'Team Transitory' is proving the fear mongers wrong and winning the battle over inflation

• Economists and experts who believe the recent inflation surge is temporary are known as "Team Transitory."
• "Team Transitory" got a big win in last week's consumer price index report.
• Inflation for major categories like used cars, hotel prices, and others cooled off and there's good reason to think many price increases have topped off.
• George Pearkes is the global macro strategist for Bespoke Investment Group.
• This is an opinion column. The thoughts expressed are those of the author.

The most recent consumer price index report, a key measure of inflation, gave a huge boost to economists and analysts on "TEAM TRANSITORY", a term coined by former Federal Reserve economist Claudia Sahm to describe those who believe the very high inflation seen in recent data releases wouldn't continue.

In other words, it's looking more and more like the rapidly rising prices coming out of the pandemic are justa short-term conflagration rather than a long-term burn.

Level shift versus rate of change

To see why Team Transitory is more confident, it's important to recognize that there are two ways to discuss inflation: level versus rate of change.

First, there is the "level" of prices: how much does a given basket of consumer goods cost now versus in the past. For instance, the consumer price index today is 272.265, 172.265% higher than its average level in 1982-1984. Put another way, a dozen bananas going from $0.50 to $2.15 would be a level increase.

Second, there is the "rate of change" of that level. When economists discuss inflation, they're typically referring to this latter basket. All but a few fringe economists believe modest growth in prices over time is healthy for an economy, giving consumers and businesses incentive to spend without eroding purchasing power dramatically. Most economists prefer to look at these prices excluding categories like food and energy, which tend to be very volatile.

Excluding food and energy, BLS data shows consumer prices rising 5% from the end of 2019 through July of 2021, or 3.2% at an annual rate of change - much higher than the roughly 2% annual change that the Federal Reserve and other policymakers aim for. There has been much debate over whether this change in prices has represented a shift in the level of prices or their rate of change.

When economists think about inflation, they tend to look past one-off changes in price levels. The reason is simple: a 5% increase in all prices today is much easier for the economy to digest than 5% today, followed by 5% tomorrow, and 5% the next day. In our current context, the worry is not about the current pop in prices we're seeing, but whether they'll keep rising at that rate.

From the perspective of policymakers, level shifts are also less important because they have to decide what will happen in the future. Level shifts are one-off, rates of change happening both now and in the future.

COVID and US inflation

During 2019, the US economy experienced consumer price inflation around 2%, or 2.2% using core CPI specifically. That was a bit slower than the Federal Reserve wanted given very weak inflation in preceding years, but was definitely not excessively high.

Then, COVID hit. Prices plunged overall as consumer demand dried up with people staying at home. That brief stint of deflation only lasted about three months, and by the third quarter of last year prices were rising again in a sharp but short bounce back.

Still-limited consumer activity meant low inflation during the end of 2020 and start of 2021, but large fiscal transfers - like the stimulus checks sent out to households - and the ability for consumers to go out and safely spend again helped stoke huge price gains earlier this year.

Adding to the price growth were supply chain issues for durable goods, especially autos. Rental car fleets were slashed last year, but low rates and fiscal stimulus meant that they were able to sell those cars. Then, when it came time to rebuild rental fleets, there were no cars to buy. New cars are also in short supply: ports were and are at capacity, shortages of critical parts like semiconductors jammed up production schedules, and consumers still had lots of cash available. All of this added to suddenly soaring car prices.

To break it all down, the chart below shows month-to-month changes in core CPI (which excludes food and energy) converted to an annual rate of change. Core CPI is decomposed into three categories. About 6% of core CPI is "reopening sensitive" categories that are most affected by people getting out of their homes after long restrictions - used cars and trucks, rental cars and trucks, airline fares, and the category of rent that includes hotels. A second category focuses just on non-hotel rent paid explicitly by renters and implicitly by homeowners, accounting for 44% of core CPI. The third and final category is everything else, about half of all core consumer prices.

"Team Transitory" argued that the recent surge in prices was a level shift: it was a real increase in prices, but it wouldn't sustain into the future. Since it was temporary, "Transitories" further argued that policymakers in Congress and at the Fed shouldn't ease up on their support for the economy - which is still weak - in reaction to the price jump.

Others, ranging from Republican politicians to economist Larry Summers argued that the recent move higher in the rate of change of prices would continue.

As shown in the chart above, the July inflation report released on Wednesday was a point for Team Transitory. Core prices are still rising sharply, at a 4% annualized rate, but that's much slower than the double-digit annualized advances in April, May, and June.

Will transitory truly triumph?

Despite accounting for a very small slice of overall core CPI, reopening categories that drove so much of the level shift in prices earlier this year still added 1.26% to the total annualized change, almost entirely because of hotels which added 1.27%. Car and truck rental prices declined, and used cars and trucks added 0.1% to the total annualized change.

Turning to the remaining two major categories from the chart, the biggest concern is rent. Excluding hotels, rental prices added an average of 0.74% annualized per month to overall core CPI from June of last year through April of this year, but over the last two months that has ramped up to 1.43% and 1.35%. That's a pretty big acceleration, but keep in mind rent accounted for an average contribution of 1.35% during 2019 when inflation was roughly where policymakers wanted it.

In other words, rent is now consistent with pre-COVID policy success when it comes to inflation. Hot rental markets across the country are likely to firm a bit more, especially given the wave of evictions and associated turnover that are taking place with the end of the federal government's eviction moratorium. But there is some room for higher rent prices that don't drive overall inflation out of control.

Finally, all other categories are quite volatile. During 2019 they averaged about a 0.85% contribution to the total, compared to 1.40% in August. But as supply chains normalize, durable goods outside of autos are likely to see less price pressure, and a number of historical drivers of consumer inflation in the US (medical care and tuition) are seeing very weak prices - tuition rose just 1.1% over the past year (near a record low), prescription drug prices fell over the past year, and medical care services prices rose less than 1% over the past year.

It's too early to call the inflation game over, but the July data from the BLS suggests Team Transitory is winning, and a wide range of economic forecasters who cried wolf are going to be sucking wind in the locker room with a loss.