The rapid descent of U.S. inflation over the last few months is likely too good to last.
New upside risks in categories that have played an outsize role in the recent deceleration – like used cars and airfares – are raising the question: Can price pressures in services components like housing slow enough in coming months to sustain the downward trend?
While many think the Federal Reserve’s own projections for underlying inflation over the next several months seem too high, there’s more agreement between the central bank and private-sector analysts that a return to the 2% target in 2024 is unlikely.
JPMorgan Chase & Co. chief economist Bruce Kasman, for example, sees inflation in “core” consumer prices excluding food and energy snapping back to a run rate of about 3.5% annualized over the coming six months as used-car prices, airfares, and health-insurance costs stop falling.
“Do you think you could get the other components to decelerate core inflation on a run-rate basis by a percentage point to get you back down to where we are now, which is around 2.5%?” Kasman said. “I don’t think so.”
Here’s a look at some possible bumps in the road in the months that follow Thursday’s September inflation report that help explain why the Fed and Wall Street economists see elevated inflation continuing through next year:
USED CARES
A surge in used car prices during the pandemic helped kick off the inflationary cycle. They rose nearly 60% between June 2020 and January 2022, and have become an important drag on the consumer price index over the last year as prices have retreated somewhat.
However ongoing shortages and the risk of production disruptions from the United Auto Workers strike could spark fresh price pressures in the months ahead.
“Even away from the strike, I think a more structural, fundamental problem is that we continue to be really, really short on used cars,” said Omair Sharif, founder of Inflation Insights LLC.
“Any time you have a pickup in demand for whatever reason, you’re going to see a spike in used cars,” Sharif said, adding that inventories aren’t expected to improve materially until 2025.
The range of estimates for used-car prices in the September CPI report due Thursday from the Bureau of Labor Statistics underscores how hard the category can be to forecast: Bloomberg Economics expects them to jump 2.2%, while strategists at TD Securities, for instance, see them falling 1.5%.
AIRFARES
In 11 of the past 15 months, airfares in the CPI – an important component in the broader core services inflation basket – have declined.
While airfares may not actively fan inflation in the months ahead, they also probably won’t be as reliable of a drag. The category itself is quite volatile, in part due to its close relationship with fuel costs.
“The concern is that we’ve seen, now, higher energy prices driving headline prices for quite some time, which eventually, then, leads to a reversal in the core, or at least upward pressure on the core,” Lindsey Piegza, chief economist for Stifel Financial Corp., told Bloomberg TV.
A big wild card is whether the Israel-Hamas war spreads and impacts the flow of oil from the region.
For now, the latest surge in oil prices has abated somewhat, and more fundamentally, global airline capacity is finally back to pre-pandemic levels.
“You could potentially still see some moves up and down in airfares, but to me, a lot of that has honestly even wrung itself out,” Sharif said. “Capacity is back to normal. Demand is pretty stable.”
MEDICAL CARE
In almost every month over the past year, medical care services have acted as a substantial drag on the CPI, largely due to the indirect way the Bureau of Labor Statistics calculates health insurance costs based on insurer profit margins. That’s set to begin reversing in the October report due a month from now.
But the measure of health-care costs in the personal consumption expenditures price index – published by the Bureau of Economic Analysis and favored by the Fed – is quite different. While the CPI aims to measure out-of-pocket costs, the BEA’s index is a broader measure and includes medical services paid for by employers and the government – like Medicaid.
The trajectory of the PCE version will probably play an important role in shaping the overall path for the Fed’s preferred inflation gauge in the year ahead due to its weight in the index.
Jonathan Millar, senior U.S. economist at Barclays Plc, calls the health care PCE component “one that’s particularly susceptible to uncertainty.” He pointed to lingering cost pressures in the sector, noting outflows of medical professionals in the wake of the pandemic, as an upside risk.
HOUSING
Housing costs are paramount because they’re the biggest component of the CPI and among the largest in the PCE index. Rents for those signing new leases surged in the aftermath of the pandemic, but there was a significant lag between reality and when those price increases showed up in the government’s inflation data.
The same is true on the downside. By some private-sector measures, rents outright declined at the end of last year, and growth has been relatively subdued in 2023. But it’s not exactly clear when those dynamics will be reflected in the official price indexes.
There’s also a bigger question about the balance of supply and demand for housing. On one hand, a glut of multifamily units starting to come online seems to be pressuring rents lower. On the other, mounting affordability challenges in the purchase market – fueled by higher mortgage rates and climbing prices – may keep rental demand elevated.
“There’s good reason to think that it will continue to decelerate,” Millar said. But “we are worried that given the fact that housing demand has proven to be so resilient, and this cycle seems like we have a structural shortage of housing, it wouldn’t be hugely surprising” to see rents re-accelerate, he said.
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