Used car prices in the US continue to surge due to both the country's economic recovery and an ongoing supply crunch.
There are two components to watch in the core inflation report due next week. First is, and most importantly, are used car prices and second is the rent of shelter.
Core inflation in April saw a more significant contribution to used car prices pushing inflation upwards of 2% YoY mainly because prices of used vehicles on the month jumped 21% YoY.
For those who haven't seen what is going on in the used car space, here is a chart of the Mannheim used car index:
"Prices on used vehicles increased by an astonishing 21 % YoY in April (contributing 0.8% to the yearly change in core inflation). According to Manheim Consulting, prices on used cars and trucks are expected to climb further to 50 pct YoY in May or June (3 months lag). If we assume a 50% yearly increase in used cars in May (Manheim may exaggerate the yearly price increase a bit), then core inflation will potentially surpass 4%. Supply chain disruptions, shortage of semiconductors and Covid-19 restrictions have all played a part in disturbing the price action in the car market, but bottlenecks are not always the root cause of inflation - they can also be seen as a symptom," said Nordea.
This means that the May inflation report next week (due June 10) could be an absolute shocker.
"We see clear risks of a big positive surprise to the May inflation report as well with core inflation around or just above 4%. The market is still buying the transitory inflation narrative but for how long? Lately, increasing (US) inflation has been the main concern of markets," Nordea said, adding that, "We are likely in for another inflation shocker in June, but the question is whether the market will explain it away as a transitory effect."
Peering into the real world, Financial Times speaks with people within the industry and in financial markets about what's fueling used car prices.
Carey Cherner, a 36-year-old used car dealer in Maryland, sold a 2001 Ford F-150 pick-up truck with close to 200k miles for $7,500, more than 50% higher than pre-pandemic prices.
"There are more people buying cars than there are cars in the market, which makes it go kind of crazy," Cherner said.
Policymakers, such as Federal Reserve members, continue to soothe the market with the word "transitory" almost daily, as a form of a communication tool to admit there are inflationary pressures but avoid market participants from panicking.
Lael Brainard, a Fed governor, said earlier this week that used car cost pressures "may persist over the summer months, I expect them to fade and likely reverse somewhat in subsequent quarters".
But the problem here is that policymakers have been telling us that these pressures are "transitory" for months and keep pushing out the goalposts of when they want everyone to believe inflation diminishes.
Nathan Sheets, the chief economist at PGIM Fixed Income and a former under-secretary at the US Treasury, said there is an "unprecedented level of stimulus plus other forms to support spending" floating around the economy. A combination of helicopter drops by the federal government and supply chain disruptions resulted in the quickest "V-shaped" recovery that ultimately sparked supply constraints, driving up prices.
"How sure am I that I am right that inflation is going to dissipate? Probably 80 percent, but that is still a pretty fat tail," Sheets said.
"It's incredibly tight right now: you have more demand . . . that is supported by fiscal stimulus, so it's just like a perfect storm. And we see that clearly in prices," said Laura Rosner, a senior economist at MacroPolicy Perspectives.
But Jonathan Smoke of Cox Automotive, a consultancy for automobile dealers, noted that "several leading indicators of what's happening at our auctions" suggest "the price appreciation streak is likely going to end."
However, in Maryland, Cherner doesn't believe there will be a "steep drop-off [in prices] until there's way more supply than there is demand. They [automakers] still have to build the new cars and get the chips in them and get them out. I just think it's going to last."
So the main driver in next week's inflation report will most likely be surging used car prices, and the red hot numbers may cause the Fed to start tapering or at least continue to communicate a future wind-down of its emergency pandemic policies this summer.