As The Inflation Surge Continues, Here Are Three Key Things To Watch

Headline inflation came in at 7.9% for February 2022 in this morning’s release. Stripping out moves in food and energy prices it’s 6.4%. Both are increases on recent months and are the highest levels since the early 1980s.

However, this was largely expected and one reason why the Fed is expected to raise rates next week. The more interesting question is what can we learn about inflation going forward?

Importantly, the debate about transitory or sustained inflation is ongoing. Yes, inflation has not, so far, been as transitory as many observers hoped. We are now at the point when some thought transitory pressures would ease, and that’s not obvious in the data yet. However, the questions of when and if pricing pressure might moderate remains.

Here are three things to watch.

Housing

If you want to forecast inflation, one way to do it is to look at where people spend the most money, since those prices are more heavily weighted in the inflation calculation. Unsurprisingly, the cost of shelter, as the CPI report calls it, is a big one. Housing makes up a third of the inflation index, since people spend so much on where they live.

Unfortunately, there’s not too much to be optimistic about in the latest report. Firstly, shelter costs have risen faster in February than in recent months, its hard to discern too much from small changes, but it’s not moving in the right direction.

Different Measurements

Secondly, there’s a disconnect between different housing data sources. The rate of increase in the report is 4.7% for housing year-on-year. Importantly, that price change is a lot lower than other house price trackers showing. Most of those other services have double digit increases for housing recently.

For example, the most recent Case Shiller House Price Indices have prices up 17% to 18% over the past 12 months ending in December 2021. Despite the time periods not being completely aligned, that a stark difference with the inflation report. If CPI data catches up with what other sources are finding on house prices, then inflation prove be less transitory than many hope.

Services

Broadly, speaking, the surge in inflation that we’ve seen has been more weighted to goods than to services up to this point. That means that prices for goods like clothing, food and energy have generally risen faster than services like medical care, education and pet care.

That make sense as the prices for a lot of commodities have surged and supply chains have been disrupted causing the prices of those goods to increase. However, if prices in services now start to rise more strongly, that may mean inflation will spread more broadly and persist at higher levels for longer. Again, here the signs are not too encouraging at the costs for services may be accelerating slightly in the most recent report.

Ukraine

Then of course, this most recent report is for February 2022. As such, the recent run up in energy costs linked to the Ukraine conflict is not fully captured. Energy prices are volatile and economists often exclude them when looking for the true trends in inflation. However, surging energy prices may lead to even higher inflation headline inflation numbers in coming months should the current run up in prices last.

It’s clear that inflation has not been as transitory as many hoped, and unfortunately the latest data doesn’t imply that inflation is set to fall in the near term. The challenge is that if inflation is not transitory, then the Fed may have to raise rates quite aggressively to contain it. That’s currently the outcome that the markets expect and it may continue to make 2022 a challenging year for investors.