Wednesday, March 16, 2016

Inflation is alive and well

I suspect a good many people would be surprised to learn that, if you abstract from volatile energy prices, consumer price inflation in the U.S. has been running at an annualized rate of 2.0% for the past 10 and 20 years. In fact, the CPI ex-energy is up 2.1% in the 12 months ended February and it has even risen at a 2.3% annualized rate over the past six months and 2.5% over the past three months. Inflation is far from dead, and the deflation concerns you've heard about in recent years are all the by-product of collapsing energy prices, which, by the way, are now a thing of the past.

The FOMC undoubtedly will take note of this fact in their deliberations today, and it will encourage them to move—albeit slowly—to raise short-term interest rates to a higher level. This should not be surprising nor scary. On the contrary, it would be scary if they ignored the behavior of core inflation.

The chart above shows the year over year change in the CPI (total) and the CPI ex-energy. Note how much more volatile the total is compared to the ex-energy version. Note also how the most recent period, during which oil prices have collapsed—is similar to the 1986-87 period, when oil prices fell about as much in percentage terms as they have in the past 22 months. In both periods, the total CPI suffered a significant decline followed by a significant rebound, while the ex-energy version was relatively unchanged. There is every reason to believe that the headline (total) CPI will register 2% year over year growth (if not more) within the foreseeable future, since oil prices are no longer declining and have even rebounded some 40% in the past month or so.

The Fed's preferred measure of inflation, the Core Personal Consumption Deflator rose 1.7% in the 12 months ended January, and it is likely to post a slightly higher rate of growth in February. This is entirely consistent with the behavior of the CPI, since the PCE deflator tends to register about 30-40 bps less than the CPI. What this means is that the Fed's preferred inflation gauge will soon be very close to the top end of its 1-2% target range.

Memo to FOMC: Raising short-term interest rates to 0.75% in the next few months—thus leaving real short-term rates still deep in negative territory—would not only be fully justified, it might even be too little too late.


Matthew Grech said...

It might also surprise a lot of people to know that the trade weighted dollar is LOWER than it was 12 months ago. And gold was recently at a 52-week high.

Many of us were saying that the Fed was too tight in the latter half of 2015. And we were right. Now, it appears that the Fed has significantly reversed course. They even appear to be ignoring their own commentary. Despite continued improvement in employment (which I think has been overstated, but still) and a recent increase in the PCE, the Fed just lowered its projection of rate increases.

Go figure.

It would appear that the FOMC does little more than react to markets. I guess it could be worse. But just the sheer volatility of things like gold and TIPS spreads are highly suggestive that the Fed, and indeed, the whole Fed system, is a failure. It is very difficult to plan when you're face with this kind of monetary volatility.

Johnny Bee Dawg said...

And Gold Miners index is up another 6% today. Up 67% in 2 months.

Scott Grannis said...

It does look like an inflation trade is underway. Commodities, gold, emerging markets all up, while the dollar is flat to down on the margin. The Fed is going to commit the error of giving more weight to the weak economy than to the evidence of rising inflation. I've worried about this happening for many years.

Matthew Grech said...

Scott: In your opinion, why do you think Yellen is doing this? I'm really amazed by the radical shift in posture over the course of just a few months. I should say that I'm not at all worried about toxic inflation (because of the IOER). I'm just having trouble synthesizing the comments from the Fed re: employment and the PCE and what they did today.

Is it the election? Is she genuinely scared about something? Is she somehow kowtowing to the Euros/Japanese? I'm at a loss and I'm wondering what you think.

Scott Grannis said...

I think she's just bowing to the pressure from the market, which had been very upset at the idea the Fed would move rates up faster than one or two times a year. The Fed is rarely a leader, and most often a follower of the market.

Matthew Grech said...

Thanks Scott. Good point.

Johnny Bee Dawg said...

Maybe the Fed is trying to take away the Trump talking point of "cheap foreign currencies hurting our profits". They hate him, and want to head off his uprising, and take away one of his main complaints. I've contended that Trump will get his way with foreign and domestic politicians by threats rather than by actually enacting the bad trade policy that everyone fears. Especially if he has voters behind him. I think his threats are by design to get elected from discontent. I think the Fed may be overreacting to head off this Trump populism, which is his own particular brand of "big stick" moral suasion. (No debate pun intended.) I think the Fed is reacting to politics as well as markets, and I don't think markets dislike the idea of a Trump Presidency at all. That scares everybody in charge.

As an aside...I think the Fed ought to be a follower of markets, fwiw. They should promote their point of view until markets agree, and act only then. Letting the market do their work for them is always the best policy, imo.

Benjamin Cole said...

Not sure why the rush to raise interest rates.

If inflation is stuck at 2% long term, that suggests something other than the Fed is keeping inflation there--like global competition.

The US economy has radically altered in the last 40 years. Unions are dead, international trade is huge, whole industries have been deregulated, such as transportation, finance and communications. Top tax rate cut from 90% to 40%. All good.

Auto prices, for example, have not budged in 20 years. There is a global glut of supply, and that describes just about every manufactured good or commodity.

The inflationary impulses in the US today come from property zoning, and national security spending. Most cities, and I think I could safely say every city on the Pacific Coast, criminalize free enterprise, highest and best use of land, and robust housing construction. Naturally, housing is scarce and rises in price in any decent economy. Everyone loves free enterprise but not in their own neighborhood, where everyone become a pinko-greenie. No condo towers or manufactured homes here!

