US Inflation Preview: CPI is set to reaccelerate as tailwinds fade

Thursday night will mark another high-stakes US CPI print and the market anticipates a re-acceleration in inflation data as beneficial base effects from last year begin to roll off.

Economists expect a rise in inflation 

Consensus expects headline inflation to rise to 3.3% year-on-year in July from 3.0% in June, which would mark the first year-on-year rise since June 2022. Core inflation is expected to remain unchanged at 4.8% year-on-year. Risks are potentially skewed towards the upside following the recent spike in oil and gasoline prices. 

The Cleveland Fed’s Nowcast is guiding towards a hotter-than-expected print of:

• Headline of 3.42%

• Core of 4.92%

• Month-on-month of about 0.4% for both headline and core

Source: Cleveland Fed’s Nowcast

What is the base effect?

By definition, inflation measures current price levels against price levels a year ago. It’s simple but often lacks context, especially if the point chosen for comparison is abnormally high or low. And that’s what we’re seeing right now.

US inflation hit a peak of 9.1% in June 2022, the highest level in about 40 years. 

As June 2023 comes around, we’re then comparing prices against elevated prices from a year ago. This implies that inflation has come down dramatically when instead, it’s just a reflection of the base effect.

What happens from here?

The month-on-month print becomes more important as tailwind base effects come to an end. 

The below table from Bespoke Investment Group shows a number of inflation scenarios based on month-on-month prints between 0.0% and 0.8%. It suggests we need to see month-on-month prints of 0.2% or lower to achieve the desired 2-3% inflation range.

Under a constant 0.2% scenario, headline inflation will re-accelerate to 4.04% by December 2023 and ease to 2.92% by March 2024.

Month-on-month inflation projections (Source: Bespoke Investment Group)

Inflation headwinds and tailwinds

Disinflation momentum: Used-car prices, shelter

User cars: The Manheim Used Vehicle Value Index is more than 11% from its peak in March, while the CPI’s Used Car component is only down 5% from its recent peak. The Index typically leads by approximately two months, which suggests more cooling in this component, according to Liz Young, Head of Investment Strategy at SoFi.

Shelter: Shelter accounted for more than 70% of headline inflation in June. The San Francisco Fed said “our baseline forecast suggests that year-over-year shelter inflation will continue to slow through late 2024 and may even turn negative by mid-2024 ... the most severe contraction in shelter ... since the Global Financial Crisis.”

Year-on-year shelter inflation forecast (Source: SF Fed)

Inflation expectations: Back in 2019, Powell said that the most important driver of actual inflation was inflation expectations. US consumer inflation expectations for the year ahead fell for a third consecutive month to 3.8% in June, the lowest level since April 2021. 

Source: TradingEconomics

Upside risks to inflation: Oil prices, PMIs

Oil resurgence: WTI crude is up more than 20% from its late June low and marked its sixth consecutive weekly rise last week. At the same time, average US gasoline prices are up around 35% from December lows to levels not seen since October 2022.

WTI crude price chart (Source: TradingView) 

Sticky prices: The Global PMI survey’s selling price index – which covers prices charged for both goods and services in all major developed and emerging markets – was 53.6 in July, down almost 10 points from the survey high of 63.5 in April 2022 but higher than the reading of 53.4 in June. 

“The monthly rise in the index between June and July of this year therefore indicates that the rate of inflation accelerated slightly,” notes S&P Global. 

“While it is always unwise to read too much into one month's data, the latest rise follows a mere 1.6 point fall in the index over the first half of 2023. That compares with a 4.6 point decline in the second half of 2022. In short, the speed of inflation's descent has slowed, and may even have stuck around the 4% level globally relative to a pre-pandemic decade average of 2.7%.”

S&P 500 on inflation days

Inflation days are generally pretty positive for markets, provided they are cooler-than-expected or at least in-line with expectations. Does the music stop as base effects end?