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Why is Inflation So Sticky?

by Brandon Michaels and Chris Adnams

This week, the Bureau of Labor Statistics released its most recent consumer price index (“CPI”) report showing annual inflation at 4.0% through May, down from 4.9% a month earlier. The battle against high inflation began at the end of November 2021, when inflation crested at 6%. At that time, Federal Reserve Chairman Jerome Powell retired the word “transitory”, initially used to describe the impermanence of heightened inflation, in exchange for a steadfast position to lower inflation to 2%. Beginning in January of 2022, the Federal Reserve has raised its benchmark rate, the Federal Funds Rate, 500 basis points, and stifled bond buying programs. In June of 2022, the United States economy saw its highest inflation in forty-two years at 9.1%. This week’s Federal Open Market Committee (FOMC) meeting marks the first time in more than a year and a half in which the benchmark interest rate did not see an increase. In that time, how much progress has really been made to thwart rising prices and why has inflation been so sticky?

CPI vs Core CPI

Sticky inflation refers to a phenomenon where prices do not adjust quickly to changes in supply and demand, leading to persistent inflation. This is an undesirable economic situation where there is a combination of stubbornly high inflation and often stagnant growth.

Inflation is most commonly measured using the consumer price index or CPI, often referred to as “headline inflation”, to determine the increase or decrease of prices of a certain basket of goods and services. This month’s CPI report shows a significant drop in inflation, down to 4.0% from 4.9% a month earlier. This figure, however, doesn’t tell the whole story.

Instead of CPI, economists more regularly use a deviation called Core CPI, a report that excludes some goods and services generally regarded as staples with consistent demand but that are more sensitive to uncontrollable pricing shocks. These goods and services are food and energy, which can typically vary dramatically during periods of bad weather, natural disasters, times of war, and changing international politics, amongst other reasons.

While CPI has shown a consistent and steady reduction towards the Federal Reserve inflation target of 2%, progress with Core CPI has not been as encouraging. This month’s report showed Core CPI at 5.3%. This figure is down from just 5.5% a month earlier and only a 1.3% reduction since its peak of 6.6% in September of 2022.

Source: Department of Labor Statistics

Wage Growth

Among the forces working against price stability, most are employment based. During the mid-2021’s, wage growth increased well above average and has remained elevated since. This has afforded Americans more disposable income, allowing them to meet the market as prices for goods and services rose. As of the May report, the Federal Reserve Bank of Atlanta indicated wage growth of 6.0%, well above the 3.4% pre-pandemic average, and peaked between June – August of 2022 at 6.7%. Wage growth is currently the highest it has been since they began tracking data in 1998.

Source: Federal Reserve Bank of Atlanta

Labor Shortages and Supply Chain Issues

This increased consumer demand from increased wage growth is driving further increased demand for goods and services from American companies. As a result, unemployment has reached near historic lows, currently at 3.7%, as of the June report. In fact, employment is so robust that many crucial industries don’t even have enough workers to fill available job openings. The U.S. Chamber of Commerce reports, “…durable goods manufacturing, wholesale and retail trade, and education and health services have a labor shortage […] even if every unemployed person with experience in the durable goods manufacturing industry were employed, the industry would fill 44% of the vacant jobs.” Without a stable workforce, companies can’t supply goods or services on demand, as necessary, creating supply shortages and furthering inflationary pressures. Supply chain issues may be further exacerbated by new reports of the dock workers and longshoreman’s union that may strike or “severely impact” major ports along the West Coast in light of their contract’s expiration this month. If issues persist, barges and cargo ships may be indefinitely rerouted to the East Coast, further impacting the cost and speed of delivery for imported products.

What Does the Future Hold, and What Does This Mean for Commercial Real Estate?

In this week’s Federal Open Market Committee meeting, Chairman Powell noted that inflation still has “a long way to go” and that while some show signs of easing, these inflationary pressures may persist for an extended period. In fact, forecasts released to supplement the meeting don’t show inflation reaching its 2% target until 2025. “It will be appropriate to cut rates at such time inflation is coming down significantly. And again, we’re talking about a couple of years out,” Powell said. “As anyone can see, not a single person on the committee wrote down a rate cut this year, nor do I think it is at all likely to be appropriate.” The Federal Reserve Board’s median prediction shows boosting the Federal Funds Rate to 5.6% before the year is over. That adds up to two more rate hikes if the Fed raises in quarter-point increments.

This could prove problematic for the commercial real estate industry. With an already significant slowdown in transactional volume, stable or increasing interest rates could further impact the marketplace, adding stress to property owners facing pending loan maturities, or those looking to execute a sale. It is also meaningful for business operators, placing more strain on operations as the cost of capital increases. This may ultimately have an impact on rental rates as time moves forward and a softening of rental rates in conjunction with stable or escalating interest rates could prove devastating.


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