Inflation – Persistent or Transitory?
One of the biggest financial news themes this year has been inflation. There is no question that price inflation is on the rise. Is it here to stay, or will recent increases be short-lived and transitory?
Each month, a US government agency called the Bureau of Labor Statistics (BLS) measures and publishes average prices for a basket of consumer goods and services. Increases in prices from one period to the next are what we call inflation. The most common measure of inflation is the Urban Consumer Price Index (CPI-u or CPI for short).
In April 2021, CPI increased 0.8% from the previous month. This may not be the highest increase ever, but it is one of the highest readings since 2008. For context, the month over month number is typically 0.1% or 0.2%.
Since the start of the pandemic, annualized CPI increased 4.2% to April 2021. Looking at the 10-year period leading up to the pandemic, the BLS inflation calculator shows that a $1.00 item in April 2010 inflated to $1.18 by April 2020. So, the 10 year average annual inflation prior to the was only about 1.7%. On the producer side, the Producer Price Index (PPI) grew 0.8% in May, and a record final demand increase of 6.6% over the past twelve months.
Former New York Federal Reserve (the Fed) President William Dudley said in a CNBC article that he believes inflation will be transitory. However, Dudley warned that persistent inflation could become a threat if the labor force becomes tight or constrained as more people return to work.
The Fed is comfortable with some inflation and has an annual inflation target of 2%. According to Fed committee members, “When households and businesses can reasonably expect inflation to remain low and stable, they are able to make sound decisions regarding saving, borrowing, and investment, which contributes to a well-functioning economy.”
Lumber, Copper, & Grains
As we mentioned previously, the number that gets the most attention is “headline inflation” CPI-u. However, CPI is comprised of sub-components like food items, building materials, services, energy, and more.
In the past year some components have notably experienced much larger price changes than others. For instance, average lumber prices inflated about 6.6% annually in the five years leading up to February 2020. During the pandemic year, lumber more than tripled, up 358% between April 2020 to April 2021.
Other building materials, like copper, essentially doubled from a five-year average -0.91% annually to 93% during the pandemic year. Food essentials wheat and corn both averaged less than 1.5% inflation annually over the past five-years. Both items shot up 42% and 111%, respectively during the pandemic year.
Domestic crude oil prices (West Texas Intermediate or WTI), were at $48.35 to end 2020. In June 2021, prices surpassed $72 per barrel. This represents more than a 48% increase so far in 2021. Fewer government regulations, free market supply/demand dynamics, and record production of domestic crude oil brought the average price per barrel to $39.30 during 2020.
The Impact of Higher Prices
Crude oil is refined for a wide variety of goods, including polyester & nylon clothing and materials, plastics, paints, cell phones & laptop parts, lotions & lubricants, pharmaceuticals, fertilizers and much more. More obvious uses include kerosene, diesel, and gasoline for airplanes, trucks, and cars.
Low crude oil prices translate into low gasoline prices for retail and commercial consumers. High crude prices push up prices of oil-derived goods and cause higher gasoline prices at the pump. Higher costs for goods and gasoline are inflationary for all consumers. However, lower-income households are especially hard hit as they must spend more of their budget to buy inflated goods, heat their homes, and fill their gas tanks to get to and from work.