Is The Fed Getting Inflation Wrong?
Falling energy and electricity prices helped disinflation in headline CPI, which rose just 0.1% on the month, while stickiness in shelter, used cars and transportation services kept core inflation steady at 0.4%.
The May consumer price index (CPI) report showed inflation is continuing to decelerate, but stickiness in core components has kept enthusiasm at bay. Falling energy and electricity prices helped disinflation in headline CPI, which rose just 0.1% on the month, while stickiness in shelter, used cars and transportation services kept core inflation steady at 0.4%. Both measures, however, are down considerably from their peaks and now sit at 4.0% and 5.3% year/year (y/y) on headline and core CPI, respectively.
In recent months, the Federal Reserve (Fed) has paid specific attention to the sleeve of inflation excluding food, energy and shelter. This so-called “super core” inflation measure has been slower to come down compared to the headline measure, and Chair of the U.S. Fed, Jerome Powell, has commented that progress will have to come through either softening demand or softening labor market conditions, which has yet to be seen (1).
While labor market conditions may have had some effect on pushing up services prices, we think its impact is overstated. Over the last 4 months, more than half of the year-over-year gain in core services ex-shelter inflation has come from transportation services alone. Excluding airfares, transportation services accounted for 3.5 percentage points of the 4.7% y/y gain in May, as shown in the chart, whereas inflation in other categories such as education and communication services, recreation services and medical services has been relatively benign.
The CPI transportation services is mainly comprised of the following components, which account for the bulk of “sticky” inflation remaining:
Auto insurance premiums, which are up a whopping 17% y/y in the CPI, have been highly influenced by (1) the climb in prices for new and used vehicles and replacement parts since pre-pandemic and (2) an unfortunate rise in car accidents, with fatalities up 17.7% from 2019 according to the U.S. Department of Transportation (2).
Leased cars and trucks are similarly affected by the lagged hangover of semiconductor and vehicle production shortages but are also uniquely impacted by the Fed’s rate hikes, which has increased the cost of leasing. Because of this, significantly fewer people are leasing cars today than they were in 2020 and 2021, when they accounted for nearly a third of all car transactions (3). Notably, 2023 CPI weights are based off of 2021 consumer spending data, so leased cars and trucks may also be overstated in the index.
Auto repairs is one area where wages may be playing a role as the shortage of skilled auto technicians has been especially acute post-pandemic. However, the problem here is more of a secular decline in the willingness to work in laborious trade roles.
The good news is that the auto supply chain problems are now largely resolved, which has allowed wholesale inflation for auto parts to decelerate and used car prices to come down, with the Manheim used vehicle index down 7.6% from a year ago. The bad news is that it may still take a while for this to flow through to transportation services prices. In their 1Q2023 Report, auto insurance provider Progressive commented they are “re-evaluating our rate plans and intend to be aggressive with raising rates over the remainder of the year".
Regardless, it appears the drivers of this key component of remaining inflation aren’t the demand-side kind that the Fed fears, and the Fed may even be making matters worse by raising rates, at least when it comes to auto lease prices. As such, Chairman Powell may be wise to grant transportation services a similar kind of grace he’s given to shelter prices—by acknowledging inflation is coming down, it’s just a matter of time (4).
Transportation services account for the lion's share of "super core" inflation
Source: BLS, J.P. Morgan Asset Management. *Core services ex-shelter CPI is a custom index using CPI components created by J.P. Morgan Asset Management. Data are as of June 13, 2023.
Chairman Powell’s Federal Open Market Committee Press Conference (FOMC), March 22, 2023.
The U.S. Department of Transportation 2022 estimates show fatalities from vehicle accidents were up 17.7% compared to 2019.
Transunion study on the auto lease market.
In the March FOMC press conference, Chairman Powell said “Housing services is [coming down], it’s really a matter of time passing”.