DEEP DIVE: Slicing & Dicing Inflation

Most economists, including Debbie and me, believe that if the data don’t support our forecasts, then there must be something wrong with the data and that they will be revised to show we were right after all. Most economists, including yours truly, also often dismiss components of headline indicators that don’t support our story and look to the remaining “core” indicators for conformity to our outlook and therefore confirmation of it.

This slicing-and-dicing approach to the major economic indicators is usually what happens when the monthly employment report is released. If the seasonally adjusted data don’t support one’s narrative, the thinking goes, perhaps the data on a not seasonally adjusted basis will. Or perhaps the revisions to the prior months’ data will point in the “right” direction and therefore be what to highlight. If the payroll measure of employment isn’t as friendly as the household measure, focus on the household one.

Another major economic indicator that is invariably sliced and diced by the brotherhood and sisterhood of economists is the CPI. September’s number was released along with all its components last week on Thursday. Some economists (such as us) claimed that it confirmed that inflation is still moderating and is turning out to be relatively transitory. Others looked at the report and concluded that inflation is stalling at a pace well above the Fed’s 2.0% inflation target. A few economists found evidence that inflation may be accelerating again, so it remains a persistent problem.

So who is right? We all are right all the time because there’s plenty of data to support all of our stories. Nonconforming data are dismissed as preliminary estimates that undoubtedly will be revised or simply are flawed. Future revisions no doubt will show that we are on the right track after all; if not, different data do so. We may not all be Keynesians or monetarists, but we are all prescient based on the data we choose to support our outlook!

Now let’s slice and dice the latest CPI and see what’s left:

(1/7) Ignore the headline.

Pay no attention to the headline inflation rate. That was one of the messages in the speech delivered by Fed Chair Jerome Powell at Jackson Hole on August 25. From the get-go, he said that “food and energy prices are influenced by global factors that remain volatile and can provide a misleading signal of where inflation is headed.” So he focused his analysis on the core inflation rate, i.e., the headline rate less energy and food. Of course, this has been the Fed’s approach for many years.

The Fed’s preferred measure of inflation has been the core PCED, which closely tracks the core CPI (Fig. 1 below). The latter tends to exceed the former. For today, we will focus on the CPI through September since the PCED’s September reading won’t be out until near the end of the month.

The headline CPI inflation rate was 3.7% y/y through September (Fig. 2). The core rate for the CPI was higher at 4.1%. Both are down from their 2022 peaks of 9.1% and 6.6%, respectively. But both remain well above the Fed’s 2.0% target.

(2/7) Taking out shelter.

Before we go any further, here’s our punch line: The headline and core CPI inflation rates excluding shelter were both 2.0% y/y during September (Fig. 3 below). So to the question of when we’re going to get to the Fed’s inflation target, the answer is that we’re there now excluding shelter, at least based on the CPI measure!

Rent of shelter accounts for a whopping 34.7% and 43.6% of the headline and core CPI measures. Its inflation rate jumped from a low of 1.5% during February 2021 to a peak of 8.2% during March 2023 (Fig. 4). It was down in September but only to 7.2%.

In his speech, Powell observed: “Because leases turn over slowly, it takes time for a decline in market rent growth to work its way into the overall inflation measure. The market rent slowdown has only recently begun to show through to that measure. The slowing growth in rents for new leases over roughly the past year can be thought of as ‘in the pipeline’ and will affect measured housing services inflation over the coming year.”

Also, Powell acknowledged in his speech that “market rent” inflation (i.e., for new leases) has declined “steadily” this year. The Zillow rent index was down to 3.2% y/y during September. Using that reading rather than the CPI’s rent of shelter reading of 7.2%, Debbie found that the headline CPI is up just 2.3% versus 3.7% for the actual headline CPI!

Based on our analysis so far, the latest bout of inflation is turning out to be transitory rather than persistent after all, in our opinion. The Fed might achieve its 2.0% target for the core PCED inflation rate well ahead of schedule, i.e., in 2024 rather than 2025.

(3/7) Goods inflation is good.