U.S. Inflation: Gradual Recovery Feeding Through
The highly anticipated March 2021 U.S. CPI report printed very strong and, surprisingly, managed to surpass lofty expectations. Headline inflation rose 2.6% y/y and 0.6% m/m compared to the expected 2.5% and 0.5%. Likewise, Core CPI came in at +1.6% y/y and +0.3% m/m, above expectations of +1.5% and +0.2% respectively.
The narrative going into the release was for base effects to provide the boost for yearly numbers while the monthly changes would remain somewhat muted as the March – May 2020 deflationary data started to roll off. Though the report confirmed some of this narrative, a deeper analysis revealed evidence of some feed-through of the ongoing economic recovery. March inflation was more than just base effects.
Shelter normalizing: The worrisome weakness in the shelter sector seems to have finally bottomed and is starting to reflect a normalization trend. This report makes it back-to-back months of positive contribution in measures of rent (+0.2% m/m) and OER (+0.2% m/m). Looking forward, we expect the recent rebound and ongoing recovery in the labor sector to provide support.
Services firming up: COVID-sensitive services sectors such as hotels (+3.8% m/m), vehicle insurance (+3.3% m/m) and airfares (+0.4% m/m) are starting to strengthen as the rapid pace of vaccination activates reopening of the economy faster than previously anticipated. The potential normalization of consumer behavior as the population approaches herd immunity continues to offer upside.
Goods holding gains: The volatile goods inflation sector continues to hold onto gains, changing the weaker pre-COVID trend. In this report, all goods sectors were in positive territory, with the exception of apparel (-0.3% m/m) and education commodities (-1.7% m/m), which we expect to catch up to pent-up consumer demand and school reopening. Also, limited used car inventories on the back of rental fleet contraction should continue to support overall goods prices.
Conclusion: This report confirms some inflationary green shoots, a result of an economy reopening at a faster trajectory due to effective vaccine distribution. Core inflation showed broad-based strength in both services and goods sectors, accompanied by a firming in shelter that should provide sustainability to inflationary pressures in the medium to long term.
Investment Implications: We continue to maintain exposure to breakeven inflation expectations as recovering inflation dynamics, a patient Fed and an attractive Treasury Inflation Protected Securities (TIPS) carry profile offer strong tailwinds.