Consumer prices were firmer than widely expected in June, but underlying softness in the report was a stark reminder that the U.S. economy remains fragile and that more stimulus will likely be necessary to support the recovery.
The headline consumer price index (CPI) increased 0.6% month over month in June, boosted by a rebound in energy prices – a strong result after several months of declines. The core index, which excludes the volatile food and energy categories, was also firm, rising 0.24% over May – after dropping for three consecutive months. The categories that contributed to the June price recovery, including travel services and some retail goods, were the same categories that were hit particularly hard by government restrictions on mobility. And, overall, the rebound confirmed that more lenient social distancing measures boosted economic activity as well as prices.
However, the underlying details in the core CPI index were softer. Shelter price gains recorded one of the softest increases since 2010. And although one never wants to over interpret any one print, the June performance suggests that still-high unemployment and rising rental nonpayments may have started to weigh on shelter inflation in June.
Notwithstanding the rebound in some goods and services prices, the details of June CPI report serve as a reminder of the lingering underlying weakness in the economy. Similarly, recent data have shown that a notable recovery in employment, spending and manufacturing activity occurred in May and June, but the rebound has recuperated only a fraction of the larger contraction in March and April. Similarly, the unemployment rate has recovered from a 14% peak in April, but at 11% remains above the highest level reached in the wake of 2008 financial crisis.
What's more, the outlook has deteriorated somewhat further recently, as another outbreak of the novel coronavirus – this time in the southwestern and south Atlantic regions of the U.S. – has raised questions about the extent to which the recent rebound will continue. New cases, hospitalizations and deaths have risen in several states, increasing the likelihood that tougher economic restrictions (in addition to mask mandates) will be necessary to control the spread. Just this week, California reinstated tougher restrictions on business activity across several counties in the state that make up around 10% of U.S. GDP. In any case, consumer and business behaviors appear to be shifting ahead of more possible restrictions. According to Opportunity Insights, small business revenues and consumer spending have deteriorated recently, and have deteriorated more in the states with the most acute outbreaks.
On the other hand, more government stimulus may help offset any virus-related economic weakness by supporting household and business incomes during this period of continued disruption. And, we expect the Congress to pass another stimulus bill worth at least $1 trillion before the end-of-July expiration of additional unemployment insurance benefits.
In addition, the case for more central bank accommodation, which we have long expected, has also grown stronger. Given these recent developments, we see downside risk to FOMC participants’ forecasts that growth will recover strongly in the second half of this year, and that core PCE inflation (the Fed’s preferred measure) will trough around 1%. This, coupled with medium-term expectations for a slow recovery, argues for stronger forward guidance supported by additional asset purchases now and a medium-term monetary policy strategy that waits at least until inflation reaches 2% before hiking rates.
Softer shelter costs a concern
On the details of the CPI report, although the aggregate core price index rebounded firmly in June, the price gains in both rent and owners’ equivalent rent were softer, rising 0.1%. More worryingly, the weaker readings were broad-based across regions and metro areas and were somewhat more pronounced in the areas experiencing more severe COVID-19 outbreaks, including Dallas (-0.66%) and Houston (-0.1%).
Taking a step back, high unemployment and lower aggregate incomes resulting from the COVID-19 crisis should moderate rental inflation over the next several quarters. However, the softness in June was surprisingly pronounced and was a stark contrast to the relative stability in April and May. The previous stability suggested that household government stimulus checks were helping to avoid a wave of rental nonpayments, while the June report raises the prospect that many households are still suffering economic stress, despite government efforts, and more might be needed to continue to support the economy.
Elsewhere, rising activity across the U.S. started to filter through to prices of nonessential goods and services in June. Travel services prices rebounded strongly, but retraced only a fraction of the price declines over the last three months. Transportation prices rose for the first time since December, supported by an increase in fuel prices and a rebound in airfare, which rose 2.6% month over month, but were still 27.2% below a year ago. Meanwhile, rental car prices climbed 17.5% from May, and lodging away from home rose 1.21% on the month as activity and travel increased, but remained down 13.9% from June last year. Finally, apparel prices, which had fallen sharply as consumers stayed home, rebounded 1.66% in June versus May but were still down 7.24% from June 2019.
Meanwhile, used car prices once again declined (-1.19%) in June despite firmer auction data. Although used car prices have been quite volatile over the past several months, industry indicators suggested that auction prices had rebounded in May and June after collapsing in April. The CPI data didn’t reflect the full extent of the price declines, and has yet to reflect a rebound, suggesting that other factors, including a shifting mix of cars, may be contributing to the volatility in the wholesale auction markets.
Finally, prices of medical care services also remained firm in June, rising 0.48% over May, although they cooled somewhat from last month. Prices of professional medical care services such as physicians (+0.45%), dentists (+0.23%), and eye doctors (+0.28%) all rose more modestly after posting strong price gains in May as offices reopened for nonemergency services.
The bottom line
While aggregate price gains were firmer than expected in June, underlying softness in today’s report should serve as a reminder of the economic fragilities that still exist in the U.S. economy. We expect more stimulus, both monetary and fiscal, will be necessary to support the recovery. Nonetheless, the recent virus outbreak across the south and western regions of the U.S. increases the downside risk to our growth and inflation outlook.
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Tiffany Wilding is a PIMCO economist focusing on North America and a regular contributor to the PIMCO Blog.