To understand what’s happening with inflation at the moment, you have to dig a tiny bit.
For the past two months, the cost of living has been rising quickly. In May, the Consumer Price Index jumped 0.6 percent, faster than economists anticipated. It was the second largest monthly increase in more than a decade, just behind April’s 0.8 percent spike.
Some inflation hawks, such as Republican Sen. Rick Scott of Florida, have treated the latest numbers as confirmation that government spending on coronavirus relief is causing prices to spiral out of control. “Today’s CPI data again proves true what I have been warning about for months – inflation is rising and so are the prices of goods for Florida families,” he said in a release. “[T]he data clearly show that spending beyond our means has consequences.”
But beneath the big topline numbers, there’s a more a complicated and reassuring picture. It turns out that a large share of the inflation we’re now seeing is being driven by just a small handful of consumer-spending categories that have been affected by the pandemic, mostly related to transportation. More than half of last month’s increase in the CPI was due to the rising cost of new and used cars, auto rentals, and airline fares. Used vehicle prices, which jumped 7.3 percent in May after a 10 percent increase in April, were alone responsible for more than a third of the index’s overall jump.
Right now, the big question about inflation is whether the price rises that consumers are seeing now are just a transitory blip or the beginning of something more sustained and dangerous. Inflation doves have argued that the increases are probably just temporary, and have been largely fueled by problems with supply chains that have cropped up as the economy has awkwardly emerged from the pandemic, but which are sure to fade. The hawks believe that excessive government spending has created too much demand in the economy, which could create a self-fulfilling spiral of rising prices as businesses and consumers come to expect higher inflation in the future.
The fact that so much of last month’s price increases were concentrated in cars and travel suggests that at least a significant portion of what we’re seeing now really is temporary.
After all, it’s not a mystery why travel and auto purchases are getting more expensive at the moment. People have started to fly again, pushing up airline ticket prices, which cratered during the pandemic. The car market, meanwhile, has been beset by a complicated cascade of supply-chain problems, which have created a shortage of vehicles on dealer lots just as demand has spiked from consumers flush with stimulus cash and eager to take summer road trips. Thankfully, these are likely to be temporary issues. At some point, the cost of airline tickets will stabilize, and car production will get back to normal. Happy Honda Days will come again!
Even if you ignore cars and planes, inflation is still running somewhat higher than normal. Consider the core Consumer Price Index, which excludes volatile food and energy prices. If you take out vehicle purchases, car rentals, and airfares, it still rose at roughly a 4.3 percent annual rate, which is quick, though not exactly out of control by historical standards.
But investors also seem to be buying the idea that inflation will mostly be transitory. Traders mostly yawned off Thursday’s surprise numbers. Stocks rose a bit, suggesting that Wall Street doesn’t expect the Fed to intervene by raising interest rates earlier than anticipated. Meanwhile, Treasury yields fell a bit on Thursday. If markets were really worried about higher long-term inflation, you’d expect them to rise, since investors would demand higher interest rates to keep up with rising prices.
This, more or less, has been the story of the last few weeks. As the consumer price index has run hot and economics pundits have become increasingly vocal about the threat of inflation, actual traders with money on the line seem to have relaxed about it. After peaking at 1.69 percent in early May, the yield on the 10-year Treasury bond has gradually declined to around 1.47 percent. The 5- and 10-year break-even rates—market measures of how high investors expect inflation to rise—have also declined. The money guys simply don’t seem to think inflation numbers like the ones we saw on Thursday are much to worry about.
One theory floating around is that the bond market might not really reflect how worried investors are about inflation because of slightly obscure technical dynamics playing out underneath its surface. Most importantly, banks have been buying lots of Treasuries over the past year in order to satisfy some of their regulatory requirements, helping to keep prices high and yields low. But while that may be the case, it’s not clear why all that activity, which has been going on for a while, would suddenly be causing yields to fall now. The more likely explanation is that investors are looking under the hood of the inflation data, and just don’t see anything worth getting worked up about.