Consumers ‘most definitely’ going to experience higher prices

Recent inflation readings from the Índice de Precios de Gastos de Consumo Personal (PCE) y el Consumer Price Index (CPI - Índice de Precios al Consumidor) came in as expected. That is some measure of good news. The bad news, however, is that expectations already reflecting the beginning of a surge in inflation based on higher energy costs from the conflict in Iran. Headline inflation is being led by a massive rise in gasoline prices and the increased cost to produce and distribute food. Given the higher costs for fertilizer impacting production costs, we expect food prices to show more upward pressure over the coming months.

Importantly, we know the Federal Reserve removes food and energy from the equation and looks more closely at the "core" rate of inflation. On that front, the primary driver of inflation is shelter costs, and here we see a continued moderation in rents which is allowing the core inflation rate to show more moderate increases. Based on Friday's CPI report, headline inflation is up 3.3% year over year, while core inflation is up "only" 2.6%. This may be a harbinger of things to come as headline inflation shows greater upward pressure for some period of time.

From the Fed's perspective, moderate core inflation readings and continued stable long-term inflation expectations may provide them the cover to not raise rates. Still, consumers are most definitely going to feel the pinch of higher prices.

With that in mind, our chart this week is one we have used often. It shows the aggregate inflation gains in CPI compared to aggregate wage gains going back to the onset of the pandemic. The U.S. had just begun to make some progress on closing this gap as inflation slowed and wage gains were higher than price increases.

However, now it appears the conflict in Iran is going to widen this gap going forward. We all feel the impact of higher prices, but lower income brackets feel it most acutely. That's primarily because lower income brackets spend a larger proportion of their income on items like food and gasoline. The implications of this re-widening are both economic and political. There is no single economic data point with a higher correlation to a president's approval rating than gasoline prices. And while the gap between inflation and wages had been narrowing, we all feel the impact in areas like home heating bills and insurance, where costs have gone up significantly faster than overall inflation rates.

In short, while the Fed might be able to avoid rate increases as they look through the upcoming period of higher prices, consumers are going to feel the pinch. All of this sets up for what could be a grumpy electorate in the mid-term elections. And is always the case, if voters are unhappy, the party in power, which is currently the Republican party, is going to pay a price at the polls.

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