Inflation is Getting Broader, Not Cooler
Jacob Hess
January 20, 2022
Inflation is 7%. You definitely don't say that every day. In fact, you probably haven't said it since the 1980's (assuming you could talk back then). The December CPI report capped off a year of volatile prices. In the second half of 2021, we saw a rapid increase in inflation caused by supply disruptions and surging demand. The latest report suggests those factors are persisting into 2022.
We got to this point thanks to gains in two particular subindexes: energy and vehicle commodities. Supply shortages in the energy and automotive industries were some of the first to crop up and made headlines over the summer. Both also suffered from the recession of demand during the pandemic which set back capacity utilization when economic activity resumed at a stronger pace. The initial thinking was that these shortages could be temporary since they could be resolved by supply ramping up. That resolution hasn't come.
Energy
Everyone has seen rising energy prices as they pass by gas stations in their car, and they feel the pain when their tank nears empty. The index for energy prices started its sharp rise in Q1 2021 reaching an annual gain of nearly 28% in May before flattening out shortly over the summer. The trend continued in October when Energy CPI recorded a 4.8% monthly increase. The index was just slightly off its high (made in November) in December after it registered its first monthly decline since April.
Retail gasoline prices have followed a similar trend but without the slight pause in May. In fact, the -2.6% monthly decline seen in December was the first of the year and that still left prices above the October 2021 peak and up over 52% annually. Crude oil prices in December averaged over 50% higher than a year before; however, they also retreated in the last month of the year, down -2.6% month-over-month. Some may point to the softness in energy CPI and commodities in December is a sign that shortages in the industry are easing, but there is still a long way down. Omicron has also complicated things and delayed any resolution here.
Transportation commodities
Vehicles were hard to find in 2021 due to a semiconductor shortage that led to a massive decline in car and truck production. Transport exports and inventories suffered in just about every country's economic reporting. In the US, monthly auto production reached its 3rd lowest point of all time in September at 84,300 units (only above April and May 2020 production) and was reported at 126,000 in November, more than -42% below its pre-pandemic level.
Since there is still a massive deficit in auto production, prices are still rising. The earliest gains in transportation commodities (less fuel) prices were bulky with monthly gains of 4.3%, 4.0%, and 5.6% from April to June driven by sharp gains in used car prices. The elevated used car prices bled over into other indexes, and 4/6 of the base indexes that make up the transportation commodities were up over 10% annually. The other two are up over 9% annually. There has yet to be a resolution to the surge in vehicle prices, but semiconductor companies have indicated that increased capacity should be here in 2022. Until then, prices could keep rising.
Broader Inflation
These categories were to blame for the initial CPI surge. The breadth in price growth wasn't really there over the summer of 2021 and lead to many (including the Fed) to believe that inflation would be largely transitory and could even be trending normally by the end of 2021. The opposite has happened. Supply disruptions leading to price increases spilled over into other industries and other subindexes of the CPI. Looking at the 210 base indexes that are reported in the CPI, an increasing amount surged past annual gains of 5% and 10%. In December, there were 95 indexes above 5% and 33 above 10%, both higher than any other month in 2021.
With the many increases over those 5% and 10% thresholds that came across different indexes, there weren't a comparable amount of decreases below those thresholds. Net increases minus decreases over those thresholds were positive in every month in 2021 except for September. Inflation is not cooling, and we enter 2022 with no clear signs that it should in Q2 2021.
The implications for the Federal Reserve are urgent. The resounding 7% at the end of 2021 means that they missed on their inflation forecasts. The latest median projections that the Fed made in December have the FOMC voting for 3 rate hikes in 2022 after tapering finishes in Q1 2022. If Chair Powell and members want to maintain credibility in the face of inflation, it seems that they will have to have a more hawkish response. Normalization at the speed of 4 or more rate hikes in a year would surely be aggressive in the current policy environment, but unusual inflation may well call for unusual policy.
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