Data as of May 31, 2022. Sources: Bureau of Economic Analysis, Wilmington Trust.
The key to it all is the path forward for inflation. The Fed started getting hawkish in late 2021 at the first sign of broad-based inflation and it is committed to aggressive rate hikes until it sees “convincing [and] compelling evidence that inflation is coming down” in the form of a “series of declining monthly readings.” We believed that had started in earnest in February and March before getting stung by consecutive monthly readings of 0.6% m/m in April and May (Figure 2).
On one hand
Digging into the details, we’re encouraged by the slowdown in most categories (gray). Even the upside surprise reading for May (that sent markets into the current selloff) showed encouraging price declines for consumer goods, such as the ones that national retailers like Walmart and Target have indicated overstocking. Prices fell for smartphones, televisions, sporting goods, appliances, furniture, bedding, and window treatments, to name a few. We expect this dynamic to continue as demand for goods continues to wane.
On the other hand
The surprises came from cars, airfare, hotels, and housing. Autos, particularly used ones, have been a main culprit in the rampant inflation and consumers finally started to get relief on prices in February and March only to see another acceleration in the past two months. High frequency trackers are pointing to relief again so far in June, and major automakers have signaled optimism on production of new autos this year, yet risks remain. Airfares, which track very closely with jet fuel prices also jumped in April and May. Here again high frequency data are showing an encouraging, regular seasonal decline in prices in June, but jet fuel prices could drive airfares higher again.
Housing, or “shelter” as it is known in the inflation data, is likely to be the most persistent challenge for inflation even though housing activity is hitting a wall. In last week’s inflation report, the month-over-month gain in the overall shelter line item moved up 0.6%, the biggest jump since 2004, and the owner component had the biggest gain since 1990.
We do expect home prices to slow very soon. The average 30-year mortgage rate has jumped 2.7% since the Fed first turned hawkish six months ago, the largest six-month jump since 1981. That has put the brakes on activity, sharply pushing down homebuilder confidence, foot traffic of potential buyers, building permits, housing starts, and mortgage applications. Home price data lags by several months but should reflect a slowdown in price gains very soon. However, there are quirks in the methodology of collecting data for the inflation index that mean we may not see weaker prices flow through to the data for as long as 14 months.
Figure 4: Core consumer price index inflation contributions from components (% m/m)