US: Potential inflation surprises for 2018 - Wells Fargo
Analysts from Wells Fargo, focus on five specific inflation categories that have the potential to drive an inflation surprise next year. “We are watching a number of categories that could similarly upset our baseline forecast of moderately stronger inflation next year. These items, however, offer the potential of both upside and downside pressure. As a result, we see the risks these categories present to our forecast as roughly balanced”, they concluded.
Key Quotes:
“Inflator: Natural Gas – From One Weather Extreme to Another. Heading into the draw down season, natural gas in storage is currently at the lowest level for this time of year since 2014. This alone would not be enough to generate higher heating costs in the coming months, but when combined with unusually cold temperatures this winter, prices could jump (...) “There has been no shortage of extreme weather lately. With the past two winters cracking the top 10 warmest on record, if this winter went from one extreme to the other, natural gas prices could soar like in early 2014. That winter was only the 29th coldest on record, but saw consumer prices for utility/piped gas services jump 16 percent between December 2013 and March 20142. When combined with prices for electricity (for which natural gas is now the number one source), utility services had lifted the year-over-year rate of headline CPI by 0.3 percentage point by March.”
“Inflator: Food Away From Home – Not to Be Minimized. The cost of dining out has grown more slowly over the past two years. The 12-month change in the CPI for food away from home, which carries a 5.8 percent weight in the index, has fallen by half a percentage point since mid-2016. That slowdown is ripe for a reversal, however. Prices for food away from home are especially sensitive to changes in minimum wages given the high share of low-wage workers in the hospitality industry. In 2018, 20 states are scheduled to raise the minimum wage (...) While a growing number of states and cities have been raising the minimum wage in recent years, restaurants and other food prep establishments have gotten a respite from declining food costs. That breathing room could change in the coming year as food costs are beginning to rise again.”
“Inflator: Medical Care – “Healthy” Inflation Again. Medical care price growth has moderated somewhat in recent years amid efforts by insurers and the government to rein in costs. However, upward pressure from drug prices and labor costs could boost the CPI for medical goods and services in 2018. Prescription and over-the-counter drugs make up about 1.8 percent of the CPI consumption basket while medical services contribute 6.6 percent, giving them considerable weight in the overall CPI. As recently as September 2016, an upswing in medical goods and services contributed more than 43 basis points to year-over-year CPI inflation (...) Fewer generic drugs are set to enter the market in 2018, which will likely push up prescription drug inflation (...) Higher labor costs as the labor market continues to tighten are also likely to put upward pressure on medical care prices. More than half of the industry’s input costs is employee compensation, and wage costs have been picking up over the past year. With the rate of job openings also trending higher, we expect to see higher labor costs to put more upward pressure on the services component of medical inflation.”
“Deflator: Rent of Primary Residence – The Affordability Wall. Slower rent growth may be in the offing next year as the torrent of multifamily housing supply since the recession and eroding affordability collide (...) The CPI for rent of primary residence rose 25 percent since the start of the expansion in 2009, but median household incomes have expanded 18 percent. Unlike the purchase market where financing terms can keep monthly payments in check, landlords may be unable to continue raising rents at the same pace until incomes catch up.”
“Deflator: Lodging Away from Home – Hotel Headaches. Growth rates in the CPI for lodging away from home have already moderated this year. However, there is scope for a more dramatic fall if a mismatch between hotel supply and demand pulls down occupancy further, and hotel managers respond with substantially lower rates (...) An uptick in the number of hotel rooms in planning or construction phases this year suggests that hotel occupancy may continue to be a challenge in 2018, as new supply outpaces demand.”