US CPI inflation in June hit a new high since 2008, exceeding market expectations for the third month in a row. This shows once again that the market and the Federal Reserve have underestimated the upward risk of US inflation, and inflation is not temporary (It is non-transitory). Our repeated reminders over the past few months not to underestimate US inflation have basically been confirmed. Looking ahead, rising inflation will present challenges to the Federal Reserve, and uncertainty about US monetary policy will rise further. One risk to be wary of is that the Federal Reserve will be forced to withdraw early from easing, which in turn will have an impact on asset prices.

The US CPI quarterly increased 0.9% month-on-month and 5.4% year-on-year in June, the highest level since August 2008. Core CPI increased 0.9% month-on-month and 4.5% year-on-year, the highest level since November 1991. This is also the third month in a row that US CPI inflation has exceeded expectations.

Looking at the breakdown, prices for goods and services related to going out increased significantly, continuing the May trend. On the commodity side, used cars increased 10.5% month-on-month, which is also the biggest monthly increase in the history of this indicator. New cars grew 2% month-on-month, the highest growth rate since 1981. Gasoline (2.5%) and food (0.8%) prices are also rising at an accelerated pace, while clothing prices (0.7%) are still expanding. In terms of services, hotels (7.9%), car rental services (5.2%), air tickets (2.7%), cinemas (0.9%), and car insurance (1.2%) increased significantly. The above data suggests that the rise in prices brought about by the economic restart may be far from over.

In terms of products with new price increases, the price increase for cable TV services (1.2%) is quite obvious. We speculate that this is related to many major sporting events held in June. The price of express delivery services (1.3%) showed an accelerated upward trend, which we think is more in line with the current labor shortage. Looking ahead, if the labor shortage cannot be alleviated, then the transmission effect of rising labor costs on inflation may be further highlighted. We also emphasized earlier that labor costs in the service industry are high, and most service products are non-tradable goods, making it difficult to transfer the pressure of price increases outward. This may also bring greater pressure on service inflation.

As it turns out, the rise in US inflation may not be a temporary phenomenon. Since the beginning of the year, most Federal Reserve officials have viewed inflation as transitory (transitory), one reason being that supply bottlenecks will subside over time. However, this is not the case. Until now, we have seen no sign of supply bottlenecks abating; on the contrary, labor shortages are getting worse. This shows that the Federal Reserve underestimated the extent of supply constraints and therefore underestimated the risk of rising inflation. Although the Federal Reserve adjusted its PCE inflation forecast for this year (from 2.4% to 3.4%) at the FOMC meeting in June, this adjustment may not be enough. Looking ahead, the Federal Reserve may further raise its inflation forecast for this year at the September FOMC meeting. Furthermore, the possibility that higher levels of inflation will continue until next year is not ruled out.

For the market, one risk to be wary of is the early withdrawal of the Federal Reserve from monetary easing. Currently, the Federal Reserve is in a rather embarrassing situation: on the one hand, employment recovery is progressing slowly due to labor shortages, and the spread of the Delta virus has increased the uncertainty of the epidemic. It is difficult to say that the economy has made “substantial further progress.” But on the other hand, inflation continues to rise, and housing prices and asset prices have risen sharply over the past year, increasing the need for the Federal Reserve to tighten its currency. In fact, the minutes of the June FOMC meeting show that some Federal Reserve officials hope that despite starting Taper discussions, they will at least cut back on MBS purchases first to reduce the upward pressure on housing prices. We believe that if the Federal Reserve eventually withdraws from easing early due to high inflation or concerns about financial risks, those liquidity-driven and highly valued assets will face greater adjustment pressure.