The Doctrinal Dismissal of Inflation
The Church of the High Dove has pronounced its verdict on claims that the ghost of inflation has once again been haunting the U.S. economy.
It is just an illusory apparition. A single month’s data. Only a fool would mistake the aberrational January price surge for an economic trend.
Federal Reserve Bank of Chicago President Austan Goolsbee donned the mantel of the Mouth of Immaculate Disinflation on Wednesday, providing the faithful with their catechismal reassurance that there really was nothing to worry about. Inflation remains on “the path to the target.”
Bloomberg reports:
The Chicago Fed president, who does not vote on policy decisions this year, emphasized it’s important not to judge the inflation trend from one month’s number and that the Fed’s 2% target is based on the personal consumption expenditures price index, not CPI.
He noted that the two metrics can differ “somewhat significantly.”
“I don’t support waiting until inflation on a 12-month basis has already achieved 2% to begin to cut rates,” said Goolsbee, adding that the central bank’s current policy stance is “quite restrictive.”
For those of us navigating the markets without the abiding faith that inflation is on a path to two percent, however, the latest consumer price index (CPI) report looks not like a deviation but the continuation of a months-long course toward higher inflation.
We noticed back in December that the consumer price index was no longer indicating a sequential slowdown, as it had in the previous two months. The pace of CPI accelerated in November from 0.08 percent in the previous month to 0.16 percent. While still a slow pace, it was a warning sign that inflation was no longer slowing. In December, it picked up to 0.23 percent. Tuesday’s data showed that last month, CPI rose 0.3 percent.
As we explained a month ago, it appeared to us that “disinflation is over.”
The chart below illustrates the point perfectly. January was not a deviation but the third month in a straight-line trend toward higher inflation.
The upward trend in core inflation has been in place since last summer. The numbers have bumped around; but the trend is clear, as the chart illustrates.
The Median Is the Message
For those willing to look deeper into the data and break from the orthodoxy of Wall Street and the Fed, there’s been an even longer series of data indicating that disinflation had run its course. The Cleveland Fed’s measures of median inflation and 16 percent trimmed mean inflation have been flashing warning signs of the risk of higher inflation for more than half a year.
And for those readers who missed it, here is our analysis from May:
Our preferred measures of underlying inflation, which we think points to the likely direction of inflation in the near future, is the Cleveland Fed’s median CPI and 16 percent trimmed mean CPI metrics. Median CPI rose 0.4 percent in April, exactly as it did in March. The alignment of median CPI, core CPI, and headline CPI suggests that inflation is no longer being driven by outliers but has converged on a central tendency and is likely to remain sticky at this elevated level.
Over the past 12 months, median CPI is up seven percent. Since December, when median CPI was also seven percent, this has been stuck in a range between seven percent and 7.2 percent. In other words, there’s no sign of underlying progress. And the fact that median is above the headline and core suggests that the underlying pressures remain strong. That means the risk to inflation remains to the upside.
In July—when headline CPI was just three percent year-over-year and rose 0.2 percent sequentially—we were still warning that there were ominous sounds rumbling beneath:
More troubling than either core or headline inflation, however, is the resistance of underlying inflation. Median CPI was unchanged at 0.4 percent for the month, the third consecutive month at that rate, according to the Federal Reserve Bank of Cleveland. The Cleveland Fed’s calculation of 16 percent trimmed-mean CPI came in at 0.2 percent, exactly where it was last month.
This suggests that inflation is unlikely to come down by much more in the months to come.
In September, we were pointing out the problematic median and trimmed mean CPI numbers again:
The measures of underlying inflation indicate that price pressures really did pick up in August. Median CPI rose to 0.3 percent for the month, up from 0.2 percent, according to the Federal Reserve Bank of Cleveland. The 16 percent trimmed mean measure did the same thing, rising from 0.2 percent to 0.3 percent.
We’re not quoting ourselves simply because we enjoy reviewing the accuracy of our past forecasts. We do enjoy that, but this time it makes an important point: the inflation data has not been depicting an economy on the path to two percent. For anyone with eyes to see, the inflation data has been telling the story of not just clouds on the horizon but a gathering storm.
The following chart of the annualized monthly change in median GDP tells the story very well. Median inflation bottomed over the summer and then climbed back to a high rate. For some months it was range bound but broke higher in January.
Ironically, the core and median CPI charts both suggest that disinflation died right around the time the Fed decided it no longer needed to raise interest rates to push down inflation.
PCE Inflation Is Also Rising
Goolsbee raises the point that the Fed targets two percent on the personal consumption expenditure (PCE) inflation index rather than CPI. But this climbed in December and will likely climb further when the January figures are released later this month.
“It’s important to remember that the Fed targets PCE inflation rather than CPI. Therefore, the read-through to PCE is what matters for monetary policy. Based on today’s CPI numbers, we estimate core PCE could also accelerate from 0.17% m/m to 0.30% m/m in January,” Bank of America‘s analysts wrote in a recent client note.
Next month’s reports will likely not provide any relief. The Cleveland Fed’s inflation Nowcast has headline CPI up 0.4 percent for the month and core CPI up 0.3 percent.
Joe Lavorgna of SMBC Nikko Securities points out that recent history in a note to clients on Wednesday that we should expect an upside surprise in the next CPI report also:
Inflation tends to be the highest in January and February and then sharply slows thereafter. While this pattern should still hold, the January and February gains are getting larger relative to the rest of the year as shown below. The upshot? This “residual seasonality” increases the probability that core inflation surprises to the upside again next month. [emphasis in the original]
Those singing from the High Dove hymnal appear to be entranced by the siren song of transitory disinflation. To paraphrase Ben Affleck of the Dunkings: ignore inflation at your peril.
The evidence is mounting, as solid and as undeniable as the ground beneath our feet. Inflation is here, it’s real, and it’s time to pay attention.
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