Headlining with the CPI all-items 9.1%, reporters connected the worse-than-expected, 40-year high inflation rate to consumer misery, higher interest rates and recession. Alarming commentary to follow. Woe to us.
But, wait. Let’s find out some more information from a mock interview with one of those reporters…
Note: All percentages are trailing 12-month changes, except as noted
Us: “Your article’s gas pump and food aisle photos highlight the sharp rises in their prices. But what about that ‘core’ inflation number the Fed and others talk about – the measure of price changes that exclude energy and food?”
Reporter: “Oh – well, that was 5.9%, but it, too, was worse than expected.”
Us: “How much were 9.1% and 5.9% higher than expected?”
Reporter: “Um, 0.3% for all-items and 0.1% for core.”
Us: “Well, that doesn’t seem earth-shattering. The difference between 9.1% and 5.9% looks like the real story. By the way, is the core 5.9% also a 40-year high number?”
Reporter: “No, but it did hit a 40-year high earlier this year.”
Us: “When was that? Also, what was the reading, and how did that compare to the all-items inflation number?
Reporter: “It was February. Core was 6.4% and all-items was 7.9%.”
Us: “So, the gap between the two has more than doubled from 1.5% in February to 3.2% in June. That needs explanation. But, before doing so, explain how the core declined from February’s 6.4% to June’s 5.9% – all at once?”
Reporter: “No. After February’s 6.4%, it was unchanged at 6.4% in March. Then, 6.1% in April, 6.0% in May and 5.9% in June.”
Us: “Now, that looks newsworthy: Core inflation topped in February-March, then declined over the next three months. Okay, back to the all-items inflation 3.2% gap at 9.1% – Why?”
Reporter: “Well, both energy and food prices were higher, and that affects consumers a lot, which is why we focus on the all-items results.”
Us: “How much higher were energy and food, and how did they compare with February?”
Reporter: “In February, food was 7.6% and energy was 25.7%. June’s rates were food, 10.0%, and energy, 41.5%. So, now you see why the 9.1% is important to report.”
Us: “While energy and food are important, they aren’t the only items that affect consumers. The BLS creates an ‘average’ CPI basket of goods and services people spend their money on. So, how much is allocated to food and energy in that basket? Also, what are the sizes and inflation rates for each of their key components?”
Reporter: “In the latest basket, 13.4% is allocated to food, with 8.3% in food-at-home (12.2% inflation) and 5.1% in food-away-from-home (7.7%). For energy, allocation is 8.7%, with three main components: 4.8% in gasoline (59.9%), 2.5% in electricity (13.7%) and 0.9% in utility natural gas (38.4%).”
Us: “With food representing 13.4% of the total, and energy, 8.7%, that leaves 77.9% in the ‘core’ spending. As you told us, the February and June 12-month inflation rates for that portion declined from 6.4% to 5.9%. We’re sensing your 9.1% headline has missed the real story, so we’ll take it from here with more analysis for better understanding.”
Now to the dynamics, including subjective analysis:
Food-at-home’s inflation (12.2%) was higher than food-away-from-home (7.7%), implying the price-raising actions (AKA, pricing power) of food processors exceeded that of restaurants. Not surprisingly, many food processor stocks are near their 52-week highs, and restaurant stocks are mostly far below. (Note: Within the food-at-home category, that dynamic is also visible: For example, higher processed cereals-and-bakery-products, up 13.8%, vs lower processed fruits-and-vegetables, up 8.1%)
As to energy, that nearly 60% price rise in gasoline is the key driver in the overall inflation rate even though it is less than 5% of the basket. (Removing only energy from the all-items CPI drops the 9.1% inflation rate down to 6.8%)
An important point: Volatility is a key issue. Larger price shifts, up and down, complicate the search for an inflationary price trend. It’s why 12-month trailing rates are preferred to monthly changes. Also, it’s why energy and food price changes are often excluded. Those two items are more likely to be buffeted by short-term supply-demand factors, causing volatility that can hide longer-term price trends. Of the two, energy is by far the most volatile as shown in this graph of monthly CPI-Energy price changes since the Great Recession:
Note: That range of moves from +10% to -10% is for individual monthly moves – they are not annualized.
A final point: 12-month rates are driven by single month changes
This effect is a problem with any moving average or trailing longer-term calculation: Only the end points change. When June’s 9.1% inflation rate was reported, it was explained as a large, meaningful increase in the trend from 8.6% in May. However, eleven of those trailing months for the May and June rates were identical (July 2021 through May 2020).
The only alteration was the replacement of the month, June 2021 (0.9%), with the month, June 2022 (1.3%). What accounted for that 0.4% increase? The major factor was energy’s volatility: Out went June 2021’s 2.1%, in came June 2022’s 7.5%.
The bottom line: Inflation’s impact is more than a number
The many moving parts in the U.S. economy make focusing on any one issue unreliable, much less one number. Inflation is particularly challenging because price changes are composed of specific supply/demand forces combined with “fiat money” inflation (AKA, the decline in a currency’s purchasing power).
That’s why no one inflation measure is accurate. Conditions and forces vary from period to period, so separating out a currency’s loss of value requires subjective analysis. The current period is especially challenging because of Covid’s continuing effects, specific supply issues, and geopolitical effects (including Russia-related actions).
Add to that the Federal Reserve’s need to get interest rates back up to where the capital markets would set them. At that point, the 3-month US Treasury Bill will yield at least the “fiat money” inflation rate.
What would that rate and yield be if that were the case now? By evaluating all the components in the CPI as well as other inflation measures, the fiat-money inflation rate is probably about 5%. With the 3-month T-Bill now yielding only 2.3%, the Fed has a long way to go before it can truly tighten money. (“Tightening” typically means squeezing the financial system to cause economic growth to slow down.) Doing so would raise the 3-month T-Bill yield above the 5% inflation rate.
For better understanding, check out the various tables and write-ups in the BLS website for the CPI.