What It Means for Inflation and Construction Economy

Is this the light at the end of the tunnel? U.S. consumer prices remained unchanged last month, with the Consumer Price Index (CPI) showing no increase from April to May. While this might seem ay first like inflation is a thing of the past, the reality is more complex. Still, CEO of Paragon, Jeff Hall explains, “The lingering effect of double-digit inflation remains a hangover for many in the construction industry.  That coupled with the high interest rates are making projects less financially feasible.”

Market Reactions and Expectations

According to an article by Kelly Evans in CNBC’s The Exchange, the bond market reacted strongly to this development. Not only was the headline CPI flat, but the core CPI, which excludes volatile food and energy prices, rose by just 0.2%, below expectations. Although the year-over-year rates for both remain above 3%, consistent monthly readings like these could indicate a return to normal inflation levels. Consequently, markets are now anticipating two rate cuts by the end of the year. However, the Federal Reserve has made it clear that it only predicts one rate cut this year. As Jeff Hall says, “The rule remains, don’t fight the Fed.”

Consumer Sentiment and Realities

Despite these numbers, consumers are still feeling the pinch. Confidence and sentiment indicators are unusually low for a job market this strong. The reason? The cumulative impact of inflation over the past four years, exacerbated by the pandemic. No one feels good about paying $9.19 for a McDonald’s 10-piece chicken nugget meal, even if their earnings have increased. Especially as wages have stayed the same for the middle and lower classes. This is keeping people in the houses or apartments with little interest of upgrading their housing, a keep driver in the construction industry. 

The Impact of "Needs" Inflation

The most significant recent price increases have been in unavoidable expenses like healthcare and insurance—what experts refer to as "needs" areas. For many companies, non-discretionary CPI baskets were up 6.2% year-over-year, while the discretionary basket rose by just 0.3%. This shows that despite being frugal, many necessary expenses are still rising, creating tightness in the budget. This is a tax on both construction companies and individuals, since most firms only pay a portion of employees benefits.

Corporate Earnings and Consumer Behavior

"Needs" inflation is acting like a tax, reducing discretionary spending and affecting corporate earnings. For instance, Pepsi has noted that lower-income consumers in the U.S. are becoming more selective about their purchases. Similarly, Tyson Foods has observed a more cautious, price-sensitive consumer base. When consumers cut back on non-essential treats, it leads to decreased sales and tighter profit margins for companies. This reduction can also lower production rates and demand for raw materials, potentially resulting in workforce cutbacks. Businesses must adapt by reevaluating their product offerings, pricing strategies, and cost structures to maintain profitability. The broader economic shifts driven by inflationary pressures on essential needs emphasize the need for strategic adjustments across various sectors. Unemployment has risen 20 basis points in the last two months and will likely continue on that trend.

Persistent "Needs" Inflation

Unfortunately, inflation in these essential areas is likely to remain high. Healthcare costs are notoriously difficult to control, and insurance rates are expected to keep rising. Shelter inflation also continues to surge, with single-family rental prices putting upward pressure on overall costs.

The Fed's Challenge

The Federal Reserve is closely monitoring these "super-core" inflation areas and is unlikely to lower rates significantly until these pressures ease. This approach might mean that the Fed’s policies are overly restrictive, aiming to reduce inflation in sectors still experiencing pandemic-related pressures.

Diverging Inflation Trends

Parts of the economy could see deflation well before inflation is under control in these sticky areas. Online prices, for instance, have been falling for almost two years, according to Adobe's Digital Price Index. In May, the index was down 5% year-over-year, with notable declines in apparel, electronics, appliances, and furniture.

Growing Economic Disparities

As "needs" versus "wants" inflation persists, the disparity between the economic classes will likely widen. Both consumers and corporations will continue to feel these effects, creating further challenges in the economic landscape.

Potential Impact on the Construction Industry

The stabilization of U.S. consumer prices and the minimal increase in core CPI suggest a complex inflationary environment that could have significant implications for the construction industry. While the bond market anticipates potential rate cuts by the end of the year, persistent inflation in essential areas like healthcare, insurance, and housing continues to strain consumer budgets. This persistent "needs" inflation reduces discretionary spending, potentially slowing down demand for new construction projects, particularly in the residential and commercial sectors. As consumers and businesses tighten their belts, construction firms may face decreased demand for new projects and renovations, leading to potential workforce cutbacks and a reevaluation of project scopes and timelines. Moreover, rising costs in essential services could increase operational expenses for construction companies, squeezing profit margins. Firms must adapt by optimizing their cost structures, exploring innovative project delivery methods, and maintaining flexibility in their planning to navigate this evolving economic landscape.