The BLS reported this morning that the CPI was up 5.4% versus the same time last year, after reporting a 5.0% increase the prior month. Inflation appears not only high, but rising higher.
Stock and bond prices are broadly lower on the news. But contrary to popular media interpretation, it’s not necessarily because the markets fear more aggressive Fed action to counter the trend.
Less obviously, such shocking inflation data shift the risk-reward balance. The Fed may not tighten imminently, but if stocks sell off, it’s less likely to step forward with additional ease. If official inflation were running at 1.X%, and stocks sell off, it’s much easier for the Fed to justify riding to the rescue than when it’s 5.X%. The bar is raised for how deeply stocks can decline before the Fed put is in play. At these lofty valuations, that’s all it takes for markets to be vulnerable.
Meanwhile, is inflation really accelerating? No. As we discussed in our last Inflation Update, with the exception of an offsetting plunge and spike related to last year’s corona crash, inflation has been steady since the end of 2018. Instead, what has been happening more recently is that the bulk of the price effects have been spilling over from assets to consumer goods and services. The acceleration in the CPI merely reflects its narrow focus on consumer prices. That not only results in it failing to register when inflation is actually accelerating, but falsely registering acceleration when it’s not. It’s a defect based on the faulty assumption that consumer prices alone are an adequate gauge of inflation.
So no, while it is showing no sign of being “transitory”, inflation is not accelerating.
This has implications for what to expect going forward. As we concluded in the prior post, trend inflation has been holding steady at around 11.5% for two and a half years. If that were to remain the case, consumer price inflation would be expected to asymptotically approach a steady state rate of 11.5%. The CPI would do the same, less the amount by which it systematically understates consumer price inflation. The understatement amount isn’t known with precision, but is likely in the range of 3%-6%. So the CPI rate of increase should level off somewhere between 5.5%-8.5%.
Stating it with more precision would be fruitless anyway. Before the CPI converges to its steady state analog of 11.5% actual inflation, the actual rate of inflation itself is likely to change.