On My Mind: Just a Flesh Wound?

Prices continue to climb, with the US CPI rising in June by the most since 2008. Financial markets seem to be unfazed, but businesses and consumers appear considerably less sanguine. In her latest “On My Mind,” our Fixed Income CIO Sonal Desai discusses why inflation may be less “transitory” than many expect.

US Consumer Price Index (CPI) inflation jumped to a new high of 5.4% year-over-year (y/y) in June. This comes after a 5.0% rise in May and a 4.2% rise in April. Yet the US Federal Reserve (Fed), many investors and a number of economists still act unimpressed. They shrug and say, “it’s nothing, it will pass soon.” It’s beginning to remind me of the scene in Monty Python’s Holy Grail where the Black Knight, being hacked to pieces, insists “it is but a scratch, it’s just a flesh wound.” Those who claim inflation is no cause for concern are quick to point out the outliers: used car prices and gasoline prices were both up 45% y/y in June. They are outliers; but people do have to drive and new cars are hard to find these days, so these outliers hurt.

A quick look at Table 1 of the June US CPI release shows that significant y/y price increases were not limited to one or two items: transportation services were up 10%, car insurance 11%, apparel 5%, commodities other than food and energy close to 9%, and food away from home over 4%. Quite a few “flesh wounds.”1
I do not worry about 1970s-style runaway inflation. But investment strategy is mostly about understanding and assessing risk; and in a situation where markets and the Fed appear convinced that inflation will soon drop back under 2% by itself, with no need for policy action, the risks seem very much skewed to one side—namely that we might be underestimating inflation.

In assessing this risk, there are two factors worth considering, in my view.