rent rose 0.7%. Lodging away from home (hotels and such) actually fell 2.8% in June after a string of increases in recent months.

Food

The food index rose 1% in June, the sixth consecutive increase of at least 1% in that index. Food away from home rose 0.9%. The only major grocery group to decline in June was the index for meats, poultry, fish and eggs which fell 0.4%.

Overall, food at home rose 12.2% over the last 12 months.

CPI

To review, the bulk of the CPI is made up of Shelter (32%), Commodities (21.2%) like apparel, new/used vehicles, alcohol, tobacco, Food (13.4%), Energy (8.6%), Medical Services (6.8%) and transportation services (5.8%)

My main take away is that the longer this elevated inflation continues, the longer it will continue. Anyone not asking for a significant, 8-10% raise from their employer at this point is effectively getting a pay cut. Eventually people are going to take their financial lives in their own hands, and when they do, I think it’s going to lead to a wage-price spiral where people get raises, but everything becomes more expensive because everyone is getting raises just to keep up.

The Fed now knows it needs to act, and it needs to act quick. So what are the likely results from this higher-than-expected inflation print? It will likely lead the Fed to a 75-100 basis point (fancy way for saying .75% or 1%) federal funds rate hike in at the July FOMC (Federal Open Market Committee) meeting. This is pretty significant — the current federal funds rate is 1.5%-1.75% (it’s set as a range between an upper limit and a lower limit) so with an increase of 75-100 basis points it would go up to 2.25-2.5% or 2.5-2.75 depending on how aggressive they choose to be.

The popular viewpoint at the moment is that the fed will continue tightening until they “break something,” and then they will ease up. A bit of historical context here might be helpful.

For the last 20 years we have had both historically low interest rates and quite low inflation. Post financial crisis in 2008 they had many years of 0% rates (which was a first at the time), until 2015. When they tried to raise rates up to 2.5% in the period of time from 2015 to 2019, the hiking cycle was cut short when the economy was showing signs of stress.

The Fed has what they call a “dual mandate” which is 1. Stable Prices and 2. Full employment. They really shouldn’t be concerned about asset prices (real estate, the stock market, etc.) but they have started to be more and more influenced by the markets.

In the covid period, The Fed responded by moving rates back down to zero, by resuming Quantitative Easing, by sending out stimulus checks and increasing the amount of unemployment, pausing student loan payments, and that sort of thing.

Links:

BLS.gov news release

https://www.bls.gov/news.release/pdf/cpi.pdf

Reuters

https://www.reuters.com/business/past-fed-hiking-cycles-sanguine-severe-may-say-little-about-this-one-2022-03-17/

Brookings:

https://www.brookings.edu/research/fed-response-to-covid19/