Uncategorized

Inflation road trip

| May 14, 2021

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Like kids on a summer road trip, the market will likely have a familiar question over the next few months about inflation: “Are we there yet?”  In this case, the question is whether the “transitory” jump in prices seen in the shocking April CPI brings prices of key sectors affected by pandemic back to normal or whether there is more to come. With the notable exception of used vehicles, the answer to the question is, as it always is on the road trip, “No, but we’re getting closer.”

Defining our destination

Before we can ask “Are we there yet?,” we have to define “there.” It seems reasonable to define normal as getting back to the pre-pandemic trend.  For categories that were running flattish on a trend basis, that means getting back to the pre-pandemic level. For line items that were on an upward trend, it means getting back to a trend line, extended through the pandemic period.

Travel industry

Appropriately, we will start with the travel industry.  This summer looks likely to be a crazy one for the sector, as families will be looking to book trips and vacations that have been postponed over the past 14 months.  As airlines bring planes and pilots back into service and beef up their routes, it remains to be seen whether demand will outstrip supply. But it seems likely that it will, making planes full and flight tickets tough to come by and expensive.  Similarly, hotel rooms in popular vacation spots are likely to be hot tickets. This dynamic began already in April as the CPI reported a 10.2% spike in airfares and an 8.8% jump in hotel rates.  However, the price level for each remains well below pre-pandemic levels (Exhibit 1, Exhibit 2).

Exhibit 1: CPI for airfares

Source: BLS.

Exhibit 2: CPI for Hotels

Source: BLS.

In both cases, even after the April spike, prices remain well below the pre-pandemic levels.  In fact, airfares in April were 17% below the April 2019 reading while hotel rates were over 9% below the April 2019 level.  So, the answer to our question for the travel industry might be an old favorite: “We’re two miles from halfway.”

Motor Vehicles

Again, consistent with the theme, we move on to the auto industry.  Here, the answer is mixed, depending on the category (Exhibit 3, Exhibit 4, Exhibit 5).

Exhibit 3: CPI for New Motor Vehicles

Source: BLS.

Exhibit 4: CPI for Used Motor Vehicles

Source: BLS.

Exhibit 5: CPI for Motor Vehicle Insurance

Source: BLS.

Starting with new autos, it was important to try to match the scale to the other charts, because the reality is that new vehicle prices have not moved by very much, either before or after the pandemic began.  One might say that we are “there” for this category.  However, we are likely poised for a substantial overshoot.  The supply disruptions that are plaguing automakers are probably going to lead to a noticeable jump in prices, as extremely tight inventories are going to result in little or no discounting until production can ramp back up.

Used motor vehicles are clearly the one category where prices have already overshot.  After the 10% surge in April, used motor vehicle prices were up by 21% over the past 12 months and 20% over the last two years combined.  However, while we may have already overshot our ultimate destination, we are probably nowhere near peaking.  The wholesale auction price gauge that tends to lead the CPI measure by a few months has spiked by 52% over the past 12 months, including nearly 20% since the beginning of 2021.  With the supply of new vehicles constrained, the used market is likely to remain hot for a while.

Motor vehicle insurance rates sank during the lockdowns last year, as many carriers chose to offer rebates to their customers, who were not driving as much and therefore not generating as many claims.  Prices have recovered significantly so far in 2021, as drivers are getting back to their normal habits.  Although it might be difficult to tell from the trend line, motor vehicle insurance had been rising at 2% to 3% per year in the period just before the pandemic.  The April 2021 reading was basically flat against the February 2020 reading, which means that we are almost there, but perhaps just a few more miles to travel.

Clothing

You have to have cool clothes to wear when you get to your destination (Exhibit 6).

Exhibit 6: CPI for Apparel

Source: BLS.

Apparel prices have been trending down for a long time but dropped sharply during the pandemic, as the need for new clothes was dampened by the fact that adults were working and children were learning from home.  Extrapolating the pre-pandemic pace of declines of around 0.5% a year, apparel prices probably need to rise by something like 3% to 4% to get back to the pre-pandemic trend.

Entertainment

Finally, we need fun things to do once we get to our vacation destination.  The “other recreation services” category of the CPI includes admissions to sporting events, concerts and amusement parks, among other items (Exhibit 7).

Exhibit 7: CPI for other recreation services

Source: BLS.

This line item was rising at roughly a 2.5% annual clip prior to the pandemic and has been roughly flat since February 2020.  Thus, as with apparel, we are not terribly far from our destination but have at least a few more miles to travel, perhaps another 3% to 4%.

Conclusion

These items are not the only possible sources of inflation going forward, but they do represent the majority of the transitory forces likely to push inflation higher in the short term as the economy reopens.  Based on a quick analysis of the levels of these seven categories, it appears that, with the exception of used motor vehicles, they have not fully recovered to pre-pandemic trends.  Moreover, in all seven cases, we probably have further price increases to go before we get to the end of our transitory period of unusually firm inflation.  Even though the April CPI rise was shockingly large, there will likely be additional firm readings as the economy continues to reopen.  Fed officials have stressed the temporary nature of the price increases, but it is unclear how much tolerance market participants will have to further acceleration in inflation, even if it is likely to prove mostly temporary.

admin
john.killian@santander.us
1 (646) 776-7714

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2023 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.

The Library

Search Articles