US CPI rose sharply in April, up 4.2% year over year (YoY) on a headline basis and 3.0% YoY excluding food and energy. A large increase had been expected, but not this large. One of the key drivers for this above consensus print was supply constraints in the face of accelerating demand (see display).
Supply chain bottlenecks have been evident in the data for several months and have caused us to expect core CPI near 3.0%. We might have expected the acceleration to take another month or two, but the very strong demand response made it happen more quickly. Evidence of capacity constraints in other economic data through the summer will be one of our best leading indicators of the persistence of price pressures.
To be sure, the economy is reopening and pent-up demand is fueling consumption. But reopening is a process, and the demand side of the economy is ahead of the supply side for now. As long as that is the case, prices are going to rise. But it isn’t likely to be that way forever, and when the supply side catches up in the second half of this year we expect prices to settle down – we’ve penciled in inflation around 2% by the end of 2021. That said, there are going to be some uncomfortable moments for policy-makers in the coming weeks as market participants wrestle with how to probability weight what is a very wide range of potential inflation outcomes.
All told, this acceleration in prices was expected and it’s causes well understood by the markets. Importantly, this single reading should not be cause for alarm, but rather reason to ensure allocations are consistent with goals and tolerances for risks of all kinds, including inflation.
- Investment Strategy Group