Changes are getting embellished by the relatively low-price level from 2020 when the economy struggled, making recent growth rates appear outsized.
>> Quick takes:
- Inflation remains elevated
- Uncertainty causing worry
- How high and for how long?
- Consumers unfazed
- CRE poised to capitalize on concerns
Inflation readings for June, released last week, once again showed rates unseen in decades, across several indexes and subindexes. Those readings stirred concern and uncertainty among many over rising prices and their potential impact. While an issue like accelerating inflation always proves partly subjective, some of the problem arises from ambiguity over the meanings of some of the terms being thrown around and what they represent. To help frame our view, we discuss the situation in the context of these terms.
Price level — typically, the average of prices during a particular period across a range of goods and services. This is sometimes defined broadly, sometimes narrowly, across various indexes and subindexes. The price level should reflect prices consumers are paying. Undoubtedly, the price level has risen recently, and some consumers are clearly feeling this change.
Inflation — the general rise in the price level of the economy over some period, which erodes purchasing power. But the specific cause of concern is really the inflation rate, the percentage change in the price level (as represented by an index) over some period. In the June data, inflation on a month-over-month basis grew by about 1% for the headline consumer price index (CPI), the core CPI, the headline producer price index (PPI), the core PPI, and the import price index. On a year-over-year basis, the headline CPI increased 5.4%, the core CPI increased 4.5%, the headline PPI increased 7.3%, the core PPI increased 5.6%.
That raises the question, how concerning are these figures? Both the monthly and the annual changes are getting embellished by the relatively low-price level from 2020 when the economy struggled, particularly during the second quarter when the inflation rate declined considerably. That makes recent growth rates appear outsized. But a deeper perspective helps here. To understand this, let’s focus on headline CPI. The CAGR for headline CPI from June 2019 to June 2021 comes to about 3%. That clearly sits above the Fed’s target range of about 2%, but not in a panic-worthy way. Moreover, the headline CPI is a more volatile index than the tamer core CPI — roughly twice as volatile since the financial crisis. A headline index like CPI often overstates underlying inflation. Less-volatile core indexes enable more sound decision-making because they provide insight into the true underlying inflation rate, shorn of volatile and often misleading components like food and energy.
Moreover, in many respects, CPI does not accurately convey consumers’ economic reality — a key reason why the Fed prefers to use the personal consumption expenditures (PCE) index, which is also rising, but at a slower rate. Finally, stripping out just a few key items, such as the ongoing surge in used-car prices, makes the figures look even more reasonable. n short, headline CPI appears to overstate the current rate of inflation. In short, headline CPI appears to overstate the current rate of inflation.
In short, headline CPI appears to overstate the current rate of inflation.
That brings us to the last word in our partial glossary: Transitory — not permanent. But that definition leaves much room for interpretation. We have intentionally avoided using that word for just that reason. By that definition, almost any level of inflation should ultimately prove transitory. But people get hung up on this word. Rather than define a reasonable interval for “transitory,” we would simply reiterate our view that temporary factors are driving inflation higher — the release of pent-up demand, supply bottlenecks, dovish monetary policy, and robust debt-financed fiscal policy. None of those appears durable, beyond any reasonable definition of “not permanent.” Consequently, we do not see recent readings of inflation rates as sustainable. But we continue to emphasize that inflation should ultimately settle down at a level above the incredibly low inflationary readings from the last business cycle.
What about consumers?
First, related to our discussion above on inflation, data from the BLS showed that real wages (net of inflation) for June declined by 50 basis points (bps), meaning that wage growth is failing to keep pace with inflation (or at least one measure of inflation). That matters because anyone looking for evidence of a classic wage-price spiral which would propel inflation for a period beyond “transitory” will not yet find it in the wage data. Second, related to the first point, despite rising prices, nominal retail sales outperformed expectations in June — growing at a brisk rate when consensus expected a decline. Why? At least partly because consumers are shifting their spending patterns as the economy more fully reopens. Not only are they shifting away from some expensive goods to cheaper goods, but also shifting away from goods toward services.
| What we are watching this week |
Initial jobless claims should continue their downward trend. Housing starts and building permits for June both likely increased a bit. Existing home sales for June likely remained relatively unchanged in June, with risk to the upside.
| What it means for CRE |
We emphatically reiterate that commercial real estate (CRE) should capitalize on concerns over inflation, whether those concerns appear warranted or not. But CRE should avoid taking a predatory stance and focus on its merits. CRE offers a good, if imperfect, inflation hedge and offers relative value that other major inflation-hedging asset classes do not, namely attractive (and often rising) cash flows. That could give CRE an important role in diversified, multi-asset-class portfolios, even if inflation ultimately abates as we anticipate.
That could give CRE an important role in diversified, multi-asset-class portfolios, even if inflation ultimately abates as we anticipate.
Ongoing strength in retail sales continue to support our relatively positive view for retail centers. While the sector continues to undergo meaningful evolution, the death of retail remains greatly exaggerated. Centers that can capitalize on both the return of goods consumption and services consumption should fare well heading into the sector’s recovery phase.