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Inflation fears may be starting to pass

·3 min read

This article first appeared in the Morning Brief. Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET. Subscribe

Wednesday, July 7, 2021

Pricing pressures stopped getting worse for the service sector last month

If we wind back the clock to mid-May, the only idea it seemed investors wanted to discuss was inflation. 

The argument from many economists and Federal Reserve officials — then and now — was that pricing pressures would prove "transitory," or that these pressures would pass in time. Investors at the time disagreed. 

But survey data released Tuesday shows that while pricing pressures remain elevated today, the rate of change has slowed. And an eventual slowdown in inflation's rate of change is what the transitory crowd has been arguing for all along. 

The Institute for Supply Management's service sector activity report published Tuesday showed the price paid sub-index fell 1.1 points in June, but remained at a historically elevated 79.5. Any reading in this report over 50 indicates activity increasing — in this case, prices rising — while readings below 50 suggest contraction in the sector. 

IHS Markit's final look at service sector activity in June also suggested input prices remain elevated, with this index registering its second-steepest rise on record. Only May saw prices rise more quickly. 

But like the ISM report, IHS Markit's data showed a dip in the rate of input price increases when compared to the prior month. In other words, costs are rising across the board but are increasing at a slower rate. Which also means cost pressures appear to be transitory, an outcome that has brightened the outlook for businesses in the economy's biggest sector.  

IHS Markit's report noted that "business expectations regarding the outlook for output over the coming year improved at the end of the second quarter. The degree of optimism strengthened to the highest since November 2020, as firms gained confidence following a more extensive reopening of the economy and expressed hopes of further boosts to client demand. Survey respondents also cited a reduction in concerns over inflation." (Emphasis ours.)

And markets seem to be preparing for this outcome. Long term Treasury yields have steadily declined in recent months, with the 10-year yield touching 1.37% on Tuesday, its lowest level since February. Other measures of inflation expectations like 5-year, 5-year breakevens have also cooled in recent weeks.

And as the IHS Markit report showed, current input pressures for businesses — be they labor, materials, or other costs — are also in part being offset by higher prices amid a strong consumer backdrop and fueling what Oxford Economics said Tuesday is a "services boom." 

According to Nancy Vanden Houten, lead U.S. economist at Oxford Economics, "the summer services revival has taken hold."

She added: "Looking ahead, re-openings and rising confidence fueled by the much-improved health backdrop – despite the recent uptick in cases — will continue to propel the services boom. Labor shortages and high input costs will restrain the expansion, but those pressures should slowly lessen in the second half of the year."

By Myles Udland, reporter and anchor for Yahoo Finance Live. Follow him at @MylesUdland

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