Published 10 Aug, 2023
US Inflation Update: July 2023
The past three months have seen a swift decline in the US inflation rate, from 4.9% in April to 3% in June, as the Federal Reserve’s aggressive monetary tightening continued to pay off. However, we expect CPI to begin edging higher again in July, moving further away from the Fed’s 2% target.
Truflation’s real-time US CPI index mirrors this trend, having risen from a low of 2.1% on July 19 to 2.31% as of August 7. Below, we dig into the factors driving inflation higher and upgrade our end-of-year US inflation forecast from 3.5% to 4%.
Despite the recent strong downward trajectory in CPI, in July the Central Bank chose to increase interest rates again by 0.25% to 5.25%-5.5%. The driving force behind this decision was twofold: firstly, core inflation as reported by the Bureau of Labor and Statistics (BLS), which remains significantly higher than the 2% target at 4.8%, and secondly, the stubbornly tight labor market.
Because of the tight labor market , with unemployment at historic lows and wages continuing to increase, the downward pricing movements are more pronounced in goods rather than services. Though prices in the services sectors are also on the decline, the tight labor market means they are slowing at a significantly lower rate.
Given these indicators and the anticipated reversal in inflation, we do not expect interest rates to come down any time soon. Instead, the Central Bank will maintain its “wait-and-see” approach, and another rate hike in September remains on the table.
Truflation’s data shows that the significant contributors in driving inflation higher are food, other lodgings, other vehicle expenses, and utilities. The biggest downward contributors are vehicle purchases, gasoline, clothing, communications, and – finally – owned housing.
The tightness of the labor market, combined with rising prices in the all-important food, transportation and utilities sectors reinforces Truflation’s expectation of a trend reversal in July’s CPI number. The latest resurgence of inflation is compounded on top of already elevated prices, so it’s fair to say that the fight to get inflation under control is far from over.
Truflation's mission is to provide the most accurate inflation measurement in the market by leveraging 30+ data sources and over 12 million price points for goods and services. Truflation is not designed to measure BLS numbers as its index is based on just 80,000 items and uses a different methodology to ours, but we are able to reliably predict the BLS inflation estimate.
After a significant drop of 1.0% to 3.0% in June, the CPI trend (as reported by the BLS) is set for a reversal in July. Market expectations range from 2.7% to 3.42%, and Truflation’s model shows that this figure will come in at 3.4%.
This upward movement will certainly put pressure on the Fed to increase interest rates further at its next meeting in September, especially with core inflation continuing to increase – an indicator the Central Bank is currently watching closely.
In addition, other economic indicators suggest the economy remains strong. In Q2, GDP growth increased to 2.5% from 2% in Q1, primarily reflecting rising consumer expenditure (in part offset by inflation). In addition, business investment has also been on the rise, though this was partially offset by lower exports.
Retail sales, which represent the majority of discretionary consumer spending, were an outlier, down 2.7% in June month-over-month (MoM). However, this decline can be explained by prevailing seasonal trends in June and July. On an annual basis, June’s retail sales were still 1.7% higher, though this marks a slowdown from 8.8% annualized growth in January.
Source: US Census Department; Advance Monthly Retail Trade Survey
In July, the Department of Labor (DOL) reported another marginal decline in unemployment from 3.6% to 3.5% – a level not seen for more than 50 years. This is well below the Fed's latest median estimate of 4.1% by the fourth quarter of 2023.
Despite this, the US economy only added 187,000 new jobs in July – fewer than expected. The sectors with the most rampant hiring were health, financials, and leisure and hospitality. Yet with 1.6 job openings for every unemployed American as of June, companies may be simply failing to find workers to fill the positions. The economy needs to generate roughly 100,000 jobs per month to keep up with the growth in the working-age population.
This also partly explains wage growth (according to the BEA), which rose again in June to 6% from 5.8% in May and 5.6% in April. This trend is another concerning factor for the Fed, especially considering wage growth continues to outpace inflation, which boosts household purchasing power, supports consumer spending, and keeps the economy on its growth trajectory.