National security spending has become a $1 trillion a year government-industry, economically consuming but not producing. National security spending is like Obama's one-time $750 billion infrastructure stimulus spending, but in the case of defense, it is every year and bigger.

Pat Buchanan once said, "What starts as a cause or true need becomes a movement, then become politics, then becomes a business, then becomes racket."

The US Congress and contractors are going to build and bill taxpayers a $1.50 trillion fighter plane, the F-35, they say it stealthy, but which the US Naval Institute says is not. Seems the bad guys have better radars now. It doesn't matter whether the plane is stealthy or not. It is going to get built.
Ask Pat Buchanan about that.

I wonder if Trump would shake things up. Maybe.

Rob said...

Scott, what about inflation in other developed economies, eg my own, the UK ? Many "wise old owls" here still obsessing about deflation. Thanks.

Scott Grannis said...

Rob: Sterling's weakness against the dollar and the beginnings of a commodity reflation are like an insurance policy against deflation. And in any event, what's wrong with a little deflation? Those worries are way overblown.

Rob said...

Thanks Scott but just to be clear: do you see inflation as being as evident in the UK as it is in the US, or perhaps the UK has a bit less inflation ?

Scott Grannis said...

I'm not an expert on UK inflation, but it looks about the same as in the US. Any differences are essentially irrelevant in the great scheme of things.

Scott Grannis said...

Of course, UK inflation has exceeded US inflation by a meaningful amount for most of the past 40 years.

Benjamin Cole said...

Scott/Rob: my recollection is that in Britain it is difficult to change the way the CPI is measured, due to legal and contractual reasons. It is then possible that their CPI overstates the rate of inflation. Again, this raises questions as to any measure of prices and how long they are accurate or meaningful.

Obsessing about microscopic rates of inflation is not a good monetary policy.

The Reserve Bank of Australia seems to have good luck with an inflation target band of between 2% and 3%.

William McKibbin said...


Rob said...

Many thanks again Scott. If it's not too cheeky, could I ask you to maybe write a blog post about your investing style over the years ? You seem to be a very calm and optimistic person whose economic forecasts look generally very astute. Does that translate into a fantastic track record as an investor ? I'm definitely not asking for investment advice but I think lots of readers would be fascinated to know more about this. You used to talk a lot about how well one of your investments had done - Apple. Are you still into that one ? Would you say you are a conservative investor ? Are you a longtime buy and hold investor, like Buffett ? Or are you more influenced by government and central bank policy, like Russell Redenbaugh ? Hope you feel able to say something on this subject !

honestcreditguy said...


Why do you keep repeating auto prices are the lowest in 20 years? I guess your not in the industry buying ABS paper and know the difference between a 19K loan average vs 29K loan average and terms at 84 months. Stop with this BS meme...

Similar to the job picture that Scott and the Fed point too. Where are the 15 million missing jobs from the BS UE reports.

Inflation in things you need and deflation in others is the worst of inflation. Housing is now in the biggest bubble since 2007...go figure, Pigmen and their sorts are going to eat off the carcass of the poor and middle class. That is America now, wholly owned by pigmen and their corporate overlords. The govt. and the fed and stupid keynesian policies are like a 1950's vehicle still on the road pieced together by duct tape and cuban auto parts..

Benjamin Cole said...

Honest credit guy--

Just call me Porky.

You can check out the auto price figures yourself on the FRED St. Louis Fed website.

And auto price can be higher in nominal terms, but lower when adjusted for improvements in quality.

In fact, over 20 years, the auto price story again suggests that any price index is somewhat dubious. An obsession with microscopic rates of inflation is probably an unwise monetary policy.

William McKibbin said...

Inflation? Really?

Tom Nugent said...

"Government statistics" reflect a belief that corporations and labor cause inflation when it is the government through regulation that is the factor that creates inflation/reduces private sector output. And how do we accurately measure inflation in a post industrial society when we are using industrial benchmarks?

Johnny Bee Dawg said...

I like using the number of hours of work it takes to buy stuff, measured over time to measure inflation.

Almost everything is cheaper than ever right now...except for college and healthcare.

Scott Grannis said...

JBD: And it's not a coincidence that education and healthcare are the two industries most heavily influenced by the federal government.

Gelu Tudose said...

I follow your blog with interest and wondering how would you account for:

1 - Rail traffic data - It shows lower numbers than during previous 3 years (

2 - Total Business Inventories to Sales Ratio - reads 1.4, which is high for the last decade (but rather average if starting from 1990 (

Scott Grannis said...

Rail traffic has indeed weakened, but an important source of that weakness is petroleum shipments by rail, which have dropped by 35% since oil prices peaked in 2014. That's an understandable response to lower energy prices, not really a sign of overall weakness.

Not everything moves by rail, in any event. Consider the Truck Tonnage series published by the American Trucking Association. That surged in February, recording an almost-unbelievable rise of more than 8% over the past 12 months. I suspect there are some faulty seasonal adjustment factors at work, but despite that this clearly shows the economy is far from collapsing.

I don't think the inventory data is convincing, and as you note, it's rather average in an historical context. I also think the inventory/sales ratio is a lagging indicator.

Positive things are happening on the margin in the commodities area, with industrial metals prices up almost 20% in the past two months. That's real-time information that suggests global economic activity is heating up.

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