Investment Strategy Brief:
August CPI Preview

Below is a transcript of this week’s video.

Hi, this is Mike Reynolds with Investment Strategy at Glenmede.

The August Consumer Price Index report is set for release this Wednesday, which is pretty important given it’s one of the last major data points to be seen before the FOMC meets for its September session. While there has been a general normalization in both headline and core CPI, which strips out the more volatile food and energy components, neither are quite at the Fed’s 2% target. What’s more, is that expectations for the August report point toward a reacceleration. In particular, the Cleveland Fed’s Inflation Nowcast is predicting a 0.8% month-over-month gain in headline inflation and a 0.4% reading for core.

To really get a good understanding of the latest inflation trends, it’s helpful to break things down a bit. Looking at the 3-month change in inflation helps to remove some of the base effects that are inherent with annual growth numbers and also gives a chance to see through more erratic month-to-month observations. As it stands now, there has already been a significant moderation in many parts of the CPI basket, from food, energy, goods and most services. Up to now, shelter has been the primary opposition to a more full-throated normalization. But all that tells us is where we’ve been, not necessarily where we’re going. To give more context, it’s important to walk through the outlook for each of these major categories of consumer prices.

To start, one of the biggest reasons many see an acceleration in inflation for August is the summer rally in crude oil prices. Unsurprisingly, there’s a very close correlation with crude oil prices and those ultimately observed at the pump by consumers. That could be something that starts to show up in the August CPI report.

On the other hand, offsetting this to some extent are food prices. Agricultural prices received by farmers continue to fall, which often starts to be observed in grocery stores with an approximate 6 month lag. So when looking at headline inflation, which includes both energy and food, there’s a bit of a push and pull.

For all other goods excluding food and energy, the outlook points to continued moderation. Supply chain snags appear to have mostly dissipated and supply/demand mismatches have made meaningful strides to working themselves out. Early indications seem to point to continued moderation for big ticket items like cars, but also for many others like apparel as well.

As mentioned before, shelter inflation has been one of the biggest holdouts so far. It’s expression in the CPI is a notorious laggard, but it may soon start to follow other, more timely indicators lower, such as Zillow’s Observed Rent Index.

However, services excluding shelter inflation has the potential to stay sticky. Part of the reason for that has been wage growth, which has remained high. One of the best ways to judge this is the Atlanta Fed’s Wage Tracker, which uses a methodology following wage gains specifically for those who remain in their jobs, excluding those that score a larger payday by jumping ship. This suggests that services inflation could have some more upside in the near-term.

Put all this together, and it remains unclear whether the inflation genie has been effectively placed back into the bottle. The Fed appears to be at the stage of fine tuning its policy. If inflation comes in below expectations while continuing to moderate closer to the 2% target, the market may become increasingly confident that the peak in rates has been reached. However, if inflation does reaccelerate as expected, it could push the Fed toward additional rate hikes at September’s meeting or perhaps beyond. But what matters most, is the Fed has had to raise rates significantly over the last year and a half, to the point where monetary policy is now on a tight footing, which has historically been a harbinger for impending recession.

So to summarize, the August CPI report will be a closely watched event, with some potential for a reacceleration in inflation due to rising energy prices and sticky wage growth. Offsetting those factors, to some degree are softening prices for food, core goods and the potential for shelter costs to turn the corner. The Fed may or may not hike again depending on the path of inflation, but in either case, the U.S. economy will likely have to reckon with the collateral damage that recession could bring.

Thanks for listening! And please don’t hesitate to reach out with any questions.

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