On Tuesday, the government reported that the headline consumer price inflation rate for August was near zero, 0.1%, on a month-on-month basis. But don’t be fooled into believing that the inflation fight is nearing its end.
The headline report was largely influenced by the fall in gasoline prices over the course of the month. According to the AAA, at the beginning of August, the average price of gasoline across the country was around $4.21 a gallon. At the end of August, gas prices averaged about $3.80 a gallon. Thus, in August, gasoline prices were down about 8%. As all drivers know, gasoline prices are volatile; moves up and down are transitory.
Two components of inflation that are not transitory are wages and the cost of shelter. Those two inputs to inflation remain very elevated and show no signs of rolling over any time soon. Shelter accounts for about 32% of overall consumer price inflation. It’s important, a lot more than most people realize.
The Federal Reserve Bank of Dallas forecasts housing and rental inflation. Economists for the bank explain that rising house prices have pushed up rent and owners’ equivalent rent, or OER, (OER being what it would cost a homeowner to rent his or her residence). The Dallas Fed explains that OER and the cost of rent for non-owners are the most important components of the consumer price index and the personal consumption expenditures price index. The bank says that OER will continue to rise from the current 6% or so to a projected peak of almost 8% in May 2023. Similarly, rent inflation is expected to increase from around 6% to 8.4% in May 2023.
By itself, shelter inflation makes it highly probable that, over the next eight months, overall consumer price inflation will remain above 3%. The other input to inflation that will remain very elevated is wage inflation. When wage growth outstrips secular productivity growth, inflation follows. According to the Federal Reserve Bank of Atlanta, national wage inflation is running up almost 7%.
Professors of economics often aligned with the Democratic Party, such as Jason Furman, opine that the Federal Reserve must continue to raise the Federal Reserve funds rate to a level that will cause significant slack in the labor market, in plain words, a much higher unemployment rate. The professors note in separate papers that wage growth remains too strong. And they explain that elevated wage growth is consistent with an underlying core inflation rate of around 4%, well above the Federal Reserve’s target.
Equally notable, professor Larry Summers and his colleague Alex Domash suggest that the combination of 8% inflation and unemployment below 4% makes the probability of a recession occurring within the next 12-24 months very high, around 70%.
Top line: The market is too optimistic about inflation and future Federal Reserve interest rate tightening. Inflation is strongly embedded at 4% plus. Unemployment must rise significantly in order to reduce wage inflation. Moreover, higher interest rates will flow through to the residential housing sector, causing a negative cascade effect on the overall economy. Federal Reserve Chairman Jerome Powell, at his Jackson Hole speech, said economic pain was coming; he wasn’t kidding.
Democrats love the sugar high of helicopter drops of money on the economy. They don’t like the “calories” — the pain of inflation that follows. The August CPI was a head fake. I continue to anticipate economic pain over the next several months.
Don’t be fooled; the economy in 2023 won’t be pretty.
James Rogan is a former foreign service officer who later worked in finance and law for 30 years. He writes a daily note on finance and the economy, politics, sociology, and criminal justice.
