Key Takeaways
- Despite high inflation expectations, price pressures have steadily cooled, with May’s CPI at just 2.4%. This suggests public sentiment may be overreacting to tariff headlines.
- Deflationary signals from China, declining oil prices and a slowdown in housing cost inflation indicate a balanced environment that supports a Goldilocks scenario of stable prices rather than runaway inflation.
- While tariffs present headline risks, investors should consider broader disinflationary forces, calibrating investment strategies around a thesis of generalized price moderation.
The tariff saga is front and center in the public’s future inflation perceptions, but should it hold such importance? When Donald Trump was elected in November, respondents to the University of Michigan’s Consumer Sentiment Survey anticipated 2.6% consumer price inflation over the proximate year, roughly in line with that month’s Consumer Price Index (CPI) inflation rate of 2.7%.
Expectations have leapt higher. Last month’s Michigan survey had a new estimate: 6.6%, akin to responses last seen in 1978, when inflation was ripping through Jimmy Carter’s presidency. It’s a bold estimate when considering the 2.4% CPI rate reported by the Bureau of Labor Statistics (BLS) in May.
A Goldilocks scenario, where inflation is “just right,” may be a more apt forecast.
As evidence, consider this: the public’s inflation fears have ratcheted higher even though the inflation rate itself went the other way. After reaching a nearby peak of 3.0% in January, annual U.S. CPI faded to 2.8% in February, 2.4% in March and 2.3% in April before settling at 2.4% with the latest print.
The public is justifiably frightened; Wal-Mart and other retailers have been all over the news amid the tariff coverage. But lost in the shuffle were some critical data points that are printing red ink. For example, the 0.7% monthly decline in the U.S. producer price index for final demand services marked the sharpest monthly fall in data back to 2009.
I will not minimize the hit of 10% tariffs on consumers’ wallets, with an extra 20% “fentanyl levy” on China. But China just printed a 3.3% year-over-year decline in factory gate prices. That deflation is loaded onto 40-foot containers, just as it has been since China’s December 2001 World Trade Organization accession.
You can see it in that country’s bond yields too; the 30-year sovereign was paying more than 4% as recently as 2018 and has since fallen by more than half. That is helpful for a Goldilocks inflation thesis because it partially offsets the unnerving interest rate increases that have unfolded in the long-term bonds of the U.S., Germany, Japan and other major economies.
As always, an inflation key lies in U.S. housing. The S&P CoreLogic Case-Shiller 20-City Home Price just declined 0.1% over the prior month, though it popped 4.1% higher over the year.
My WisdomTree colleague Jeremy Schwartz’s research indicates the BLS immensely underestimated home price and rent inflation during Covid, so now the calculation is catching up. His real-life inflation gauge, which uses other sources for what’s going on with homes and apartments, puts year-over-year inflation at just 1.6% now.
A case in point: according to the BLS, rents were up 4.0% over the last year. But were they? Zillow says average rent is $2,100, down $20 from last year. A competitor, Apartment List, calculated a median of $1,398 in their June National Rent Report, down from $1,406 last year.
If retailers’ goods prices are in sticker shock but the landlord gives the tenant a pass on a rent hike this year, I think that fits the billing for a Goldilocks inflation scenario.
A pain point has been utilities; piped gas saw an annual jump of 15.3% in the last CPI report, though electricity was up “only” 4.5%. However, unleaded gasoline’s weight in the CPI is equal to those two household expenditures combined. According to AAA, the national average regular unleaded gasoline price is $3.12, down 32 cents in the last 12 months. A partial explanation: West Texas Intermediate crude oil kissed $80 in January but has been ground down to $68.
Milton Friedman observed that “inflation is always and everywhere a monetary phenomenon.”
Unfortunately, U.S. M2 money supply ticked up to 4.4% this spring. M2 was 3.6% in Europe and 8.0% in China, both a bit higher than their Q1 growth rates. However, each of the three economic blocs’ money growth is lower than the norm since China’s 2001 WTO entry. Adding Japan to the calculus, and that country’s 0.6% money supply growth in the year to May is as slow as the last deep plunge in the series 19 years ago. None of this screams “runaway inflation.”
For sure, this summer will witness rolling tariff news. Logic says to pay attention to trade negotiations, respect shock risks and study intently, but don’t do so in a vacuum. The public is answering inflation surveys like it’s 1978, when in fact we might be right in the middle of a not-too-high, not-too-low sweet spot.
A Goldilocks inflation moment, tariffs and all.
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