Is Inflation Peaking?

The most recent inflation data came in this morning, with the Consumer Price Index (CPI) up sharply again. The headline index was up by 1.2 percent for the month and by 8.5 percent for the year (a 40-year high). On the face of it, inflation is approaching a crisis. What if it keeps on rising?

That would indeed be an even bigger problem than the one we already see. Fortunately, though, there is reason to believe inflation is peaking. That’s not to say that prices will necessarily come down—although there are signs that is happening—but that the trends that have driven prices up so high and so fast are moderating and, in some cases, reversing. Let’s take a look at some details.

The Price of Energy

In this morning’s report, that 1.2 percent gain looks huge. But when you look at the data, on balance, it was caused by one thing: the price of energy. Gas prices were up by 18 percent last month, according to Capital Economics, which drove the energy component of CPI up by 11 percent. When accounting for the weighting of energy, it drove the CPI as a whole up by 1.2 percent. In brief, last month’s CPI pop was due to energy, specifically gasoline. Absent gas, inflation would have dropped sharply since last month and might even have been close to flat. With oil prices now trending down, at least some of that pop is likely to be reversed next month.

Core Inflation

When you look at the core inflation index, we also see inflation peaking. While the monthly increase of 0.3 percent was higher than we would have liked, it is down from a run of increases in the 0.5 percent to 0.6 percent range. This is an improvement. If we dig deeper, we can see why this is. With supply chains and product availability improving, goods inflation has dropped. Used vehicle prices, which have been a major driver of inflation so far, were down by 3.8 percent and, based on the most recent data, should keep dropping. With used car prices still 50 percent above pre-pandemic levels, this could become a significant drag on inflation going forward.

And it is not just about used cars. New car price gains slowed as well, and clothing price gains softened from prior months. Rent, another major component, also came in lower than in recent months. Based on all of this data, the peak in inflation is close, if not this month (which is likely) then in the next month or two. Things should at least stop getting worse and are likely to slowly improve.

The Expectations

Expectations are for inflation to peak shortly and end the year lower, at around 4 percent or so. This is still well above pre-pandemic levels, but much lower than where we are now. Surveys show business and consumers expect inflation to level out around 3 percent in 2023, which seems reasonable. It will be higher than it has been, between the effects on both energy and food from the Russian invasion, but as markets normalize the effects should moderate. We see these trends happening now, and they should continue.

What It Means for Investors

So, what does this mean for us? First, somewhat higher interest rates are here to stay, but perhaps not as high as are currently feared. While the Fed is currently all in on tightening policy, when inflation starts to roll over—and when rates get higher later in the year—that urgency will fade. Rates will still be higher, but the increase will be more limited than is now expected. As always, today’s problem will likely not be tomorrow’s problem.

As investors, of course, we will still have to deal with those higher rates. What to do? Next week (when I will be on vacation), we will hear from my colleagues on inflation and investments. Based on the topics so far, it should be a good week—and I am looking forward to it!