US inflation is on the rise – but will it continue?

US headline CPI ticked up 0.4% month-on-month in February on the back of higher gasoline prices.

This means the inflation index has increased 1.7% year-on-year (y/y), a larger gain than the 1.4% reported in the previous month.

We expect the rise in headline inflation to gain momentum in the coming months thanks to higher commodity prices. We forecast headline CPI to rise to 3.5% y/y in Q2 this year.

The West Texas Intermediate (WTI) index - the US benchmark of the crude oil price - has been on the rise in the past few weeks and is now up 23% from pre-pandemic levels. The price of other commodities, such as copper and lumber, is also climbing gradually, putting upward pressure on inflation in the short term.

As a result, inflation expectations have also increased, causing bond yields to move higher. This has started to bite equity markets, hurting expensive valuations.

However, we believe that the upcoming spike in headline inflation will only be temporary, as the base effect vanishes. Meanwhile, underlying inflation is set to remain low as the economy still has some spare capacity. Core inflation came in below market expectations, rising 0.1% m/m in February, as shelter (housing) prices continued to decelerate.

To understand the responsiveness of inflation to economic growth, we have broken down the core inflation index into cyclical and acyclical components using regression analysis. For example, some items such as shelter respond to the strength or weakness of the business cycle, whereas others, such as core goods, are less affected.


Source: Refinitiv Datastream, Schroders Economics Group, 10 March 2021.

As shown in chart 1, the procyclical index tends to decelerate during recessions and historically,  should reach its bottom 12 months after the recession ends, as was the case following the 2008 financial crisis. This is because the cyclical components of core inflation react to changes in economic activity with a lag, which we estimate to be of five quarters.

If this relationship continues to hold, as the chart suggests, we are not likely to see upward pressure on prices from cyclical forces before the second half of 2022, when the output gap is set to close.