Belated March CPI analysis

I've only recently returned from several weeks in Argentina. I didn't have access to my charts, and besides, I was rather more interested in people, food, and wine than in blogging. Time now to catch up on the market's latest focus: Is inflation still stubbornly high? Does the Fed need to tighten more?

The March CPI release was, in retrospect, the one that apparently convinced the Fed and the market that "disinflation has stalled." More recently, the market, with encouragement from numerous Fed governors, has come around to thinking that instead of cutting rates five times by the end of this year, we might see, at best, one cut, because the Fed has more work to do. "Higher for longer" is now the interest rate mantra that is driving the market; it's made people nervous, so an equity market correction is underway.

You won't be surprised to learn that I disagree. I still think the great inflation bubble that started three years ago has long since popped. And the main reason inflation is still marginally higher than where the Fed would like to see it is the way shelter costs are calculated. I think the following charts make that clear.

Chart #1

Chart #1 compares overall inflation to inflation less its shelter component, which is about one-third of the total. Both are calculated on a 6-mo. annualized basis, which is the best way to see if recent developments mark a change in the broader trend. My first take when looking at this chart is that if there is an inflation problem in today's numbers, it pales in comparison to the numbers we saw in the 2005-2009 period. 

Looking closer, I note that the 6-mo. annualized rate of inflation less shelter has averaged 1.6% for the past 16 months, and it has been more than 2.0% in only four of those months. Moreover, there is no sign of any meaningful recent acceleration: it has averaged only 2.01% over the past 4 months and it was 2.06% in March '24. As for the overall CPI, it has averaged 3.3% over the past 16 months, and it was 3.3% in March '24. The difference between the two is due entirely to shelter costs, which, arguably, have been artificially inflated by the way BLS calculates them.

Chart #2

Chart #2 shows that the year over year increase in shelter costs as calculated by the BLS is driven almost entirely by the year over year change in nationwide housing prices 18 months prior. (The red line has been shifted to the left by 18 months, and the two lines match up almost exactly.) Even though housing price inflation has dropped significantly from its peak two years ago, and nationwide rents have been flat to down over the past year, the BLS calculates that shelter costs currently are rising at the rate of 5.9% per year. If the relationships in this chart hold, then the rise in shelter costs will reach a low point this coming October (which is the point where the blue line falls to zero). In other words, shelter costs will almost certainly continue to decline every month from now until October, and that will subtract significantly from the increase in the overall CPI.

Inflation is not a problem. The Fed once again is late to the party, as usual. If the Fed keeps short-term interest rates higher for longer it will only push inflation lower, and there's nothing necessarily bad about that. In any event, I'm willing to bet that interest rates don't remain at current levels for as long as the market is currently forecasting. At some point the Fed is going to figure out that it's done enough.