The Big Idea
Inflation road trip
Stephen Stanley | 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.
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
Exhibit 2: CPI for Hotels
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.”
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
Exhibit 4: CPI for Used Motor Vehicles
Exhibit 5: CPI for Motor Vehicle Insurance
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.
You have to have cool clothes to wear when you get to your destination (Exhibit 6).
Exhibit 6: CPI for Apparel
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.
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
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%.
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.