Inflation appears to be easing—but a closer look at CPI reveals a dangerous uptick in goods inflation.
KEY TAKEAWAYS
MY HOTS TAKES
Below the surface. I grew up in a small shore town within walking distance of the beach. That meant that most of my recreation took place in or right next to the ocean. As a teen I spent lots of hours sitting on a surfboard staring out into the distance hoping to catch a glimpse of Europe. 😂 Really, I was just waiting for the surf gods to send the ultimate wave. Sitting on my surfboard with my feet dangling in the water took a bit of courage as the northeast Atlantic is murky and one could barely see more than one foot below the surface. That said, it took a bit of faith to overcome the fear that some massive Great White shark was not inches from my foot contemplating its next meal.
Even if you, like me, were active in the markets and the grocery store in the 1980s, you probably have forgotten just how devastating inflation was back then. It was far worse than this more recent spate, and by the time I set foot on the trading floor, things had settled down to a more tolerable 5%. 😱 That was an inside joke; of course, we know that 5% is high and would cause a modern-day Fed banker to lose their… um, you know. By the time my daughter was born, inflation settled into the 2% level which we would consider normal today. And then… nothing. Not a word, no headlines, no debates. If you drew a trendline from CPI in January of 1990 through January of 2021, you would find a clear downward trend. All clear.
Inflation had sailed off into the sunset, slipping out of the American zeitgeist. Once the counterbalance to all excess, the superego of the economy had lost its edge. Bare-knuckle capitalism flourished and only extreme economic events served as constraints. Remember, in classic economics, higher prices cause consumers to demand less and cause prices to return to equilibrium. In more recent history, the Dot Com bubble burst and Global Financial Crisis would be required to keep demand and consumption in check.
Then came the pandemic which not only killed demand, but it also broke the global supply chain. That would be the catalyst for a new wave of inflation that would feed into more typical demand-driven pull inflation, which was accentuated by massive fiscal stimulus. The inflation itself, unfortunately, was not enough to curb demand and it would take a hatchet-wielding Fed to tamp down aggressive consumption.
With those curbs, demand fell, and inflation began to slow… slowly. Goods inflation slowed–disinflation. Ultimately, goods prices began to deflate, meaning goods prices actually declined. This helped overall headline inflation decline and head back to that comfortable 2% that the Fed is so obsessed with.
However, services inflation refused to yield, remaining sticky. Sticky services inflation has been driven largely in part by shelter costs, namely rent and owner-equivalent rent. Low supply and landlords stuck with high cost bases, ensured elevated housing inflation. Economists, central bankers, and… I have been obsessively watching that data series, and it has been disinflating, albeit slowly. Lower mortgage rates and lower short-term yields can help ease that inflation further, which is the opposite of what we typically associate with inflation fighting.
With inflation easing, the Fed decided to pivot from restrictive policy to stimulative policy, and it began rate-cutting late last year. That would be confounded by President Trump’s aggressive pursuit of tariffing imports. Known by one and all to cause inflation, this most recent trade war, not surprisingly, renewed fears of inflation, and caused the friendly Fed to suspend rate cutting, opting for its famous “wait and see” approach.
Well, we are “waiting” and yesterday was our first chance to “see” in an active tariff environment, as the Census Bureau released its Consumer Price Index / CPI. The headline monthly figure came in slightly below estimates, while the annual figure registered a decline in inflation. Markets were pleased with the muted number and stocks gained.
So, is the threat of inflation increasing, driven by tariffs? Well, at first glance, it would appear not to be. All right, let’s celebrate! 🥂 NOT SO FAST. If we dig into the numbers, we note from yesterday’s release that while services inflation did continue to ease slowly, goods inflation actually picked up. In fact, core goods inflation was positive for the first time since December of 2023. Guess which category of goods contributed most to the gain. Transportation Commodities, more specifically, New Vehicles. What do you think caused that? I think it is fair to point to tariffs for driving (pun intended) vehicle prices marginally higher.
If you look at my favorite Bloomberg ECAN chart that follows, you will see how vehicle prices deflated for the majority of the past two years helping headline inflation stay in line. But you can also see how it began to climb toward the zero line, finally breaching the surface in a recent surge. It is now inflating and adding to headline inflation. So, before we begin to be lulled into another period of ignoring inflation, let’s get real and not lose focus. This will inform Fed policy, no doubt.
When I was young, bobbing to and fro on my surfboard, ignoring the reality that there probably were sharks lurking just below me, was a good enough strategy to get by–I still have 2 feet and 10 toes to prove it. However, if I ever saw a dorsal fin surface, you could bet that I would paddle toward shore as quickly as my arms would permit. A dorsal fin surfaced in CPI yesterday. What is your next move? 🦈
YESTERDAY'S MARKETS
Stocks rallied yesterday after a key inflation metric showed muted growth last month. President Trump brought America’s finest tech entrepreneurs to Saudi Arabia to flex and make a deal, and he did, sending market-leading tech shares higher. 10-year and 2-year Treasury Note yields were barely changed in yesterdays’ session.
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