Annual Inflation Continues to Accelerate, Likely Prompting Tighter Than Previously Expected Monetary Policy

Key Takeaways:

• The Consumer Price Index (CPI) increased 0.6 percent in January, matching December’s monthly gain, according to the Bureau of Labor Statistics. On an annual basis, prices rose 7.5 percent, an acceleration of five-tenths and the fastest annual rate since 1982. Core CPI rose 0.6 percent over the month and 6.0 percent over the year. Energy prices increased 0.9 percent despite a 0.8 percent drag from gasoline prices, which we believe will likely reverse in February amid higher oil prices. Relatedly, food prices increased another 0.9 percent. Apartment rent prices increased 0.5 percent, the largest monthly gain since 2001, and owners’ equivalent rent increased 0.4 percent for the fifth consecutive month and 4.1 percent over the year, the fastest annual rate since 2007. Prices in the travel industry were a mixed bag as airline fares increased 2.3 percent but hotel and car and truck rental prices declined 4.2 percent and 7.0 percent, respectively. Bucking the general upward price trend, new auto prices were flat and used car prices increased 1.5 percent month-over-month, a notable slowdown from the previous three months.
• The National Federation of Independent Business (NFIB) Small Business Optimism Index declined 1.8 points to 97.1 in January, its lowest level since February 2021. Notably, on net, 3 percent of firms reported they were planning to add inventories, while 7 percent of firms reported that inventories were too low, the smallest percentages since February and April 2021, respectively. The net percentage of firms planning on increasing employment declined 2 points to 26, though a record 50 percent of firms reported that they were raising worker compensation, up 2 points from December. Sixty-one percent of firms reported raising average selling prices, also a record and an increase of 4 points. The percentage of firms who rated inflation as their single most important problem was flat at 22, though the net percentage of firms who rated the cost of labor as their most important problem declined 2 points to 11.
• Consumer (non-mortgage) credit outstanding increased $18.9 billion in December, according to the Federal Reserve Board. Revolving credit (largely credit cards) rose $2.1 billion to the highest level since March 2020, while non-revolving credit (largely auto and student loans) increased by $16.8 billion.
• The real goods U.S. trade deficit widened by $1.3 billion in December, according to the Census Bureau. Real exports increased 3.2 percent and real imports grew 2.3 percent, though the far larger base of real imports caused the trade deficit to reach a new record.

Forecast Impact:

Inflation is running at its highest level in nearly four decades, and January’s reading came in somewhat stronger than we had expected. Combined with recent increases in oil prices, we expect to upwardly revise our near-term inflation outlook. Although we still believe some temporary components of price pressures, primarily in the durable goods space, will fade, underlying inflationary pressures from housing and the labor market are continuing to build. Shelter costs grew at the fastest annual rate since 1991 and don’t show signs of slowing; in fact, we believe the owners’ equivalent rent component is only just beginning to pick up last year’s record-setting home price growth. Further, we believe wage pressures are likely to prove persistent as a whopping 50 percent of small businesses reported raising worker compensation. There may be some small relief on the horizon as the percentage of small businesses planning to raise pay and selling prices both declined modestly in January, but both remain elevated compared to pre-COVID levels. We believe the CPI report also provided a hint of improvement in the auto industry, one of the major transitory contributors to inflation thus far, as new car prices were flat and used car price growth decelerated further. Despite low inventory levels and limited production, we believe this component will plateau in the coming months and begin to drag modestly in the second half of the year, rather than fall dramatically. Similarly, we expect other durable goods to provide a modest drag to inflation beginning around Q3 2022 as supply chain bottlenecks improve, and favorable base effects should start to slow the annual CPI growth as soon as March. Still, the broad-based nature of this CPI report reinforces our expectations that the Fed will begin raising rates in March and increases the probability of both larger and more frequent rate hikes than previously thought. Further, the Fed may begin running off its balance sheet earlier and faster than expected as well, which may on net affect the longer end of the interest rate curve (and potentially increase mortgage rates faster) than hiking the federal funds rate would alone.

Nathaniel Drake
Economic and Strategic Research Group
February 11, 2022

Opinions, analyses, estimates, forecasts, and other views of Fannie Mae's Economic and Strategic Research (ESR) Group included in these materials should not be construed as indicating Fannie Mae's business prospects or expected results, are based on a number of assumptions, and are subject to change without notice. How this information affects Fannie Mae will depend on many factors. Although the ESR group bases its opinions, analyses, estimates, forecasts, and other views on information it considers reliable, it does not guarantee that the information provided in these materials is accurate, current, or suitable for any particular purpose. Changes in the assumptions or the information underlying these views could produce materially different results. The analyses, opinions, estimates, forecasts, and other views published by the ESR group represent the views of that group as of the date indicated and do not necessarily represent the views of Fannie Mae or its management..