Guest Post by Ned Davis Research
We all expected this to happen. For most of the world’s economies, April marked the one-year anniversary of the first month of COVID-19 lockdowns in 2020. Recall that offices and schools were closed, airports, restaurants and hotels were shut down, while oil even briefly fell into negative territory. All of this created an extremely low comparable base.
Several developed and emerging markets have begun reporting April 2021 CPI data. Nearly all saw prices pop up, but none as markedly as the U.S. As shown in the chart above, U.S. annual CPI growth surged 4.2%, the most since 2008, while the core rate accelerated to the greatest since 1996. The inflation rate also picked up among several eurozone countries, but only to their highest levels since before COVID. Conversely, China’s inflation has been relatively subdued.
This puts the U.S. inflation rate not far from that of emerging markets such as Brazil and Russia, whose central banks have had to raise rates in recent months to counter inflation pressures. So, what gives?
One of the biggest reasons behind the divergence is the timing of the vaccine rollout. It just so happens that the reopening of the economy associated with the U.S.’s successful vaccine rollout coincided with the Why U.S. inflation stands out compared to the rest of the world
one-year anniversary of the lockdown.
Much of the U.S. CPI gain in April was among the battered industries in 2020 that are showing signs of life now, including lodging away from home, airlines, and recreation.
Conversely, much of Europe remained on some degree of lockdown last month due to a slower vaccine rollout. The price gains attributed to reopening the eurozone economy may not be fully realized until later in the summer.
Where all countries saw significant upward pressures compared to a year ago was in energy and transportation, as global chip shortages have led to an increase in vehicle prices.
The U.S. is also in a unique position because of its faster growth, due in part to the successful vaccine rollout, but also because to its outsized fiscal stimulus. COVID fiscal support stacked up similarly among developed economies in 2020. But the American Rescue Plan now puts the U.S. significantly ahead of the rest of the world, making the U.S. the leader in global growth.
The greater stimulus suggests larger demand pressures and may also be contributing to labor supply shortages. This, however, will likely be temporary given the one-off nature of the support.
Relative Growth Potential
That being said, even before this additional surge in stimulus (and even before COVID),
the U.S. was able to achieve higher inflation than other developed economies, such as
Europe and Japan, due in part to its capacity to grow faster, based on our potential growth estimates (see chart below). This suggests that the U.S. will generally see relatively higher inflation.
Greater Supply Chain Issues
The sharp changes in demand and preferences, coupled with COVID
restrictions, has led to an increase in supply chain disruptions, thus putting upward
pressure on prices.
The degree of these disruptions is evident via supplier delivery times from the manufacturing PMI report. Divergences abound among countries, as some developed economies, led by Europe and the U.S., are seeing record levels in their indexes, while supplier delivery times in some large emerging markets, such as China and India, are in line with long-term norms.
This likely reflects the fact that the developed economies generally experienced stricter lockdowns and traditionally depend more on services for growth. In fact, at nearly 80% of GDP, the U.S. touts the largest share. As a result, companies are having a harder time adjusting to the sharp change in demand for manufactured goods. Once supply and demand dynamics normalize, we’ll likely see these strains wane.
The U.S. also holds the distinction of having one of the weakest trade weighted
currencies compared to a year ago.
According to the JPMorgan trade weighted index, the U.S. dollar has weakened more
than any other G7 currency in April from the prior month and from a year earlier. With
imports rising significantly, this argues for higher inflation.
However, our analysis finds that developed economy CPIs generally have less sensitivity to exchange rates compared to emerging economies, suggesting it’s just part of the story.
CPI Index Weighting
One of the least exciting reasons, but just as important, behind the divergence in CPIs is
the basket weightings.
Emerging market CPIs are extremely sensitive to food prices, with the commodity often encompassing up to a half of the total basket. Indeed, one main reason China’s
CPI has remained subdued is because pork prices (a staple of Chinese cuisine) have
But even among developed economies, there are notable differences. The U.S. CPI has heavier weights in housing and healthcare, two sectors that will likely be prone to inflation, compared to the eurozone and Japan.
The rebalancing of CPI baskets may also lead to divergences this year. While the U.S. changes its basket weights every two years, Europe does so every year based on the prior year’s consumption patterns. With services spending down in 2020 because of COVID, this suggests that the sector, which is likely to see large price gains this year, may be underrepresented in 2021, resulting in more subdued price pressures.
What This All Means
Compared to other developed economies, the U.S. genuinely faces the risk of higher inflation due to outsized stimulus and greater potential for growth. But the timing of the vaccine rollout, abrupt changes in preferences, and technical factors, such as varying CPI basket weights, suggest that there’s much more to the story.
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