In the previous blog post, we pointed out how 2021’s sharp uptick in inflation has been predominately driven by rising goods prices. One thing often overlooked about this is that it is not only supply constraints leading to higher goods prices but also very strong consumer demand.
Indeed, supply chains were already extremely taxed due to pandemic-related disruptions, but add to this environment unprecedented base effects and a historic upswing in consumer spending and it should not be too surprising why we are experiencing such levels of goods inflation. Why is consumer demand for goods so strong? Well first off consumer demand, in general, is strong thanks in part to household balance sheets on average having improved considerably since the start of the pandemic.
As bad a shape as the economy was in during the peak of the 2020 lockdowns, the majority of Americans were still employed. With incomes maintained for most households and trillions in direct fiscal stimulus from the government alongside a spike in savings rates due to heightened economic uncertainty, it was clear that whenever the economy reopened consumers would be financially capable of spending. However, the economy did not fully reopen, at least not instantly, and COVID variants and regional differences have complicated matters. The result of all this is that consumer spending on services, which typically account for the bulk of Americans’ consumption, has rebounded much slower than anticipated. With pent-up demand still high, though, consumers responded by shifting their spending to goods. For example, if fewer Americans (relative to pre-COVID levels) are traveling and vacationing or visiting bars, restaurants, and movie theaters, and instead, spending more time at home, then purchasing new electronics and other stay-at-home luxuries makes sense. Similarly, prices for popular items at the grocery store have gone up a lot because people are dining out less and eating at home more, further pressuring already weak supply chains.
None of this is meant to suggest that rising prices are “good,” as some tone-deaf “economists” in the media have tried to argue recently, or that many U.S. families are not hurting from 2021’s rapid inflation resurgence. Instead, this post is simply intended to help explain why we are seeing the price increases we are this year, why inflation has been concentrated in certain areas, and perhaps most importantly why we are optimistic that such conditions will not last forever. Indeed, as COVID case counts continue to fall and more Americans become comfortable regularly venturing out of their homes once again, a significant portion of the spending on goods will shift back to services. This by itself will help take some pressure off strained supply chains, and in turn goods prices, but we also have to remember that producers have not just been sitting around doing nothing as supply frictions intensified. Many manufacturers, for instance, in response to COVID-related activity restrictions have been taking steps to increase productivity, and as case counts fall and such policies are relaxed, more factories will be able to operate again at full capacity only now with even greater output than prior to the pandemic.
Further, many ports and other critical supply junctions have started operating 24/7 to help alleviate bottlenecks, and all these dynamics are playing out not just domestically but also overseas, which is important given how dependent we have allowed ourselves to become on foreign supply chains. We must also consider that consumer sentiment has deteriorated in recent months due to the Delta variant and increased policy and economic uncertainty. Add to this the inflation we have already experienced along with the recent expiration of the federal unemployment benefit and it is easy to see general consumer spending moderate in the months ahead. So altogether we have a potential scenario where demand will increasingly shift from goods to services and overall consumption should cool from historically high levels, all while goods producers have spent months trying to increase productivity and ramp up supply. With such conditions, it will be difficult for inflation to remain at the levels we have seen recently. This of course will not be an instant fix and more likely a gradual process, i.e. we could very well see even hotter CPI prints before normalization begins. Potential hurdles include the ebbs and flows in COVID case counts, winter weather depressing the services rebound in northern states, as well as the usual exogenous risks, but overall the incoming data still suggest the pace of price increases seen this year will not be permanent.
What To Watch This Week:
Monday
- Chicago Fed National Activity Index 8:30 AM ET
- Dallas Fed Manufacturing Survey 10:30 AM ET
Tuesday
- Case-Shiller Home Price Index 9:00 AM ET
- FHFA House Price Index 9:00 AM ET
- New Home Sales 10:00 AM ET
- Consumer Confidence 10:00 AM ET
- Richmond Fed Manufacturing Index 10:00 AM ET
- 2-Yr Note Auction 1:00 PM ET
Wednesday
- MBA Mortgage Applications 7:00 AM ET
- Durable Goods Orders 8:30 AM ET
- EIA Petroleum Status Report 10:30 AM ET
- Survey of Business Uncertainty 11:00 AM ET
- 2-Yr FRN Note Auction 11:30 AM ET
- 5-Yr Note Auction 1:00 PM ET
Thursday
- GDP 8:30 AM ET
- Jobless Claims 8:30 AM ET
- Pending Home Sales Index 10:00 AM ET
- EIA Natural Gas Report 10:30 AM ET
- Kansas City Fed Manufacturing Index 11:00 AM ET
- 7-Yr Note Auction 1:00 PM ET
Friday
- 5-Yr TIPS Settlement
- Employment Cost Index 8:30 AM ET
- Personal Income and Outlays 8:30 AM ET
- Chicago PMI 9:45 AM ET
- Consumer Sentiment 10:00 AM ET
- Baker Hughes Rig Count 1:00 PM ET