As a result, economists are increasingly suggesting that a soft landing is possible. Recently, JP Morgan’s chief economist said the bank no longer expects a recession this year, though the risk of a recession for 2024 remains elevated.
With the labor market tight as a drum, it’s no surprise that Truflation’s data shows a further 6% improvement in consumer confidence in July, contributing to a whopping 18% increase year-over-year (YoY). This is the highest level we have recorded since we began collecting data in January 2022.
This reflects the improvement in economic conditions, the availability of jobs fuelling a positive outlook for business conditions, as well as the improvement in the personal financial situation of the average American as inflation continues to fall and their disposable incomes increase. The question now is whether this will change when the CPI trend reverses.
Over the past month, we have seen significant upwards pressure on inflation from food, other lodgings, vehicle expenses, and utilities, driven in part by the tight light market, as well as the
rising supply costs for goods and consumers continuing to spend on service. Demand is a key driving factor in this upward movement.
This is reinforced by the Producer Price Index, which measures the average change over time of the selling prices received by domestic producers for their output. The PPI has seen an increase of 0.1% YoY in June, driven by a 0.2% rise in the cost of services as a result of the tight labor market, while goods prices have remained flat.
Source: US Bureau of Labour & Statistics; Producer Price Index
It is, therefore, not surprising to see prices accelerate again in the food category, in particular food away from home. We are expecting another monthly increase in July of 0.83%, marking a 4.17% annual rise – an acceleration of the trend compared to the previous month.
This is consistent with data from the Census Bureau, which shows that food services and drinking places retail sales have increased by 9.9% YoY. June’s Fiserv SpendTrend Report also revealed the average transaction size and spending in food services and drinking places rose 2.4% and 5.4%, respectively. This points to the continued revenge behavior of the US consumer as they can finally afford to dine out again.
Truflation’s food at home category is also continuing to see an increase of 0.83% MoM, marking an acceleration compared to the month prior.
Spending is also up YoY, despite the US entering the summer months, which have historically seen a marginal dip in this indicator. The increase in import tariffs, rising food production costs, and some supply bottlenecks are hitting consumers hard. This is also reflected in the Monthly Retail Sales report from the Census Bureau, which shows a 1.3% increase in sales in food and beverages stores in June compared to a year ago.
This increase in food prices is a concerning trend, given the importance of this sector to the overall inflation figure. It is likely partially driven by consumers looking to replace their “just-in-case” items, which they will have dipped into during the previous months. As such, it’s too early to expect deflation in this category.
The second significant contributor to the upward pricing trend was utilities. With crude oil prices on the rise again from $70.3 per barrel at the end of June to $81.7 per barrel at the end of July, it is no surprise to see all utilities prices increasing 1.7% MoM in July.
In addition, this July was one of the hottest on record, with average temperatures rising to 77.4°F across the US (according to the National Weather Service). This marks another increase from last summer’s average of 76.4°F. The heatwave drove electricity prices 1.7% higher MoM, while on an annualized basis the category is up a whopping 8.4% – though this rate has been continuously slowing.
Other categories that are experiencing an upward trajectory include other lodgings, up 1.4% MoM with an average annualized increase of 4% over the last three months. Hyatt’s CEO Mark Hoplamazian mentioned on the most recent earnings call that the company is seeing sustained corporate demand and no signs of slowing down. They have also booked roughly $500 million in future business events in the second quarter, an increase versus the previous quarter. Meanwhile, the all-important metric of revenue per available room (RevPAR) is up 15% YoY.
Similarly, Hilton’s earnings report for Q2 also shows a 12.1% rise in RevPAR compared to Q2 2022, and 9.3% from Q2 2019, i.e. pre-pandemic levels. With bookings made, and travel
expected to continue with its strong momentum, prices in the other lodgings category are set to keep rising.
Vehicle expenses are also up 1.14% MoM and 12.9% YoY. This is predominantly driven by the constant interest rate hike impacting auto loans. And finally, a smaller contribution to inflation came from personal care and alcohol & tobacco.
