Today we’ll review the latest Consumer Price Index report in depth as our main course, but let’s start with an amuse bouche: a brief look at US inflation expectations by demographic cohort. The data here is from the NY Fed’s latest Survey of Consumer Expectations. It shows how different age groups have responded to a question about their expectations for 1-year forward inflation back to 2013.
Note that inflation expectations consistently scale with age. The oldest cohort (+59 years old, brown line) always expects more inflation than 40–59 year-olds (red line) and younger respondents (sub-40, blue line) routinely expect the lowest future inflation. Why would this be? The simplest explanation: the older you are, the more inflation matters and that sparks an availability heuristic feedback loop (worry drives attention, which becomes perception and finally “reality”). Put another way, younger people have the luxury of believing they can out-earn/out-save inflation. Older folks more often do not.
Now, on to the main course with 3 items.
#1: The largest piece of the CPI is Owner’s Equivalent Rent (24 pct of headline, 30 pct of core), which is a survey-based estimate which estimates what dwellings cost to rent over time. As such, it is not directly tied to house prices, which frustrates and confuses many people. Still, OER is the hand we’re dealt when assessing US inflation, so here’s how it has trended over the last 2 decades:
Takeaway: that drop you see on the right side of the chart is the Pandemic Recession, with OER inflation going from 3.3 pct in January 2020 down to its current 2.0 pct. In the early stages of the last 2 economic recoveries (2004 – 2005, 2013) we had very similar readings, so there’s little historical precedent to say OER is about to move meaningfully higher. In fact, if you didn’t know the cause of the current recession and just looked at this chart you’d likely say “oh, garden variety economic contraction here … OER will be around 2 percent for a year or two”.
#2: While policymakers typically exclude food and energy inflation from their analyses, these factors do impact consumer behavior and budgeting so investors need to monitor them. The following chart shows the annual percent change in the food (red line, right axis) and energy (blue line, left axis) components of the CPI over the last 20 years. Today’s report showed 3.5 pct food inflation and 13.2 pct energy inflation, as noted in the highlight box.
Takeaway: while energy inflation (blue line, mostly gasoline) is accelerating, this chart shows that it always does in economic recoveries and today’s 13 percent reading is actually below the 2003 recovery (24 pct, Gulf War II driven) and the 2009-2011 recovery (19 – 21 pct, demand driven). Food inflation is actually declining as restaurants reopen, relieving last year’s supply chain pressures on “food at home” inflation. Bottom line: there’s nothing in food and energy inflation that concerns us relative to US consumer spending. Or, for that matter, about structurally higher inflation to come.
#3: Looking forward to future inflation reports – specifically May 2021 – we can state with almost mathematical certainty that headline and core CPI will be at least 3.5/2.1 percent respectively. In the chart below we indexed both CPI measures to the May 2020 trough. Today’s report may have been “just” +2.6/+1.6 percent for headline and core, but against the May 2020 data they were +3.5/+2.1 percent higher. Absent a large shock, CPI tends to rise with every monthly reading. By May we’ll clearly be showing the “transitory” inflation Chair Powell often mentions.
Takeaway: the US inflation data reminds us of analyzing the quarterly earnings of a cyclical company just after a recession. You know the comps are super-easy, so you don’t really focus on the current quarter or even the one after. Rather, you’re analyzing what the next 2-3 years of earnings might be. That’s what markets are doing with 2021’s inflation reports: ignoring the easy comps and high headline numbers to come and focusing on the longer term. Based on today’s data we can see why bond markets are not overly concerned about structural inflation. It may come, and we’ll keep looking for it, but today’s report offered little to worry about.