The BLS announced the January inflation report on February 13, indicating that the CPI rose 3.73% in January on a seasonally adjusted annualized basis. This was much larger than December’s increase of 2.83%. As we have mentioned several times, the one month number is extremely volatile and therefore should not necessarily be a sign of trend inflation on the rise. Having said that, our preferred measure of trend inflation also increased slightly from 2.73% to 3.06%.
A large part of the increase came from the shelter component rising over 7% and is about 36% of a household’s expenditures. Energy components fell somewhat. Yet, core CPI inflation rose from 3.35% in December to 4.81% in January (monthly annualized rates). Our measure of trend core CPI inflation also rose, from 3.43% to 3.89%.
The only bright spot to the CPI report is that year-over-year inflation declined. However, as we learned a couple of years ago, this measure is very slow to respond to changes in trend.
What does the CPI report imply for policy? To start, the Fed’s 2% inflation target is for core PCE (personal consumption expenditures) inflation, not (core) CPI inflation. PCE data for January will not be released until February 29. While the year-over-year core PCE inflation rate for January may fall, based on higher trend CPI inflation, it seems likely that trend core PCE inflation will likewise rise. The Fed will probably want to see a steady decline in underlying inflation toward its target before lowering its interest rate. It seems unlikely that the Fed will be lowering rates soon.
The December CPI (Consumer Price Index) report, released by the BLS (Bureau of Labor Statistics) is bad news on the inflation front. By almost any measure, CPI inflation is up. By our recently discussed “constant gain” measure of trend inflation, it rose by 0.4 percentage points for the overall CPI, and by 0.15 percentage points for core CPI (excluding food and energy). On a year-over-year basis, overall CPI rose 0.2 percentage points while core CPI fell by 0.1 points. The figures below show that the one-month annualized inflation rates are also up.
For monetary policy, what presumably matters is not what’s happening with CPI inflation but rather PCE (Personal Consumption Expenditures) price inflation since core PCE inflation is what the Fed looks at. Although it is probably the case that the CPI works to influence the policy makers. The PCE data won’t be released for another two weeks. However, given the broad similarity in the goods covered by the CPI and PCE deflator, it’s a reasonable guess that (core) PCE inflation will also be up. If so, the Fed will be faced with some difficult choices: Do they treat December as (maybe) an aberration and stand pat, or will they view December as the harbinger of another inflationary pulse? Or, cognizant of the long and variable lags associated with the effects of monetary policy, will the Fed leave rates unchanged since they’re already added enough tightening? Having said that, the “trend” line has not risen by much and for the core is basically flat. Therefore, from a long and variable lag perspective it seems doubtful that the Fed will alter their current stance at the meeting at the end of the month.
On November 30, the Bureau of Economic Analysis (BEA) released PCE (Personal Consumption Expenditure) data for October 2023. The BEA notes a small monthly change in the PCE deflator (0.6% at an annual rate, down from 4.5% in September), and that the 12-month PCE inflation rate came in at 3.0% (down from 3.4% in September). These numbers largely mirror the earlier CPI (Consumer Price Index) release: the annualized monthly change fell from 4.8% to 0.5%; the 12-month rate from 3.7% to 3.2%. We prefer to look at the 3-month annualized inflation rate which also fell, from 3.7% to 3.2%; CPI inflation fell from 4.9% to 4.4%.
The cognoscenti know that the Fed’s preferred inflation measure is so-called core PCE inflation (taking out the food and energy components). By this measure, the monthly inflation rate fell from 3.8% to 2.0%, a larger decline than recorded by core CPI (3.9% to 2.8%). The 12-month inflation rate fell by 0.2 percentage points, to 3.5%; core CPI inflation fell by 0.1 percentage point to 3.0%. While our preferred 3-month annualized inflation rate fell, it was essentially unchanged at 2.4%. In contrast, the 3-month annualized change in core CPI rose in October, from 3.1% to 3.4%
In summary, the PCE inflation numbers for October confirm what was seen in the CPI inflation reported about two weeks earlier: inflation is down. How much depends on which series you focus upon. Keeping in mind that CPI inflation tends to run about 0.5 percentage points higher than PCE inflation, the data for October suggest that the US economy is approaching the Fed’s 2.0% inflation target.
Gross Domestic Product (Second Estimate)
On November 29 the BEA announced that real GDP for Q3 was revised up from 4.9% to 5.2%. While revisions to nonresidential fixed investment and state and local government spending were the leading causes of the increase, consumer spending was revised down.
