Rising Consumer Prices as Producers Face Higher Input Costs

After a decade of economic expansion during which annual consumer price (CPI) inflation averaged just 1.8%, consumers are now dealing with price increases of magnitudes they haven’t faced in nearly 13 years. The pandemic-induced recession of 2020 was short-lived but deep, causing sudden shifts in consumer spending patterns and manufacturing plant shutdowns due to worker health and safety concerns. The combination of these factors has wreaked havoc on manufacturing production lines and supply chains as well as the entire service industry. As pent-up consumer demand returns, these production and supply chain disruptions persist, leading to increased price pressures starting with raw materials and flowing all the way to final consumer goods.

Which Consumer Goods Are Seeing the Highest Price Inflation?

Because of the year-over-year comparison to prices that plummeted in the first few months of the pandemic, we have been seeing historically high year-over-over inflation numbers in the last couple of months. Total May CPI was up 5.0% compared to May 2020, while core prices (excluding food and energy) were up 3.8%.

Since prices have been extremely volatile over the last 12 months, to get a more accurate picture of the impact on prices we can calculate price inflation from December 2019, pre-pandemic. As shown below, after removing the periods of extreme volatility, we see large price increases for both food and energy. At the same time, core consumer prices are up 3.8%, with goods driving the above-trend growth. Within the category of goods excluding food and energy, inflation is being led by used cars and trucks (up 29.7% YOY, 28.3% from Dec. 2019), household furnishings and supplies (up 3.7% YOY, 4.6% from Dec. 2019), and other goods (up 2.5% YOY, 3.8% from Dec. 2019).

May 2021 CPI Inflation for Major Components (%)

                                                                     Sources: U.S. Bureau of Labor Statistics, FactSet

Higher Input Costs for Producers

While CPI inflation often follows increases in the producer price index (PPI), the correlation is far from absolute. However, it is interesting to break down the PPI into its components to see where producers of consumer goods will be paying more for their production inputs. While final demand producer prices are showing strong growth (up 6.6% YOY, 5.6% from Dec. 2019), we need to examine the price indices for intermediate demand goods, which include business purchases (excluding capital investment).

Prices for processed goods for intermediate demand jumped 21.9% in May compared to a year earlier; compared to December 2019, prices were up 15.6%. The processed foods and feeds component saw year-over-growth of 7.3% (up 13.8% vs. December 2019) while the processed materials less foods and feeds component surged 23.5% from a year ago (up 15.7% vs. December 2019). Within the latter category, the table below shows the products with the largest growth rates compared to December 2019.

May 2021 PPI Inflation for Intermediate Demand Goods (%, NSA)

                                                     Sources: U.S. Bureau of Labor Statistics, FactSet

Topping the list are construction materials: softwood lumber, building paper and board, and plywood, where the indices have more than doubled since the end of 2019. FactSet Insight recently explored how rising home construction prices are playing into U.S. housing market price dynamics. However, the list also includes raw materials that feed into the production processes for the biggest Consumer Staples companies. In its April 30 earnings call, Clorox leadership indicated that the company would be raising prices for its Glad products because of rising resin prices. On the same date, the Colgate-Palmolive Q1 earnings call mentioned significant pricing headwinds caused by rising prices of raw materials such as resins and fats and oils.

Rising food and energy prices are also impacting input costs for Consumer Staples companies. In their most recent earnings calls, both General Mills and Conagra Brands mentioned rising costs for both inputs and logistics as impacting their bottom lines.

The Fed Sees Current Inflation Pressures as Transitory

The Federal Reserve continues to maintain a stimulative monetary policy. In its April 28 Federal Open Market Committee (FOMC) statement, the committee stated, “Overall financial conditions remain accommodative, in part reflecting policy measures to support the economy and the flow of credit to U.S. households and businesses.” In his post-meeting press conference, Chairman Jerome Powell reiterated the language of the official statement stressing the impact of “transitory” factors on the current inflation numbers. He acknowledged the impact of supply chain bottlenecks, indicating that they were “temporary and expected to resolve themselves.” But he did concede, “It’s much harder to predict with confidence the amount of time it will take to resolve the bottlenecks.”

Conclusion

All eyes will be on the Fed this week as the FOMC holds its June policy meeting. Up to now, the equity and bond markets have remained sanguine on the inflation outlook, in line with Fed guidance. But the outlook largely hinges on how long “transitory” turns out to be.