Inflation is continuing its strong run as U.S. CPI beat optimistic expectations for the third straight month. Headline CPI for June rose +5.4% year-over-year and +0.9% month-over-month, likewise core CPI printed +4.5% y/y and +0.9% m/m, also above expectations.
Though reopening-sensitive sectors continue to boost inflation at unprecedented rates in response to the march towards normalcy, sustainable components are also starting to strengthen, with shelter inflation seeing gains. Inflation pressures are broad-based.
A Mix of Old and New Drivers
Transitory factors not fading: Contrary to expectations, reopening-sensitive and transitory components continue to trend higher as airfares (+2.73% m/m), used cars (+10.5% m/m) and new cars and trucks (+1.97% m/m) contributed 68 bps to core CPI for June versus 46 bps for May, with the supply-demand imbalance seeming to be a stronger contributing factor.
Rent inflation about flat: Though shelter (+0.49% m/m) shifted higher, driven by out-of-town lodging (+6.95% m/m) that reflected pent-up summer travel demand, rent (+0.23% m/m) and owner’s-equivalent rent (OER) (+0.32% m/m) were little changed. However, as the eviction moratorium expires and labor markets continue to tighten, we expect rent inflation to start contributing strongly and provide support to core CPI.
Long-term rates were mostly muted but with a flatter curve, implying that investors are pulling forward the timing of Federal Reserve’s asset-purchase tapering and rates lift-off. The June FOMC meeting highlighted a shift in the Fed’s tone due to higher inflation. The recent report does nothing to abate that risk but rather may amplify the debate over the pace of tapering given persistent strength in inflation.
June’s strength on a month-over-month basis was again largely driven by transitory factors and reopening strength, in a pattern consistent with the current phase of business cycle, the effective vaccination effort and improving labor market. As we head into the second half of the year, strength in shelter prices is likely to provide support to core inflation measures.
We continue to favor breakeven inflation positioning as we see risk of a more persistent inflation outlook supportive of an attractive carry profile for Treasury Inflation Protected Securities (TIPS) and Inflation expectations.