Written By: John Manley
The January CPI report, released earlier this week, showed only a modest increase in consumer prices.
The year-over-year rate of headline inflation decelerated to 1.6%, with the report’s weakness driven principally by a larger-than-expected decrease in energy prices. This latest reading appears to be part of a broader trend of persistently low inflation. Nevertheless, given an economy on the verge of its 11th year of expansion, investors may want to ask themselves: is inflation really dead?Interestingly, the details of the latest CPI report muddle the picture. Firmness in a number of components – notably, rent and apparel – helped to boost core inflation (which excludes the volatile food and energy components) to 2.2% year-over-year, much higher than the headline print. Investors may therefore want to consider the potential trajectories of the volatile food and energy components, or if broad inflation could push higher with tighter labor markets.For the food component, the message is mixed: as a large net exporter of food, U.S. food inventories could grow dramatically in the face of higher tariffs, pushing prices lower. On the other hand, rising labor costs could flow through to higher packaging and transportation costs, pushing up end consumer prices.By contrast, the energy story is much clearer. After falling considerably in the last quarter of 2018, WTI and Brent crude prices have since rebounded, each rising 20% through the middle of February. Saudi production and export cuts, announced earlier this week, should continue this trend, and rising U.S. energy inventories may struggle to outweigh weaker global output. Oil prices, as a result, could rise further.Related: Fixed Income Investing in the Late Cycle
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Perhaps the most important consideration is the trend in average hourly earnings. As shown below, after nearly a decade of muted wage growth, the most recent employment reports indicate that wages may finally be responding to an increasingly tight labor market. Absent a significant increase in productivity, this trend will either boost consumer prices or damage corporate margins.
All-in-all, while inflation is not a concern today, this may not always be true.
Understanding this, investors should recognize that monetary policy may turn more hawkish, rates may rise further than expected and equities may come under pressure once more.