Another Fed Misread: Inflation Cycles Are Not Static; They Rotate and Broaden
Policymakers continue to argue that the current inflation cycle is temporary, centered in few products and industries, and will unwind as bottlenecks dissipate. Yet, that view runs counter to the history of inflation cycles.
Inflation cycles are not static or linear; they rotate and broaden. Some items post significant increases in any given month, others smaller ones, and a few none at all. Months later, the composition of inflation could be completely reversed, with items that were not rising at the outset beginning to run faster than others. And inflation cycles continue to run as long as easy money provides the fuel.
Earlier this year, policymakers cited record increases in used car prices due to parts shortages that hampered new car production as evidence the inflation cycle was not broad or sustainable. In fact, In April and May, used car and truck prices, with a weight of only 3%, jumped 10% and 7% respectively and accounted for a third of the increase in headline consumer price inflation.
Yet, used car prices have dropped in the past three months, and headline consumer price inflation still ran at a 5% annualized rate. Why? Sharp price increases rotated to the food and energy area.
The next phase of the inflation cycle will be in consumer services. Owners' housing costs are the most significant service component with a weight of 23%. In the consumer price index, the cost of owners' housing is rent or the implied rent that owners would have paid if they were renting their home. The owner's rent series lags, not point for point, the rise in home prices by six to twelve months. Home prices are up roughly 20% in the past year, while owners rent is up a mere 2.9%. Owners' rent increases could easily double in the next year, lifting overall consumer price inflation by far more than what used car and truck prices did in the spring of 2021.
Travel-related service prices could be another area where price inflation surfaces, especially now that international travelers are welcome again. At the press conference following the November 2-3 Federal Open Marker Committee meeting, Fed Chair Powell said, "people are not traveling." But the travel industry is expecting a surge in demand. American Airlines just announced that flight attendants who work over the holiday period could receive a 300% premium in pay. Southwest airlines also announced extra pay incentives due to solid travel business and labor shortages.
Once again, the Fed is misreading inflation dynamics. Fed Powell's hope the transition from goods, where there is excess demand, to services will result in less inflation is misguided. Consumer services account for over 60% of the CPI, and pent-up demand for services along with the catch-up in housing-related inflation will result in consumer inflation running well above the Fed's 2% target in 2022 and beyond if policymakers continue with an easy money policy.