Look, I know that traders sometimes think their job is to overreact. And media folks benefit from overreacting. And political strategists have been genetically bred to overreacting. But a bit of rational analysis here is probably worthwhile.
The obvious backdrop to the CPI release this morning is the somewhat-greater-than-usual volatility in the equity market,[1] and some concerns that the economy might finally get that recession that I and others have been expecting for so long – although don’t get too chippy on that, since the Q1 contraction would be mostly due to a surge in imports from front-running tariffs. The narrative has shifted back to the question of how soon the Fed might ease, even if inflation is still a little problem, since Unemployment has risen to the nosebleed level of 4.1% and stocks are in the crapper (technical term).
Geez folks, take a chill pill.
Similarly, don’t cue the trumpets just yet on inflation. The expectations coming into today’s figure were for +0.31% on headline CPI and +0.30% on core CPI. The actual prints were +0.22% and a delightful +0.23% on Core.
Sure, the chart shows this is definitely better than last month! And it’s even better than the average of the last two months (I’d said last month you probably should average between December and January figures). But…it’s also a little early to take a victory lap. Here is Median CPI (last point, as usual, is my estimate for today).
If it’s 0.29% m/m, as per my estimate, then we are at a 3.5% run rate. And that’s basically where we have been over the last six months. Oh, and while y/y Core CPI is down to 3.1%, it’s at 3.5% over the last three and the last six months. We are settling in at the mid-3s.
The culprits behind last month’s spike were used cars, health insurance, lodging away from home, Pharmaceuticals, and hospital services. Of those, only Used Cars (+0.88% m/m) contributed very much to this month’s number. On the other hand, Airfares dropped -4% m/m. Here are the Major-8 categories.
The optimistic view is that there isn’t any one category that looks out of control on a y/y basis. That’s also the pessimistic view, because it speaks of a broad – if not particularly high – inflation that is still percolating out there. Core Goods this month was still -0.1% y/y, but Core Services dropped from 4.3% to 4.1% y/y. Pharmaceutical prices, which just had their largest monthly rise in history last month as drugmakers tried to get their licks in before the Trump Administration forces them to lower prices, rose only +0.18% m/m this month. Both Primary Rents and Owners’ Equivalent Rent were +0.281% m/m. These are also settling in, on schedule.
“Settling in” is what is happening in shelter. And that again is both good news and bad news. A lot of the forecasts we have seen over the last couple of years that called for inflation to steadily return to trend depended on the assumption that the rent declines we have seen for new rents in a few cities would become a broad-based trend in all of shelter. But it’s not, for two reasons. On the rental side, costs keep rising for landlords (that’s the basis for our model in the prior chart). And on the home purchase side, there’s just still a big deficit in homes available for sale.
While that could change – it seems to be changing in the Washington, DC area but the people leaving Washington still need homes elsewhere – if deportations pick up a lot, there is no sign yet that shelter is going to do the heavy lifting of getting inflation back to 2%. Neither is SuperCore, although this month it was +0.22% m/m and in general is looking a little better.
But none of this looks exciting. None of this looks like it’s going to be the start of a Fed victory lap on inflation. Even the Enduring Investments Inflation Diffusion Index looks like it’s settling in, and like all of the other stuff we have looked at, it’s settling in at a level higher than pre-COVID.
And while we’re talking about distributions, here’s another one I haven’t run in a while. This is the distribution of y/y changes by the lowest-level CPI components. The big spike in the middle is obviously housing. There is a cluster between 1% and 4%. But look at that big left tail. 20% of the basket is actually deflating, y/y.
What’s interesting about that column on the left is that it is a whole bunch of little things. Breakfast cereal. Pasta. “Other meats” (shudder). Potatoes. Tomatoes. Soups. Snacks. Window coverings. Dishes. Men’s shirts. Audio equipment. In other words, a whole lot of things that are so small, consumers don’t really notice them so much and so they don’t really affect their sense of inflation being high. But they notice eggs.
So this is good news…in that a lot of things are deflating…but also bad news is that a lot of these are things that tend to mean-revert. You’ll notice that some of the categories I just listed are core goods, which are still in deflation…but which are also the things which are going to rise in price when the tariffs start to hit. The largest single piece still in deflation is New Cars, at a 4.4% weight or so. Unfortunately, that’s not going to be in deflation when tariffs hit auto parts and slow the import of non-US vehicles.
So let’s wrap this up.
The conspiracy nuts will say that Trump cooked the numbers, because it was better-than-expected about something that was a campaign promise of his. But this is normal variation, and the bottom line is that the inflation figures look to be converging on 3.5% or so, before the effects of tariffs kick in. The near-term effects on inflation are definitely upwards. Peace in Israel and Ukraine, if it comes, may put a small damper on energy prices but the bigger effect there is US energy being unleashed again, which will take some time. But outside of the peace effect, there are few good near-term trends but also few really bad near-term trends other than the (relatively small) effect of tariffs. Inflation is settling in.
The funny thing is, I don’t think the Fed cares. I think they’re satisfied enough with the progress on inflation, and they still think that recessions cause disinflation (they don’t) so that they feel they can focus on the growth part of the mandate, for now.
[1] Dubbed a ‘crash’, or ‘freefall’, or some other appellation by observers who can’t remember the last time we saw a 10% pullback. Which is only about 6% if you look at the equal-weight, or a 60-40 blend of stocks and bonds. If this warrants the “what do you say to Americans who now can’t retire because they’re seeing their retirement accounts collapsing” line, my answer would be “I would say those Americans probably shouldn’t have been invested in stocks at all if this causes them to delay retirement.”