Inflation Peaking – The Page 8 Story

“The only thing that was transitory was the use of the word transitory” was how Jeff Gundlach, mincing no words, described the Federal Reserve’s handling of inflation recently. Gundlach, the CEO of DoubleLine Capital, is often referred to as the “Bond King” so his words tend to carry weight.

It’s no secret – inflation’s been bad and getting worse, increasing with every monthly report since August. In March 2020, the month the pandemic began, inflation was 1.5% – it’s currently at 8.6%, the highest level since 1980.

Things feel bleak. But there’s reason to believe we may be through the worst of it.

Peter Lynch (of Fidelity investing fame) often said he was more interested in the stories on Page 8 of the business section rather than Page 1 because the stories on Page 1 were already reflected in the price. Inflation is without a doubt, a Page 1 story.

When the most recent inflation report came out for May, Google searches for the word “inflation” hit an all-time high, with a history dating back to 2004.

With that as context, it’s hard not to feel like inflation “is in the price” if only anecdotally.

But as we look out into the world for tangible evidence, inflation may be peaking, there are some visible signs including:

Mortgage Rates

A 30-year mortgage rate is now 5.8%, the highest level since August 2009, and up from 2.7% last August. That’s a pretty remarkable jump over a short period.

In an earnings announcement this week, Lennar - one of the largest homebuilders in the country - mentioned:

“The weight of a rapid doubling of interest rates over the past six months, together with accelerated price appreciation, began to drive buyers in many markets to pause and reconsider. We began to see these effects after quarter end."

Housing costs have been a key inflation driver as home prices have been increasing at their fastest rates in more than 20 years. While home price appreciation continues to climb, the pace of growth has slowed in five consecutive months, a possible indication that increasing costs could cool off the housing market.

Used Car & Trucks Prices

The price of used cars and trucks has soared behind a shortage in semiconductors making it difficult to make new cars. Used cars and trucks have been the fastest growing segment of the inflation index for four consecutive months with growth rates ranging from 35 to 45% versus last year.

However, in consecutive months the rate of growth has slowed, similar to housing prices. Two months ago, the price of a used car was up 45% versus last year; that number is now down to “only” 25%, so again, the pace of growth is slowing.

The month-over-month numbers have also declined in two consecutive months, showing some signs the excessive used car pricing could finally be cracking.

Congestion Easing at West Coast Ports

Roughly 40% of the imported goods enter this country through the Ports of Long Beach and Los Angeles. For the better part of two years, prices of containers from China to Southern California spiked higher; pre-pandemic it cost roughly $1,700 to ship a container and that price increased to more than $10,000 last fall.

But the good news is major backlogs at those ports are finally thawing. Container shipping costs are falling and the number of ships waiting to unload has dropped considerably, which are both potentially good news for inflation.

Flexible vs. Sticky Inflation

Not all inflation is the same. The Atlanta Federal Reserve breaks inflation into two categories: sticky and flexible.

As the name implies, sticky inflation refers to a set of items that change price slowly, things like motor vehicle fees, education, public transportation, and motor vehicle insurance. Flexible inflation includes items with prices that move more often – gas, food, clothes, and jewelry.

As you can see below, flexible inflation (the stuff that changes in price more rapidly) is the biggest perpetrator of inflation’s rise, up 20% versus last year.

While not scientific, if it can rise that rapidly it’s not impossible it could fall that rapidly either.

The Market itself is not Pricing in Higher Inflation for Longer

Markets are efficient and do a good job of reflecting future expectations. On the topic of inflation, the market is not predicting higher inflation over the long-term.

We can look at five and 10-year Treasuries compared to Treasury Inflation Protected Securities (TIPS) to get a better understanding of where the market stands on inflation. The five year and 10-year inflation outlook is 2.8% and 2.6%, respectively, significantly below the 8.6% inflation we have now.

Given some of these signals, there are reasons to believe inflation could be topping out.

Like anything, uncertainty remains – we can’t be completely confident things will improve at a desired pace. We know the path back to “normal” inflation won’t happen quickly but there are reasons to be optimistic it won’t spiral from here.

Inflation moderating is a Page 8 story that is hopefully moving up to Page 1.