The Inflation Trend Is Not Yet 'Tamed'

By: Michael Ashton | Fri, Dec 16, 2011
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"Inflation Unlikely to Be a Cause for Concern," expressed the Wall Street Journal today. "The cost of oil, metals, and grains would have to jump another 20% to 30% in coming months [my note: actually, just oil] to trigger a repeat run-up in consumer prices next year. Absent that, headline inflation rates are poised to weaken."

"U.S. Consumer Prices Stagnate as Fuel Costs Show Inflation Tamed" said the headline on Bloomberg.

Why the sudden emphasis on headline inflation, now that it's converging back to core? Why are pundits abruptly myopically focused on fuel, which is 9.1% of the consumption basket (although a good part of its volatility)? I would suggest that this spin on the headline derives from the fact that economic prognosticators have been saying for some time that the slow global growth will keep inflation contained, and so they are beginning to obsess about the parts of the price index that appear contained even if they are not the important parts of the index.

Meanwhile, core inflation rose +0.173%, bumping the year/year rise in core inflation to 2.153%. Both were above expectations. Look at the chart of core inflation, below, and objectively try and decide if that looks like a "tamed" inflation trend. To me, it looks like a trending trend.

US CPI Chart
Tame? Only if you're already assuming the trend stops.

The last time year/year core inflation was 2.2% was in October 2008. It took exactly 2 years to decelerate to a low of 0.6% in October 2010. It took 13 months to return to the level. And as the chart makes clear, it has been a straight shot. Year-on-year core inflation has not fallen in a single month since October 2008.

It isn't as if this rise is being caused by wages, or by medical care, or by fuel. While the second story below takes pains to blame it on "higher medical care and clothing costs", in fact most of the basket is accelerating. The table below shows the eight major subgroups.

  Weights y/y change prev y/y change 1y ago y/y change
All items 100.0% 3.394% 3.525% 1.143%
Food and beverages 14.8% 4.373% 4.470% 1.496%
Housing 41.5% 1.918% 1.869% 0.010%
Apparel 3.6% 4.763% 4.194% -0.790%
Transportation 17.3% 8.024% 9.185% 3.750%
Medical care 6.6% 3.370% 3.116% 3.184%
Recreation 6.3% 0.348% 0.253% -0.862%
Education and communication 6.4% 1.418% 1.371% 1.590%
Other goods and services 3.5% 1.858% 1.660% 1.840%


From last month, acceleration in the year-on-year rate happened in Housing, Apparel, Medical Care, Recreation, Education & Communication, and Other, totaling 67.9% of the basket, while Food & Beverages and Transportation (mostly due to energy), 32.1% of the basket combined, decelerated. And, from 6 months ago (shown below), every major group has accelerated its year-on-year trend except Transportation (again, because of energy prices) even though the headline inflation rate itself has fallen.


  Weights y/y change 6m ago y/y chg
All items 100.0% 3.394% 3.569%
Food and beverages 14.8% 4.373% 3.363%
Housing 41.5% 1.918% 1.159%
Apparel 3.6% 4.763% 1.045%
Transportation 17.3% 8.024% 13.098%
Medical care 6.6% 3.370% 2.995%
Recreation 6.3% 0.348% -0.022%
Education and communication 6.4% 1.418% 1.029%
Other goods and services 3.5% 1.858% 1.517%


This bears repeating. There has been a 5% fall in the year-on-year rate of inflation in 17.3% of the basket. That causes an 0.88% drag on the headline number. But the headline number only dropped from 3.569% to 3.394%, because every other major group accelerated .

You can call that "tamed" if you want to. I will say that it is surprising our models, which a year ago only expected core inflation to be in the 1.6%-1.8% at year-end 2011. Housing inflation in particular has remained surprisingly high despite inventories which should be pressuring rents and home prices. And yet, prices are rising. There is just no sign of deceleration in core inflation at this point, although core inflation ex-housing rose only to 2.37% and will probably only be around 2.6% by year-end, a trifle lower than we were expecting two months ago.

This is not a growth story. While economic data on Thursday was better-than-expected, with another eyebrow-raising decline in Initial Claims and better-than-expected readings from Empire Manufacturing and Philly Fed, recovery today (such as it is) doesn't affect inflation today. Inflation, if it responds to growth at all, is supposed to respond with a lag. So that's not what is happening here.

The best candidate continues to be money and lending. M2 on Thursday night bounded ahead again, pushing the 52-week change up to +9.6%, and the 52-week rise in Commercial Bank Credit reached 2.5% for the first time since November 2008. The chart below shows both the rise in Commercial Bank Credit and the contemporaneous rise in CPI for the last few years. CPI seems to respond to changes in credit with a 6-12-month lag.

Commercial Bank Credit vs Core CPI
Commercial Bank Credit vs Core CPI - related, or at least both related to a third thing.

Well, I am not saying these things are necessarily causally related because if we trace this back to the early 1980s the fit is less persuasive, but I suspect there is a causal link which becomes more apparent when other factors are muted. It certainly fits with theory that money and lending should impact prices.

Assessing all of the data, I cannot see how a neutral observer can look at current price trends as being "tame" or "stagnated," and I can easily see how inflation might become a cause for concern...even if it isn't already.



Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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