Policy outlook
Given the continued decline in the inflation numbers and the continued strength in the output numbers, it appears the economy has digested the record increases in the Fed Funds rate without roiling the real side of the economy. There seems little doubt at this point that Fed policy is achieving its inflation reduction goal and may have reached the peak of the Fed Funds rate during this cycle. That is, nothing in the data points to the need for further increases in the rate and the market is suggesting some rate declines in 2024.
The BEA announced May PCE (Personal Consumption Expenditure) data that reinforces the earlier CPI (Consumer Price Index) report: Inflation continues to creep down. Annualizing the month-over-month change in the PCE, inflation for May was 1.55%, well below the Fed’s 2% target. As we have commented before, these month-to-month changes contain a lot of noise and our preferred measure is the annualized 3 month change. By this measure, inflation for May was 2.45% – somewhat higher than the 2.2% reported earlier for the CPI. The headline year-over-year PCE inflation rate for May was 3.85%. As we have emphasized in previous posts, this year-over-year measure of inflation is slow to respond to changes in trend which means it will take some time for the year-over-year inflation rates to reflect the lower inflation rates that have come in over recent months.
Less rosy is the inflation picture coming from core PCE (that is, excluding food and energy). While the month-over-month rate was down in May – from 4.65% to 3.84% – the year-over-year and 3 month measures fell by roughly 0.1 percentage points. Presumably, the reason to look at core PCE inflation is that it provides a better gauge of underlying trend inflation than non-core PCE measures. But for our money, the 3 month PCE inflation rate does a good job capturing developments in trend inflation.
For June, expected inflation is now running below 2% at all horizons. Collectively, the results for CPI, PCE and expected inflation suggest that the tightening of monetary policy over the past year-and-a-half has brought down both actual and expected inflation. In this context, the Fed’s decision in June to pause its tightening of monetary policy seems like a good one, especially if one takes into account the well-known long and variable lags of the effects of monetary policy on the economy.
Finally, while we at Economic Snapshot usually do not comment on GDP (Gross Domestic Product) revisions, we are making an exception for the data released on Thursday by the BEA. The output revision was a very large 0.7 percentage points, from 1.27% to 2.00%. This upward revision of output can be attributed to upward revisions in consumption and exports, and a downward revision of imports (which has a positive effect on output since imports are subtracted from output). These effects were partially offset by small revisions in investment and government spending.
Second Revision
Third Revision
Difference
Output
1.27
2.00
+0.73
Consumption
2.65
2.93
+0.28
Investment
-2.10
-2.17
-0.07
Government
0.88
0.85
-0.03
Exports
0.66
1.00
+0.33
Imports
-0.75
-0.37
+0.38
GDP growth for the first quarter of 2023, and contributions to GDP growth by its major components.
The increase in real GDP was widespread according to the state GDP estimates. Real GDP increased in all 50 states in Q1. The largest increase came in North Dakota, 12.4% at annual rate and the lowest in Rhode Island and Alabama at 0.1%. Personal income increased in all but two states, Indiana (-1.0%) and Massachusetts (-0.9%).
The BLS announced that the Consumer Price Index for all urban consumers (CPI-U) rose 0.1% in May on a seasonally adjusted basis. This 0.1% rise translates into an annualized 1.5%, well below the Fed’s 2% inflation target (the grey line in the figure below). Over the last 12 months it rose 4.13%. The preferred measure of Econsnapshot is a measure of inflation based on a 3 month interval. We prefer this measure because the year-over-year number moves very slowly while the month to month number is very volatile as seen in the graph below. This 3 month inflation rate grew at an annual rate of 2.2%, just above the Fed’s 2% target.
The bad news from the CPI report is that core CPI inflation — which strips out the more volatile food and energy prices — continues to run at 5% or more, much higher than the Fed’s target. Indeed, energy prices have declined significantly, down almost 12% year over year. When looking at core CPI over the last month it is the shelter component that was the largest contributor to the rise in prices, accounting for about 60% of the overall increase. One reason to look at core CPI inflation is that it may be a better measure of trend inflation than headline CPI. If so, the Fed still has work to do to bring inflation back to target.
Of course, Fed watchers know that the Fed focuses on inflation as measured by the personal consumption expenditure (PCE) price index. Over long periods of time, PCE and CPI inflation generally move together. That said, on average PCE inflation runs below both the CPI and core CPI. The PCE for May won’t be released until June 30. Consequently, the recent CPI inflation rates may provide useful information regarding the direction for PCE inflation.
Producer Price Index
Hard on the heels of the CPI report came that for the Producer Price Index (PPI). Inflation as measured by the PPI has been trending down since early 2022. Indeed, at an annual rate, the monthly and 3 month inflation rates are negative meaning that the price index has recently been falling.
