Recent U.S. inflation reports, including the latest Consumer Price Index (CPI) release, lend support to Federal Reserve officials’ statements that various factors unrelated to the business cycle have depressed inflation over the past several months, and that these factors should fade over time. Of note, shelter categories, which tend to be affected by economic slack, have firmed recently.
Moreover, the 15-percentage-point increase in tariffs just implemented across a range of Chinese imports should provide some support for prices on various retail goods over the next few months. However, the tariffs will also likely contribute to some near-term economic disruption, which we estimate could push real growth under trend. Overall, this may be a concerning development for the Fed, which, according to Vice Chair Richard Clarida’s comments in a recent speech, stands ready to cut rates if needed.
Core goods inflation falls into negative territory, but shelter holds firm
Diving into the details of the report, released on 10 May, core CPI (which excludes the more volatile food and energy categories) was again soft in April, but the softness was concentrated in core goods categories. Shelter inflation, which tends to be influenced by the business cycle – and is therefore a focus for the Fed – was again firm.
Core goods inflation, after reaching the strongest year-over-year pace since 2013 (+0.3%) in November, has once again fallen back into negative territory (-0.2% y/y). In fact, outright declines across used cars and retail goods categories contributed to the largest month-over-month decline in core goods prices (-0.34%) since 2003. For retail goods, the lagged effects of a stronger U.S. dollar are likely counteracting the inflationary impact of the 10% tariff hikes on Chinese imports in September of last year. However, over the coming months, the newly implemented tariff increase on various Chinese imported goods will likely provide support to these categories, which make up around 3.5% of the CPI basket. Indeed, inflation in household textiles, furniture, bedding, lamps, and cookware was noticeably weak in April, but these categories are included on the United States Trade Representative’s (USTR’s) list of Chinese imports subject to the additional 15% tariffs. As a result, they are likely to rebound in the months ahead.
Notably, prices across apparel categories also fell in April (-0.8%). Last month, the Bureau of Labor Statistics updated the underlying sample for apparel categories as a result of an initiative to incorporate “big data” into various pricing samples. This update likely contributed to the large decline in apparel prices for March, but should have been neutral in April. Nonetheless, apparel prices can be volatile and tend to mean-revert over time. As such, we expect apparel inflation will recover moving forward.
A key signal: Firmer rents and OER
The more important signals from this report came from firmer inflation in rents and owners’ equivalent rent (OER). Both of these categories are more highly correlated with the business cycle and labor market slack. Indeed, accelerating nominal wage inflation and lower economy-wide home vacancy rates are likely contributing to stronger price gains. We expect these trends to continue to support shelter inflation absent a more material deceleration in growth.
Bottom line? Inflationary trends have been a mixed bag lately. Factors that are unrelated to the economic cycle have contributed to depressing inflation, while shelter categories that are affected by economic slack have firmed. On net, this should be good news for the Fed. However, we suspect Fed officials aren’t resting easy yet. The newly implemented import tariffs, which should be a near-term support for inflation, will likely disrupt real economic activity and reduce real growth.
For more of PIMCO’s views on the complex drivers of inflation in the U.S. and globally, please visit our inflation page.
Tiffany Wilding is a PIMCO economist focusing on the U.S. and is a regular contributor to the PIMCO Blog.