The three main categories that are continuing their deflationary trend are transportation, apparel, and health. The one surprising category that is finally seeing a reversal is housing, in particular owned housing which seems to finally be cooling as interest rate hikes take their toll.
Transportation prices are cooling across the board. Demand for new and used cars has significantly waned since the early months of 2023 as financing costs have soared. This has placed downward pressure on car prices in the last three months, with a 1.2% MoM decline in July.
Dealers continue to grapple with excess supply, with auto sales inventory up by 219.9 billion in May compared to April 2020. As inventory levels outstrip demand, prices are expected to keep falling for the next quarter. In addition to this we will be entering the cooling period for the car market that starts trending downwards to the end of the year.
With the increase in crude oil prices, it is no surprise to see higher gasoline prices during the last month, though on an annual basis, they are still 22.4% lower.
The other sub-category in transportation that has seen a decline is public transportation, common during the summer months with less local travel. However, TSA checkpoint daily travel numbers are virtually unchanged in July compared to June, although still 12% higher YoY and nearly back to pre-pandemic levels – now only 1.1% down compared to 2019. With capacity continuing to expand, we expect pricing pressure. Yet with bookings at capacity in Q3, airlines are likely to enjoy another strong quarter.
The health category is also contributing to downward pricing pressure, with health prices flat compared to the previous month and now virtually on par with levels a year ago. While health insurance and medical services costs are coming down, drugs and medical supplies are becoming more expensive, most likely driven by price increases by pharmaceutical companies. Another major driver of deflation in the sector are the enhanced subsidies introduced in 2021 under the American Rescue Plan Act, which have been extended until 2025 in an effort to fight inflation.
Other sectors seeing deflationary trends include communications, down 0.9% MoM on the back of increased competition in the cellular phone market; and apparel, where prices are down 0.4% MoM, consistent with a seasonal trend in June/July. We are also seeing increased competition for consumer’s wallets as retailers kick off seasonal sales earlier than usual.
Finally, it seems that the housing market is marginally cooling; not only on an annual basis from mid-last year, but we are seeing monthly price rises starting to slow down. In July, Truflation recorded a monthly increase of 0.38% compared to 0.68% in June and 0.64% in May. This downward pressure is coming primarily from owned dwellings, where the MoM increase has dropped to 0.1%, while prices are up 2.26% YoY – a slowdown from last month.
The total number of new house sales also came down for the first time since September 2022, from 763k in May to 697k in June. This was supported by median house prices seeing a marginal cooldown.
The recent rise in mortgage rates seems to finally be curbing demand for new homes, as 30-year fixed-rate mortgages reach a new high of 6.9%, as of August 2 (according to Freddie Mac). These elevated mortgage rates are likely to hold given the uncertainty regarding the Fed’s positions on interest rates. Soaring tax premiums have also put pressure on the owned property segment.
In addition, the number of newly completed residential properties has hit a fresh two-year peak of 1.5 million, up 6% YoY. Soaring supply coming onto the market will place prices under pressure for the first time in a long while.
Increased supply combined with elevated interest rates will continue to drive house prices down before we see an upward trend again.
We believe inflation has already hit its lowest level for 2023 and expect it to increase from here on. We are forecasting 3.5% by Q3, reaching 4% by December.
In the short term, this will be driven by the tight labor market, which we expect to last until the end of 2023. Given recent consumer optimism, we are likely to see consumer spending continue to drive the economy and help the US avoid a recession in 2023. The tradeoff will be higher prices.
By the end of the year, this will be coupled with rising house prices, which will ultimately push inflation up to our 4% forecast.
Truflation provides a set of independent inflation indices drawing on 30+ different data partners/sources and more than 12 million product prices across the US. The indices are released daily, making it one of the most up-to-date and comprehensive inflation measurement tools in the world.
Truflation has been leveraging this measurement tool to predict the BLS CPI number. Since Truflation initiated coverage, four predictions were spot on, with all but one deviating by no more than 20 basis points. However, Truflation’s own US CPI index is currently much lower than the government’s reported inflation figure.