US inflation at 41-year high of 8.5% ratifies Fed hawkishness

13 Apr 2022 , 09:24 AM

After reporting 7.9% inflation in Feb-22, consensus Reuters estimates were already pegging US consumer inflation for Mar-22 at 8.4%. The actual inflation for Mar-22 announced by the Bureau of Labour Statistics (BLS) on 12th April, came in at a 41-year high of 8.5%. For the month of Mar-22, the pressure came from energy prices and higher food prices. Core inflation at 6.5% was also 10 bps higher than Feb-22.

How the US inflation components stacked up in Mar-22

At 8.5%, US consumer inflation is back to the inflation levels of 1981, before Paul Volcker had tightened the screws on liquidity.

Here is a quick inflation summary.

Category	Mar-2022 (YOY)	Category	Mar-2022 (YOY)
Food Inflation	8.80%	Core Inflation	6.50%
Food at home	10.00%	Commodities less food and energy	11.70%
Cereals and bakery products	9.40%	Apparel	6.80%
Meats, poultry, fish, and eggs	13.70%	New vehicles	12.50%
Dairy and related products	7.00%	Used cars and trucks	35.30%
Fruits and vegetables	8.50%	Medical care commodities	2.70%
Non-alcoholic beverages	8.00%	Alcoholic beverages	3.70%
Other food at home	10.30%	Tobacco and smoking products	6.9%
Food away from home	6.90%	Services less energy services	4.7%
Full service meals and snacks	8.00%	Shelter	5.0%
Limited service meals and snacks	7.20%	Rent of primary residence	4.4%
Energy Inflation	32.00%	Owners’ equivalent rent	4.5%
Energy commodities	48.30%	Medical Care Services	2.9%
Fuel oil	70.10%	Physician Services	0.7%
Gasoline (all types)	48.00%	Hospital Services	3.3%
Energy services	13.50%	Transport Services	7.7%
Electricity	11.10%	Motor vehicle Maintenance	4.9%
Natural gas (piped)	21.60%	Motor vehicle insurance	4.2%
Headline Consumer Inflation	8.50%	Airline Fare	23.6%

 Data Source: US Bureau of Labour Statistics

Clearly, energy inflation at 32% is driving the overall US consumer inflation but food inflation at 8.8% is also fairly high. The core inflation has been stable at 6.5% in Mar-22 but some of its components like airfares, new vehicles and used vehicles are sharply higher. On the energy front, fuel is up 70.1% yoy while gasoline is up 48% yoy. In the food basket, high protein food products appear to be driving inflation on the back of surge in demand.

High frequency inflation is a major challenge for the US

The BLS reports US inflation on a yoy basis, but also reports high frequency inflation on a MOM basis, i.e. rise in inflation index for Mar-22 over Feb22. That figure is influenced by geopolitical risks, commodity prices and other high frequency factors that are currently driving inflation. The sequential inflation in the US throws up interesting stories.

Chart Source: US Bureau of Labour Statistics

In the US, yoy inflation for Mar-22 came in at 8.5% compared to 7.9% in Feb-22 and 7.5% in Jan-22. From a short term perspective, the sequential spike in inflation was at 1.2% in Mar-22 compared to 0.8% in Feb-22 and just 0.6% in Jan-22. The sequential inflation of 1.2% in Mar-22 is the highest in the last 13 months and references the sharp impact that the war and input costs are having. This will have larger implications for Fed monetary policy.

What triggered 8.5% US inflation in Mar-22?

Bond yields have been rallying in the US, but at 2.75%, the bond yields are way below the inflation rate of 8.5%. This implies huge negative real rates of return. Here is what triggered consumer inflation in the US.

a) Rising energy costs has been the main reason for this spike in consumer inflation. After the energy index rose 3.5% in Feb-22, it spiked by another 11% in Mar-22 on sequential basis. That is where most of the pressure is coming from.

b) Gasoline (petrol equivalent) was the other big driver of inflation. In Feb-22 gasoline prices surge by 6.6% but this was followed by a whopping 18.3% spike in gasoline prices in Mar-22. US gasoline prices are up 48% in last one year.

c) Crude impact is not just about fuel and gasoline. Since oil has strong externalities, it manages to seep into the cost structure of most of the products manufactured or services rendered in the US economy. That is the risk.

d) If you look at the groceries basket in the US, it is up 1.5% on a sequential basis and about 10% on a yoy basis. With the Black Sea blockade already on, the food equations are likely to be impacted. After all, Ukraine remains the bread basket of Europe.

With 8.5% inflation, there may be no Fed rethink

Fed is already prepared for higher inflation this year and the minutes of the March FOMC meeting already highlighted the strategy. After raising the rates by 25 bps in Mar-22, the minutes hint at another 200 bps rate hike in 2022, with rate hikes in each of the remaining six FOMC meetings this year. Such aggression implies a couple of larger rate hikes with the Fed most likely to start off with an aggressive 50 bps rate hike in May.

For now, Fed is clear it will be inflation control above all else. Despite the risks caused by the Ukraine war, Fed refused to budge on its hawkishness. Apart from the aggressive rate hikes this year, Fed is also pencilling in commencement of its bond book unwinding. The $9 trillion Fed bond book will be wound down at the rate of $95 billion per month starting May-22. Fed is going to adopt a mix of dearer money and tighter liquidity to combat US inflation.

What does US inflation number mean for India?

In our previously monthly report on US inflation, we had estimated that if oil and food were the inflation drivers, India too will have to contend with sharply higher inflation. That view has been ratified with India’s Mar-22 inflation coming in at 6.95%. In its April 2022 monetary policy the RBI refused to give up, either on its dovish rate stance or accommodative policy stance. Higher inflation leaves the RBI with a big dilemma.

The maximum that India can now wait is up to May -22 to check if the US Fed really walks its talk on rate hikes and on bond unwinding. If the US Fed sticks to its timetable in May, then the RBI would be running out of time. Then it has to embark on an ultra-hawkish approach in its June monetary policy. Perhaps, RBI may even have to do it earlier!