Has U.S. inflation accelerated?

I'm posting this from Argentina, where inflation has been running in the strong double-digits for the past several years. Until recently, the government was fudging its CPI calculations, reporting inflation of only 10% per year, but public pressure and IMF threats finally forced them to 'fess up. A few months ago they scrapped the old, faked CPI, and began reporting a new CPI which so far only goes back to the end of last year. So, for the first five months of this year, the government now reports that inflation has been running at a 24% annual rate. That's a lot more realistic, given that the amount of currency in circulation in the Argentine economy has been expanding by 25-30% per year for quite a few years. It's a lot higher than the previously reported inflation rate, but lower than the 30-35% annual rate that most observers have been estimating. In any event, it's still by far the highest inflation rate of any developed country that I'm aware of.

In this context, the fact that the BLS yesterday reported that May inflation in the U.S. was higher than expected (+0.4% vs. +0.2%) is hardly something to get excited about. It is, however, significant, because as the chart above shows, "headline" inflation has accelerated in the past few months from 1.5% in February to 2.6% in May, on a six-month annualized basis, despite the fact that economic growth has been weak and the economy still has oodles of excess capacity. Core inflation has also accelerated, from 1.6% to 2.1% on a similar basis. Conventional wisdom holds that a weak economy with a lot of excess capacity should be vulnerable to deflation, not rising inflation. So conventional thinking might be wrong about how inflation works, and the Fed might be underestimating inflation.

In any event, it's too early to say that there has been a meaningful or worrisome acceleration of inflation. As the chart above suggests, inflation has been running at a 2.4% annualized rate for most of the past 10 years. It slowed down just a bit starting in 2011, so the recent acceleration might just be in the nature of "catch up."

In addition, the bond market seems inclined to believe that the inflation fundamentals haven't changed at all. As the chart above shows, the current difference between 5-yr nominal and real Treasury yields—the market's expected average inflation rate over the next 5 years—is 2.04%. That's only slightly above the 1.95% average expected inflation over the past 17 years.

I'll reserve judgment for the time being, but I remain concerned that inflation risk is something to take seriously, and I would like to see the FOMC express a similar sentiment in their release later today. It's better to be proactive about inflation risk than to wait until inflation becomes too high. We don't want the Fed to be driving by looking in the rear-view mirror.

Even though current and expected inflation is relatively benign, I note that the dollar is still quite weak historically, and gold and commodity prices are still quite elevated from an historical perspective. That's certainly not the sort of stuff of which deflation is made, and it is more symptomatic of rising inflation than low and stable inflation. Moreover, as the chart above shows, the big increase in housing prices in recent years is already driving a pickup in Owners' Equivalent Rent, which makes up about 25% of the CPI, and that component of the CPI could show a significant increase over the next year or so.

Conclusion: the Fed should err on the side of worry, rather than complacency, when it comes to the outlook for inflation.