Roughly speaking, the CPI reflects prices paid by the typical urban household while the PPI captures prices received by domestic producers of goods and services. Since the PPI captures prices received by domestic producers while the CPI measures prices paid by consumers, it’s tempting to conjecture that changes in the PPI will eventually be reflected in the CPI. However, there are differences in coverage which mean that this logic does not necessarily hold. For example, since the PPI measures prices received by US producers, it does not include prices of imports; the CPI does. Also, nearly 1/4 of the CPI includes the imputed rent of owner-occupied housing; this imputed rent is not included in the PPI. Finally, only some of the goods and services covered by the PPI represent purchases by consumers; the remainder are goods and services used by other producers, capital investment, exports and government. The Bureau of Economic Activity says that the PPI for Personal Consumption comes closest to the coverage of the CPI. Yet, the chart below shows that inflation as measured by this last measure is much more volatile than the CPI. The chart also shows that there is no obvious tendency for PPI inflation to lead CPI inflation.
Automotive Prices
Since the onset of the pandemic, much has been said and written about supply chain problems, with the automotive sector receiving particular attention, such as this article that makes several blunders and left out some important economics as well. Anyone who has tried to buy a new car knows that there are very long delivery lags, especially for electric vehicles. These issues in the new car market has spilled over into the used car market where prices have also risen. Keep in mind that a one time increase in the price of, say, new cars is not what we typically mean by `inflation’. To be sure, such a one time increase will, for a time, lead to an increase in measured inflation. However, this effect will dissipate with time. The chart below is based on price indices from the CPI. The used car inflation rate was much higher than that of new cars from mid-2020 to mid-2022. Recently, used car prices have been falling, and new car price inflation is moderating. Automotive maintenance and repair price inflation continues to increase.
Finally, turn again to the difference between the PPI and other price indices. From the PPI, prices received by domestic automotive producers grew rapidly through 2021 and 2022, with an inflation rate as high as 30%. While those prices have started to decline, the price level has risen 28.5% since May 2020. Granted, automotive inflation as measured by either the CPI or PCE price index also rose, but not nearly as much as recorded by the PPI, and the recent decline in PPI automotive prices has translated into a slowing of these prices as measured by the CPI and PCE.
The June 13-14 meeting of the Fed revealed a pause in rate hikes. As the graphs above show, there are certainly signs that the Fed’s early moves have worked in their favor. As we remarked above, given the core CPI numbers there still may be more work to do…and the Fed made it clear in the statement that more rate hikes are likely.
The March CPI (Consumer Price Index) brought decidedly mixed news. Year-over-year, CPI inflation fell from 6% in February to 5% in March. Indeed, the year-over-year inflation rate has trended down since mid-2022. However, as we have pointed out in earlier posts, year-over-year measures of inflation are slow to reflect recent changes in trend since they are 12 month averages of past monthly inflation rates. The good news is that monthly (annualized) inflation is down from 4.5% (February) to 0.6% (March), well below the Fed’s 2% inflation target. A glance at the chart below will remind regular readers that monthly inflation rates exhibit considerable variability. Our preferred measure is the 3-month average of monthly inflation rates. This measure declined more modestly, from 4.1% to 3.8%. More importantly, the 3-month average inflation rate is still well above the Fed’s 2% target.
The news is decidedly worse when looking at core CPI inflation (that is, excluding the volatile food and energy components). On a year-over-year basis, core CPI inflation rose from 5.5% in February to 5.6% in March. On the other hand, the monthly core CPI inflation rate fell from 5.6% to 4.7%. Again, we prefer to look at the 3 month average to gauge the direction of trend inflation. The 3 month average of core CPI inflation fell slightly, from 5.2% to 5.1%. More troubling is that these measures are all well above the Fed’s 2% inflation target.
The producer price index (PPI) was released today that offered up a little more good news. The PPI fell 0.5% in March. Moreover, as noted by the BLS, “two-thirds of the decline in the index for final demand can be attributed to a 1.0-percent decrease in prices for final demand goods. The index for final demand services moved down 0.3 percent.”
Finally, short term inflation expectations have risen: For the one year horizon, from 2.1% in March to 2.6% in April; at the two year horizon, from 2.2% to 2.4%. These developments are, presumably, unwelcome by policymakers who are worried about higher inflation expectations becoming entrenched. Fortunately, the five year expected inflation rate fell from 2.2% to 2.1% while 10 year expectations dropped from 2.3% to 2.1%.
Overall, as mentioned at the outset, the news is mixed. Yes, the CPI is down. But, the year over year core CPI is up. The main reason for the difference between the CPI and CORE CPI is that energy prices fell: gasoline, down 17.4%, and fuel oil, down 14.2%. Given the highly volatile nature of food and energy it is useful to pay attention to the core measure.
