June 10, 2022
The May Consumer Price Index showed sharp jumps in both the overall and core rates of inflation. The overall CPI rose by 1.0 percent, bringing its increase over the last year to 8.6 percent. The core index increased 0.6 percent, putting the year-over-year rate in the core at 6.0 percent. Both readings were higher than many of us had expected.
Starting with the bad news in the non-core, energy prices rose by 3.9 percent in May, bringing their increase over the last year to 34.6 percent. This is a Ukraine war story. While some Russian oil has been withdrawn from world markets due to sanctions, the bigger issue is the fear that either more aggressive sanctions or some unexpected actions from the war itself could lead to much larger losses of oil.
If the situation in Ukraine at least stabilizes, then some of the speculative fears will ease, presumably leading to a drop in world oil prices. A cease fire would be an even better story, but this would require Russia and Ukraine both accepting that major military gains are unlikely given the balance of forces. It’s not clear that either side is near this view at present.
World oil production is increasing at a modest pace, and with the world economy slowing, this should put some downward pressure on prices in the months ahead, barring major new developments with the Ukraine war. That could mean that oil and gas prices drift downward, albeit from very high levels.
There is a similar story with food prices, with the price of wheat and other grains soaring following the Russian invasion of Ukraine. Here also, a cease fire, or at least an arrangement to allow Ukrainian grain to reach world markets, could make a big difference.
There is at least some good news with some of the food items that had seen sharp price increases earlier in the recovery. The price of beef fell 0.7 percent in May, after falling 0.9 percent in April. One of the explanations given for high beef prices was soaring shipping costs and shortages of trucks and drivers. As these pressure points ease, we can expect some reversal of recent price hikes. (This is not happening with milk prices, which rose 2.8 percent in May, and are up 15.9 percent over the last year.)
The Mixed Picture in the Core
Some of the bad news in the core was expected, but some was a surprise, at least to me. Tops in the expected category were the 0.6 percent rises in rent and owners’ equivalent rent, bringing their year-over-year increases to 5.2 percent and 5.1 percent, respectively. Rental inflation had been picking up, driven in part by much sharper increases in home sale prices. Also, indexes measuring market rents (units that change hands) had been increasing much faster than the CPI rent measures.
This is likely to be a peak monthly rate as the inflation rates shown in the market rent measures have slowed. Also, the jump in mortgage rates has led to a quick turn in the housing market. The number of purchase mortgage applications is now running about 15 percent below year-ago levels. This is likely to mean that many families that would have moved up to larger units, or bought second homes, will instead stay where they are, freeing up space for other buyers or renters.
Also, we are likely to see a sharp uptick in the rate of housing completions, which will increase supply. While starts have risen from a 1.3 million annual rate before the pandemic to 1.8 million in recent months, completions remain near 1.3 million. This presumably reflects supply chain issues that are now being resolved. As one measure, lumber prices are now less than half of the peaks hit in March.
At the top of the list of the unexpected bad news was the sharp increases in new and used vehicle prices. The major auto manufacturers have been saying that they have largely overcome the supply chain problems that sent prices soaring last year. Nonetheless, new vehicle prices rose 1.0 percent in May and are up 12.6 percent over the year.
Used vehicle prices, which actually had fallen the prior three months, rose 1.8 percent in May, bringing their increase over the last year to 16.1 percent. Together, new and used vehicles added 0.11 percentage points to the May inflation rate, and 0.14 percentage points to the core rate.
Another surprising increase in May, was the 0.7 percent rise in apparel prices. They are now up 5.0 percent over the last year. Apparel prices had fallen 0.8 percent in April, and many retailers were reporting gluts of some items, forcing sharp markdowns. These will presumably be reflected in the June CPI data.
On the positive side, appliances did show the sort of price decline that some of us have been expecting for a while. Appliance prices had been relatively stable before the pandemic, but rose sharply last year due to supply chain problems. The index fell by 0.7 percent in May after dropping 0.5 percent in April. Appliance prices are still up 6.4 percent year-over-year.
With many retailers now having excessive inventories, appliance pries may follow the same path as televisions. After rising sharply last year, television prices have been falling since September. They dropped 3.0 percent in May and are now down 9.5 percent year-over-year. If the price path for appliances, and other items that faced supply chain issues, follows the path of televisions, it will be a serious factor dampening inflation going forward.
There was also some good news with medical care services. Inflation in medical care services moderated to 0.4 percent in May, down from 0.6 percent in March and 0.5 percent in April. Half of this rise was due to a 2.0 percent jump in the index for health care insurance. This is good news both because the direction of change is downward, and also because medical care has a much larger weight in the Personal Consumption Expenditure deflator than in the PCE.
Are We Seeing a Wage-Price Spiral?
It’s pretty hard to be happy about the May CPI report. It’s bad news by almost any measure. It means lower real wages for workers and is another big piece of uncertainty in an economy shaking from both the pandemic and the war. But the big fear is whether we now destined for a wage-price spiral of the sort we saw in the 1970s, which the Fed might use a massive recession to rein in.
As I’ve been saying for close to a year, there are reasons for believing the high inflation we are now seeing is temporary. Yes, I obviously have been wrong so far and may be again. On the other hand, there were big non-economic factors that I hadn’t anticipated, like the delta variant, the omicron variant, and the war in Ukraine.
Anyhow, the positive news in this picture, which I am not altogether happy to say, is that we are not seeing the wage side of the wage-price spiral. Rather than accelerating to keep pace with inflation, wage growth has actually been slowing.
The annualized rates of growth in the average hourly wage comparing three-month periods (December 2021, January, February 2022) to (March-May 2022) was just 4.4 percent. That is down sharply from a peak annual rate of 6.1 percent in the period between August-October 2021 and November 2021-January 2022. This is going in the wrong direction for a wage-price spiral.
To be clear, it is not a good story that workers’ wages are falling so much behind inflation, but if the remedy for treating inflation is double-digit unemployment (the Volcker method) then it is probably better to have slower wage growth now. If it turns out that the factors driving inflation, and especially food and energy prices, are temporary, then wages can considerably outpace inflation, even at the current rate of wage growth, when these price increases are reversed.
Anyhow, I expect to see more price reversals soon, but that has been the case for a while. The buildup of inventories, reported both by the Commerce Department, and a topic of compliant in corporate profit calls, indicate that we will be seeing more price drops like what we have been seeing with televisions and appliances. The food and energy story will depend largely on the course of the war in Ukraine. But, I remain optimistic that the worst of inflation is behind us.
 The effect of changing composition should have done more to depress wage-growth last fall than this spring, since we were adding jobs at a far more rapid rate last fall.