Red-hot pace of inflation cooling, should peak in 1Q22
The main gauge for inflation is the Consumer Price Index (CPI). We break down the key components of CPI (slide 2). Energy and used vehicles were the two biggest contributors to inflation in 2021 (slide 3). We see the following unfolding in 2022:
- Year over year CPI readings should peak during the first quarter of 2022 (slide 4). The high inflation readings of 2021 will roll off and should be replaced by more moderate figures. We expect overall CPI to end 2022 in a range of 2.5% to 3.0%, while core CPI (excludes food & energy) should end in a range of 3.0% to 3.3%. Thus, inflation remains elevated compared to pre-pandemic trends, but well below the peak levels we are seeing now.
- U.S. crude oil production is climbing, boosting supply and should help stabilize gasoline prices in 2022 (slide 5).
- Automotive production is normalizing (slide 6). With the supply of new vehicles ramping higher as supply chain issues are repaired, it should alleviate the scarcity of used vehicles that spiked prices in ’21.
- Shelter costs are coming back down to earth. New and existing home sales have declined back towards their long-term trends (slide 7). Meanwhile, apartment rents have plateaued (slide 8).
- Lastly, indirect factors such as wages should ebb somewhat going forward. The “Great Resignation of 2021” is unlikely to repeat itself in 2022. The labor force participation rate is slowly increasing (slide 9).
Updated Fed outlook – Continuing to normalize policy
By nearly every metric, economic conditions have improved much faster than expected. That's especially true with the unemployment rate at 3.9%, a few ticks above the 2019 average of 3.7%, and arguably already at full employment. As such, the Federal Reserve (Fed) is swiftly withdrawing crisis-mode monetary policies, such as zero interest rate policy and the massive monthly bond purchases, known as quantitative easing (QE). That said, the Fed is not on a pre-set course and will react as dictated by the economic data in both directions, which includes the impact of the pandemic and possible new variants.