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Global Economic Research

Tame Expectations

Investors are getting more confident that inflation will remain modest.

Sometimes, small things can create big problems.  That is certainly true in the measurement of U.S. inflation, where a small handful of items are creating outsized movements.

With the U.S. economy roaring back to life, concerns about overheating have dominated our conversations with clients over the past several months.  We’ve characterized many of the price movements as transitory, but not everyone has accepted that explanation.  With a selection of products getting more expensive and labor in short supply, more persistent inflation is certainly possible.  As we explored this week, the Fed sees risks on this front to the upside.

A look at the most recent consumer price index (CPI) report offers reasons for calm.  Five categories, which account for just over 10% of the basket of goods and services considered in the CPI, accounted for two-thirds of the inflation recorded last month.  None of these prices are likely to continue upward at their recent pace.

Taking car rental rates as a case in point, fleets were reduced aggressively last year as travel shut down; rental companies rebuilt them cautiously as travel began to recover.  The result has been a significant imbalance between demand and supply, which has allowed rental companies to charge a premium.  Over time, car lots will be replenished; auto production has rebounded after chip shortages slowed assembly lines earlier this year.  This will limit future increases in rental rates.

Investors are recognizing the transitory nature of recent inflation readings.

Similar patterns will be seen elsewhere as supply responds.  As noted earlier, lumber provides an interesting precedent; scarce and expensive two months ago, board prices are now falling rapidly.  Not only is it unlikely that extraordinary price increases will be sustained, it is also possible that some trends will eventually be reversed.

Numerically, these isolated incidents are unlikely to have long-term consequences for the CPI.  But they do have the potential to affect our perceptions of inflation, which can have a strong influence on the evolution of actual inflation.  Fortunately, the most recent readings from financial markets show reduced inflation expectations; further, near-term readings are higher than those for longer terms, consistent with a thesis that current pressures will not last.

That may be cold comfort for vacationers needing vehicles this summer.  But for investors, having perspective on the inflation picture has cooled anxieties.

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Carl R. Tannenbaum

Executive Vice President and Chief Economist
Carl Tannenbaum is the Chief Economist for Northern Trust. In this role, he briefs clients and colleagues on the economy and business conditions, prepares the bank's official economic outlook and participates in forecast surveys. He is a member of Northern Trust's investment policy committee, its capital committee, and its asset/liability management committee.

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