Inflation Is Getting Worse Before it Gets Better
Despite the big rise in November CPI, the upward pressure on prices should unwind in 2022.
November was another ugly month for inflation, with consumer prices continuing their recent trend and rising on many fronts.
But while the inflation dynamic continued to appear troubling, the story remains the same from Morningstar’s perspective: Much of the upward on pressure on prices is owed to the continued supply and demand mismatches rippling out from the coronavirus pandemic.
The November increase “was driven mainly by the same categories which have caused excess inflation throughout 2021, namely energy and vehicles,” says Preston Caldwell, Morningstar’s chief economist. “We continue to believe that the price increases seen in these categories will unwind as supply constraints are relieved, which will contribute significant deflationary pressure. Energy prices already look set to fall given that oil and gas prices have fallen in December. The timing for vehicle price relief is more uncertain, but still likely to occur by the second half of 2022.”
The Consumer Price Index rose 6.8% in November from year-ago levels. That marked the steepest year over year increase since 1982.
Price increases were widespread, with gasoline, shelter, food, and vehicles (both new and used) as the key drivers.
CPI levels for all goods rose 0.8% in November from the month prior, slightly lower than October’s 0.9%. Excluding food and energy (two of the most volatile components of the CPI), price levels rose 4.9% from year-ago levels. This is on par with October’s year-over-year change of 4.8%.
Key components this month have continued to rise. Shelter (which represents rent prices) rose 0.5% from October levels. Rising rent is troubling from an inflation perspective because it is harder to reverse than rising prices in consumables like cars, energy, and furniture.
However, Caldwell notes that shelter prices still remain below their pre-pandemic trend. “These price increases merely reflect a catching back up to trend. We don’t think it’s likely that shelter prices will soar above the pre-pandemic trend.”
As shown in Exhibit 3, the bulk of excess inflation--which we measure as CPI component changes compared with their pre-pandemic trend--has been driven by vehicles and energy.
One bright spot is that gas prices have already started to fall on a national level: $3.34 per gallon as of Dec. 10, slightly down from $3.42 at the same time last month, according to the AAA weekly survey of gas prices.
The CPI data comes as Federal Reserve officials will gather in the coming week to set monetary policy. Late last month Federal Reserve Chair Jerome Powell signaled a more wary view of inflation. “Generally, the higher prices we’re seeing are related to the supply-and-demand imbalances that can be traced directly back to the pandemic and the reopening of the economy, but it’s also the case that price increases have spread much more broadly in the recent few months,” he says. “I think the risk of higher inflation has increased.”
While fund investors are gravitating toward strategies aimed at protecting against inflation, the prices in the bond market are suggesting that concerns about a long-term rise in inflation have stabilized.
This can be seen in what’s called the 10-year break-even inflation rate. This rate--the difference between the 10-year nominal Treasury yield and the 10-year Treasury Inflation-Protected Securities yield--represents the market’s expectation of what inflation will be 10 years down the line.
Currently, the 10-year break-even inflation rate is at 2.5%--a hair lower than it was last month. That’s higher than the pre-pandemic levels, but the numbers have held steady over the past several months.