Federal National Mortgage Association : Inflation Slows as the Travel Industry Falters, but Higher Wages and Shelter Costs Likely to Keep Readings Elevated

Key Takeaways:

• The Consumer Price Index (CPI) increased 0.3 percent in August, the slowest monthly growth rate since January. On an annual basis, CPI increased 5.3 percent, down slightly from 5.4 percent readings in June and July. Core CPI also decelerated from recent readings, increasing only 0.1 percent over the month and 4.0 percent annually. Energy prices jumped 2.0 percent in August, driven by a 2.7 percent increase in energy commodities. Annually, energy prices are up 25.0 percent. New vehicle prices grew 1.2 percent, the slowest rate since April, while used vehicle prices declined 1.5 percent, the first decline since February. Prices for other lodging away from home (includes hotels and motels) and airline fares also declined, falling 33 percent and 9.1 percent, respectively. This was the largest monthly decline for both categories since April 2020. Rent of primary residences and owners' equivalent rent (OER) both increased 0.3 percent over the month. OER ticked up to 2.6 percent annual growth, the fastest annual pace of growth in a year. Import prices fell 0.3 percent in August, the first monthly decline since October 2020. On an annual basis, import prices were up 9.0 percent, a deceleration from the past four months of double-digit gains. The Bureau of Labor Statistics produces both of these reports.
• Retail sales and food services increased 0.7 percent in August, though the July reading was revised downward from a 1.1 percent decline to a 1.8 percent decline, according to the Census Bureau. Sales at restaurants and bars were flat following 5 months of strong increases as the economy reopened, while food and beverage store sales, including grocery stores, rose 1.8 percent, their largest gain since January. Nonstore retailers, representing mostly online sales, jumped 5.3 percent after a 4.6 percent decline in July. Motor vehicle and parts dealers' sales declined for the fourth straight month, falling 3.6 percent. Core retail sales (excluding food services, autos, building supplies, and gas stations) rose 2.5 percent, its largest increase since March.
• Industrial production, a gauge of output in the manufacturing, utility, and mining sectors, increased 0.4 percent in August, according to the Federal Reserve Board. Utilities output grew 3.3 percent, while mining output fell 0.6 percent, likely in part due to the evacuations of oil rigs in the Gulf Coast prior to Hurricane Ida. Manufacturing output rose 0.2 percent, led by a strong 1.2 percent increase in computer and electronic production.
• The National Federation of Independent Business (NFIB) Small Business Optimism Index ticked up 0.4 points to 100.1 in August, rebounding slightly from a sharp 2.8 point decline in July. A net 32 percent of firms plan to increase employment, a 5 percentage point increase from July and the highest percentage on record. This is in spite of a net negative 28 percent of firms reporting that they expect the economy to improve, the lowest level since January 2013 and an 8 percentage point drop from July. The net share of firms planning on increasing average selling prices remained flat at 44 percent and the net share of firms planning on raising worker compensation ticked down 1 percentage point to 26 percent. Ten percent of firms reported that cost of labor was the largest problem they faced, the highest level since November 2019, while 28 percent reported quality of labor to be the largest problem, the highest share on record.

Forecast Impact:

The deceleration of the CPI was largely due to price declines of several transitory inflationary drivers, such as airline tickets, hotels, and used autos. While we had predicted price declines in some durable goods, such as autos, and an easing of other transitory inflationary pressures, such as those from the travel industry, the timing and magnitude of the latter was unexpected. It is likely that airlines and hotels have been hurt by concerns over the Delta variant, including limited business travel, and thus are not recovering as quickly as we had expected. Due to ongoing COVID-related dynamics, it's possible that we could experience a seesawing of prices and spending in some re-opening sectors, as we now expect airline ticket to rebound during the holiday travel season. Similar volatility is possible in other industries, as the August retail numbers showed a strong rebound in online and grocery store sales, while sales in restaurants and bars were flat after several months of increases. This may indicate a shift in spending back towards goods and shopping at home due to COVID-related concerns, though we also caution that the spike in online sales may have been affected by abnormal seasonal adjustments due to Amazon Prime Day occurring a month earlier than usual.

Our forecast continues to assume that consumers will shift their spending away from goods and into services, allowing businesses time to restock depleted inventories. However, if August's rebound in demand for goods continues, we could see increased price pressures in industries where supply chain bottlenecks are already severely limiting supply. Additionally, more sustained inflationary pressures, such as wage gains and housing price pressure on rents and owner's equivalent rent (OER), are expected to become more prominent. The former was evident in the NFIB small business survey, which showed persistently high numbers of firms struggling to find workers and thus planning on raising wages. This will likely continue to add upward pressure to prices and keep inflation elevated into 2022, even as the more transitory inflation rolls off. On top of wage- and rent-related pressure, the energy sector, where utilities production and prices jumped in August, is also likely to offset price declines elsewhere, keeping our near-term inflation expectations elevated.

On balance, our topline inflation and growth expectations are unlikely to change substantially, but our expected drivers of inflation may be affected. Further, additional inflation risks remain, as we could see a second surge in prices in services industries in 2021Q4 if the Delta variant peaks and health concerns subside, potentially causing elevated inflation readings further into 2022 than previously anticipated.

Nathaniel Drake
Economic and Strategic Research Group
September 17, 2021

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