June 2023 CPI: Large Base Effects Hide Underlying Dynamics

Summary

• June CPI surprised on the downside but added little to deflation trends.
• Headline YoY inflation at 3% reflects mainly base effects and a 17% YoY decline in energy prices.
• While core goods prices were flat for the third month in a row, structural changes underway in the US and globally suggest this is unlikely to last.
• Shelter inflation was virtually unchanged from April, in line with vacancies that remain near historical lows.
• Services ex shelter inflation slowed, but this reflects short-term volatility rather than a trend.

Market Implications

• The release is consistent with the Fed hiking twice more this year: once this month and once in November.

CPI Lower Than Expected

June MoM headline and core CPI were 0.2%, 10bp below expectations (Table 1).  

The slowdown in MoM core inflation came mainly from core services and used cars. Despite the slowdown in MoM inflation, annualized inflation remained high, with core services inflation excluding housing slowing only gradually (Chart 1). 

The Cleveland Fed April YoY median price CPI, which is a better measure of inflation trends than core when prices are volatile, was 6.4%. This is the same as July 2022 (Chart 2). YoY headline CPI was 3.1% due to a combination of falling energy prices and base effects, with energy goods and services prices falling by 17% YoY.

Core Goods Prices Flat, But Likely Not for Long

Excluding used car prices, June core goods prices were flat, for the third month in a row. I do not think this signals a return to the core goods deflation that preceded the pandemic for two reasons. First, the US economy is becoming less open: imports as a share of consumption have been falling, leaving consumer prices more driven by the PPI than import prices. At the same time, PPI inflation has been much greater than import price inflation, i.e., domestic producers are less efficient than global ones.

Second, global producers’ efficiency gains could be more limited going forward. Import price deflation had started to moderate well before the pandemic (Chart 3). This could reflect that the limits of globalization had been reached before the pandemic, as shown for instance by the decline in the ratio of trade to global GDP in the aftermath of the GFC (Chart 4).

Shelter Inflation Remains High

OER remained near 50bp MoM, in line with rental and owned home vacancies that remain close to historical lows. In addition, rental indices such as Zillow or apartment list have been rising.

Slower Services Inflation ex Shelter Reflects Short-Term Volatility

June core services ex shelter prices were flat against a MoM increase of 24bp in May (Chart 6).  June flat prices reflected in part a 3.6% MoM decline in health insurance, which in turn reflects CPI accounting conventions rather than actual cost decreases. As a result, medical services prices were flat. Excluding insurance, medical care was up 29bp MoM. 

In addition, education and communication services prices were down 27bp MoM on the back of a 1.5% MoM decline in wireless telephone services.

Transportation services inflation increased by 0.1% MoM, which partly reflected an 8.1% MoM decline in airline prices.

Market Consequences

The data is consistent with a Fed hike this month.  

Longer term, the data does not give a clear enough disinflation signal for the Fed to abandon its plans for a second rate hike in this year, which I expect in November.

Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed, the IMF, and the World Bank. She joined Macro Hive soon after its inception.

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