US CPI data - A very rare red flag
As widely reported, the US Consumer Price Inflation (CPI) release on Friday was weak, but there is a significant standout in the reported data.
The annual Headline rate dropped as expected from 2.3% yoy to 1.5%, thanks to a substantial decline in energy prices which have an 8% weighting in the basket (see chart below). Energy should continue to drag headline inflation lower in coming months.
The annual core "ex food and energy" inflation rate dropped by less, from 2.4% to 2.1%. The driving force in this was the decline in "Shelter" inflation (33% basket), which reduced "Non-Discretionary" inflation. This represents inflation of goods and services that the consumer has to buy - predominantly Shelter, Medical and Educational items. Discretionary inflation of goods and services, which consumers can choose to purchase, remains at very low levels at a mere 0.6%yoy. As discussed on previous posts, a decline in shelter inflation could drag core inflation lower in the future.
But how does March 2020's data compare to previous inflation declines? Has the Covid19 pandemic impacted it more or less?
US CPI is seasonally adjusted for holidays and discounting. As a result, the month on month (mom) change in the core inflation rate is one of the most stable reported economic series in the USA. As a rule of thumb, the monthly inflation rate tends to be between 0.15% and 0.2% each month.
This stability can be seen by the BLACK columns in the chart below, which show the average mom inflation rate for the last 10 years for any particular month. The BROWN columns show the data releases for the last 12 months, and the RED shows the difference between the last reading and the 10 year average for that particular month.
I have been updating this chart for 20 odd years. A series of negative (positive) red bars quickly identifies disinflationary (inflationary) periods, which warns of changes to Fed Monetary Policy. What is very unusual in the above chart is not that the red bar is negative, it's that the brown bar is negative. This is a very unusual occurrence due to the way CPI is constructed (predominantly because to the large Shelter weighting, but that's another story). How unusual?
The chart below shows the monthly core mom changes going back to 1970. It has been negative only 5 times in the last 50 years, and only twice since inflation was tamed by Paul Volcker.
There are a lot of commentators discussing how the FED printing presses will bring hyperinflation. That may or may not be true, depending on how much the Government's fiscal policy will be, to whom it is directed, as well as how the recipients of that fiscal policy behave. Whilst the numbers seem huge, they could be very small if corporates and households decide to deleverage.
More immediate and pressing for financial markets is that the current data is pointing to a classic disinflationary slowdown as businesses retrench and unemployment rises in a highly leveraged economy. Whilst the outlook for inflation in the longer term will be clearer when we know more about fiscal policy, current trends suggest low consumption in the short term and the likelihood of disinflation.