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Inflation Sizzles

RFP
A year after inflation first started to accelerate in response to robust demand and supply chain problems, it is hitting a new pandemic high. The Consumer Price Index (CPI) surged 1.2% from February in March and 8.5% from a year ago. That marks the fastest annual rate since 1981.

Food and energy costs skyrocketed in response to the war in Ukraine and a global outbreak of the bird flu. Proteins - meat, poultry, fish and eggs - jumped 13.7% from a year ago, the seventh month in a row of double-digit gains. That is the longest and largest surge in protein prices since the late 1970s. The rise in food costs will get worse before it gets better and hits those who can afford it least the hardest, both at home and abroad. The war is exacerbating global hunger.

Energy prices jumped 32% from suppressed, year-ago levels. Prices at the gas pump skyrocketed nearly 50% from a year ago but have begun to slow. A record release of oil from the strategic oil reserve and new lockdowns in China are bringing down prices. The problem is that everything else is likely to continue to rise in price as supply chain disruptions worsen.

The core CPI (excluding food and energy) rose 0.3% from February in March and 6.5% from a year ago. That is the highest annual pace of core inflation since mid-1982. The month-to-month increase in the core marks a slight slowdown from the pace we saw earlier in the year.

Gains have spread from goods into services. Big-ticket items including new vehicles, furniture and sporting goods all continued to surge in price. Supply chain problems re-emerged, especially in the vehicle sector. Disruptions by truckers at the Canadian border, a closing of key plants in Ukraine, an earthquake which idled computer chip production in Japan and a new round of lockdowns in China all dampened production and the ability to fill backlogs.

The only major exception was used vehicles, which fell in price, but were still 35.3% higher than a year ago in March. The slowdown in used vehicle prices, which are still more than 50% above pre-crisis levels, will likely be temporary given ongoing supply problems in the new vehicle market. Dealers and the rental car companies are still strapped for inventories.

We were desperate to travel. Throughput at TSA checkpoints, walk-ins and reservations on OpenTable and hotel occupancies picked up. Airfares and rental cars were up more than 20% from year ago levels, while hotel rooms rates were up more than 30% from a year ago.

Weddings, which were delayed by the pandemic, are picking up. Many resorts and popular venues are already booked solid. Two of the four restaurants at a popular destination I recently attended were closed due to staffing shortages; the remaining two were forced to scale back their services to deal with staffing problems. Some restaurants have closed parts of the dining room and scaled back their hours to stay open despite staffing problems.

Pet services also picked up along with costs for financial services. Everything from vets to day care facilities has been swamped by the surge in pet adoptions that occurred during the pandemic. Sadly, some are being returned to shelters as they have proven more than families can juggle with children returning to school. Checking accounts and financial services are rising in price along with interest rates.

The rise in financial service costs represents yet another setback for lower and moderate income households, who tend to carry lower balances at banks and are now draining instead of building their savings accounts. Credit usage soared in February as inflation became more of a problem for those households. Home buyers scrambled to lock-in what they saw as the last in ultra low rates.

There was some moderation in the price of tickets to sporting events and theaters. Medical costs have also been slow to pick up in the wake of outbreaks. That could change over the course of the year. Many have read that as a moderation in the pace of inflation - it is too soon to tell, given the composition of the gains we are seeing.

Last but by no means least, rent and home ownership costs accelerated at the fastest pace since the early 2000s in March and are likely to get worse before they get better. It can take more than a year for a drop in apartment vacancies and rise in home values to show up in the CPI measures. That means much of the surge we saw in 2021 is still ahead of us.

Either supply shocks work themselves out or the Federal Reserve could be forced to hit the brakes and bring demand more in line with supply. The latter has proven to be the case. A half percent hike in rates at the May meeting is a foregone conclusion. The Fed is also expected to announce reductions to its mammoth balance sheet in May and will likely hike by another half percent in June. That would make the current credit tightening cycle even faster than we saw in 1994, when the Fed pushed for an intermeeting rate hike to cool what it feared was a surge in inflation.

Bottom Line
Inflation is rising and likely to remain too hot well into 2023. The Fed is behind the curve. Fed officials would like to get rates back above the 2% level by year-end and 3% in early 2023. Reductions in the balance sheet are expected to amplify rate hikes. Mortgage rates have already soared as the Fed has threatened to pull back on its purchases of mortgage backed securities. Bundle up. A chill is coming on the rate front.

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