Consumer price inflation is heating up

Today's release of March consumer price statistics was unsurprising to the market, with headline inflation coming in as expected (0.5%), and core inflation coming in a bit below expectations (0.1% vs. 0.2%). On a year-over-year basis, headline inflation was 2.7%, while core inflation was a mere 1.2%. Both measures are below their long-term averages. 

But looking under the surface, the news is not all that rosy. Over the past six months, the CPI has increased at a 4.7% annualized rate, well above its long-term average, and reminiscent of the heady inflation we experienced in the 2004-2007 period. Over the past three months, the CPI is up at a 6.1% annualized rate. It's thus quite likely that the year over year CPI figure will exceed its 30-yr average (3.1%) by a comfortable margin before this year is out.

Even the core CPI is showing some underlying acceleration, with prices up at a 2% annualized rate over the past three months, and a 1.4% annualized rate over the past six months. It is noteworthy that both the core and the headline rates of inflation are accelerating at the same time. If monetary policy were non-inflationary, then the strength in food and energy prices that are driving the headline inflation index higher would be offset by declines in non-food and energy prices. But that is not happening—all prices are accelerating. This confirms that monetary policy is in fact accommodative, and that is exactly what the Fed is trying to achieve. The Fed wants inflation to move higher, and they are getting their wish. There is every reason to believe that this will continue for at least the balance of this year, since monetary policy operates with a lag and the Fed has made no move yet to tilt policy in a restrictive direction.

Investors will be interested in the behavior of the non-seasonally-adjusted CPI, since the interest payment on TIPS (Treasury Inflation-Protected Securities) is based on changes in that measure of inflation, with a two-month lag. The chart above shows the 3-month annualized rate of change of the CPI (nsa). It also illustrates the seasonal tendencies in the CPI: inflation typically reaches a low point around the end of every year, then a high point around March-April of every year. As should be evident, the seasonal low last December was a good deal higher than it has been for most of the past decade, and the recent high is almost as strong as any we have seen in the past two decades. In the first quarter of this year, the raw CPI is up at a 8.1% annualized rate. This means that the inflation adjustment that TIPS receive will be unusually strong on an annualized basis over the next few months, and possibly for longer.

The ongoing rise in China's inflation rate is making headlines today, but U.S. inflation is not too far behind, as this chart shows. It's not surprising that inflation should be moving higher both in China and the U.S., since China has essentially outsourced its monetary policy to the U.S. Federal Reserve by pegging the yuan to the dollar. Chinese inflation is somewhat more volatile than ours, and that is also not surprising since its economy is smaller and less burdened by long-term supply and labor contracts. If China has an inflation problem, then so does the U.S. It will just take longer for the problem to become obvious in the U.S.