Commentary Directory

All Eyes on Inflation

Jacob Hess
April 19, 2021

In the last two weeks, the Bureau of Labor Statistics (BLS) gave important updates on the price indexes, the Producer Price Index (PPI) and the Consumer Price Index (CPI) for the month of March. The releases are the latest insights into the fears of inflations that are on the minds of just about anyone participating in the economy. Both consumers and firms are ready to expand their spending (presuming the vaccination push is successful), and the anticipation of that expansion has already seen inflation expectations rise. The bond market has been the number one indicator of inflation expectations after an entire year of record low rates suppressed by monetary easing.


Treasury yields have been on the move over the last 6 months since November (around when the 2nd wave of the pandemic neared its worst). Near-term yields have remained muted as Biden's fiscal stimulus was passed, and the Federal Reserve continued to signal it would be dovish at least through the end of 2022 (hence the 1-year yield getting caught in the drop). The back end of the yield curve growth starts with the 2-year yield which has grown 14.3% which is modest compared to the 3-year yield, 5-year yield, and the 10-year yield which have run the most at 79.0%, 121.1%, and 80.7%. The market has clearly indicated where it sees inflation risks the most, over the next 3-5 years, and it even sees longer-term price growth higher than it did previously (30-year yield up 37.0%). Perhaps suggesting the extreme dovish footing of the Fed will be difficult to dislodge even in a boom.


The PPI release was first up with a monthly gain of 1.0% in March the 2nd highest since 2009 (the highest is two months ago in Jan 2021). The rise reflected rising input prices reported by firms in PMIs in early 2021 and supply shortages reported in various goods markets. Energy prices have been one of those rising input prices pushing PPI higher with three straight 5%+ monthly increases. While this category is ruled out of the often-cited core PPI, it's still a very real cost that firms deal with. Gas prices alone in March jumped 8.8% affecting any business that maintains vehicles. Besides energy prices (and food prices), core PPI grew 0.7% (also the 2nd highest reading since 2009).

Industrial materials saw some of the biggest gains. Machinery and vehicle wholesale prices grew 6.7%. Iron and steel prices grew 13.5%. Industrial chemicals prices grew 10.1%. Building materials continued their surge with a 10.5% increase in plywood prices (up 53.1% YoY), steel mill products grew 17.6%, and building paper and board grew 8.5%. These are just a few of many indexes that surged in March and are representative of the broad pressure being put on firms' margins at the moment. In the end, manufacturers have no choice but to press forward to resolve inventories unprepared for the surge in consumer spending.


The CPI release came in the next week keeping the inflation discussion on the table after strong PPI numbers caught the attention of many. The headline figure increased to 0.6% in March after an 0.4% jump in February. Most of the gains were energy-related with that index up 5.0% and core CPI up just 0.3%. The headline monthly gain of 0.6% doesn't seem like a large jump compared to historical data since 1947, about 1 standard deviation above the average of 0.28%. However, looking at more recent periods of muted inflation 2000-2021 and 2009-2021, the March gain is well above the mean + 1 standard deviation and just barely above the mean + 2 standard deviation respectively.

Some other monthly gains of note in the CPI:

  • Gasoline (all types) up 9.1% MoM.
  • Sporting goods down -1.3% MoM but up 4.8% YoY with restrictions relaxing.
  • Lodging away from home up 3.8% MoM but down -6.4% YoY.
  • Car and truck rentals up 11.7% MoM and up 31.2% YoY.
  • Airline fares only up 0.4% MoM and down -15.1% YoY. Might be an interesting index to track as a signal of consumers willing to spend.
  • Admissions (to events) up 2.6% MoM and down -4.0% YoY. Another possible signal of consumer hesitancy.

One question will continue to arise in inflation discussions: are the moves in inflation representative of a shift into a more inflationary period or will they be temporary and lead back to lower inflation? In a nominal sense, there is likely to be some sort of permanent shift to accepting more inflation in order to maintain what the Fed deems as "full employment." The FOMC has made this clear in the design of their new framework which indicates that they will look to "overshoot" the previous inflation target of 2.0%. Some might say that they've already done this successfully, after all, the headline CPI figure (including food and energy) was up 2.4% annually.

The caveat here is that the low PPI and CPI figures during the pandemic are distorting price data as numbers from the sharp reflation in 2021 are compared to the depressed 2020 numbers. TD Bank sees this statistical effect boosting YoY CPI at or above 3.0%. These numbers will stabilize in the latter part of 2021 and will give a better idea of what longer-term inflation might look like. The 30-year breakeven inflation rate based on the 30-year Treasury and TIPS read 2.23% at the beginning of April (before these releases) and seems like a sensible estimate of where things could be when the dust settles.

NOTE: Energy should not be ignored. The indexes measuring energy goods and services are often glossed over because they are exogenously determined and not considered in the statistics that the Fed uses to guide policy. However, they represent real costs that both producers and consumers will have to pay to consume things during an economic recovery. This is especially true for the summer where energy is used for fueling air conditioning, driving cars, flying planes, and much more. The more spenders have to spend on energy, the less they have to put towards sectors that have been suffering the most and are looking forward to savings turning into spending. Energy prices have cooled since they rose from about $36 in Nov 2020 to around $65 in March 2021, but demand in the summer (if not buoyed by supply) could cause them to heat up again. The effect this can have on dampening consumption is not negligible.