We came across the chart below while reading up on the Consumer Price Index inflation report released this week. While the stark contrast of the chart is dramatic in this form, it was not that surprising given the current climate. But why should an individual’s expectations for future inflation be so tied to their political affiliation? Could you argue that a particular party’s economic and fiscal policies are superior and, therefore, will result in lower inflation? Perhaps. But isn’t it clear by now that both parties have little fiscal restraint? Regardless of why, please don’t let this happen to you.
So, how do we escape this phenomenon? One method would be to focus on the facts and not on hyperbole. And that’s precisely what we’ll try to do here. On that front, let’s dig into the current inflation report.
At the highest level, headline CPI was up 3.4% in April, down one-tenth of a percent from March and in line with consensus expectations. Additionally, core CPI was down two-tenths of a percent from last month and also in line with forecasts at 3.6% in April. At face value, the report was well received, and markets rallied in response to the news.
After reading many expert opinions, the takeaways remain mixed. They ranged from: Inflation is still way too hot and likely to re-accelerate, to, if you strip out X, Y, or Z from the numbers, underlying inflation is clearly under control. Generally speaking, it is safe to assume the truth lies somewhere in between those extremes. And in this case, that seems to be accurate as well.
We have touched multiple times on the impact of Shelter on overall inflation. This is one area where the inflation optimists seem to be going a bit overboard. The chart below shows headline CPI and the contributions of various pieces. Shelter remains the most significant single contributor at 1.9% of the 3.4%. Many commenters continue to state that if you remove Shelter and re-weight the calculation, headline inflation would only have been up 2.2% YoY. That sounds great, but unfortunately, you can’t just take away an inflation component.
That said, there is a better way to look at this. Instead of completely removing the Shelter component, what if we look at the disinflationary trend over the last twelve months? Then, using that trend, we can forecast where it might be later this year, allowing us to gauge the future impact on overall inflation.
Going through this process, we can reasonably expect Shelter inflation to drop from 5.5% YoY in April to around 3.4% by early 2025. Coincidentally, this represents a level consistent with Shelter inflation from the late 2010s until the start of COVID.
If Shelter inflation drops to this level (which is a continuation of the downtrend since the peak in March 2023), it would represent a 0.70% reduction in headline CPI and a 0.90% reduction in core CPI. This would bring both measures into the 2.6% range, and while it is not 2.2%, it is certainly much more palatable.
In addition, CPI can fall to these levels without any further improvement in troubled areas like motor vehicle insurance. If you recall, motor vehicle insurance is up almost 23% YoY, contributing six-tenths of a percent to headline CPI. And while it is reasonable to expect this will not continue indefinitely (auto prices are normalizing), we also can’t assume a change will be around the corner. (See aggregate transportation services below.)
However, that is ok. Inflation can be improving and be too high at the same time. There is no need to force a square peg in a round hole. You don’t have to force the numbers to fit your narrative when you remain objective and data-dependent. In fact, it is the complete opposite; the numbers tell you what the narrative should be.
Economy
- Markets rallied again this week as the Dow broke 40,000 for the first time ever. The S&P 500 was up 1.5%, the Nasdaq was up 2.1%, and the small-cap Russell 2000 was up 1.7%.
- U.S. Retail Sales were unchanged MoM in April, following a downwardly revised 0.6% gain in March and defying market forecasts of 0.4% rise, suggesting consumer spending has eased.
- U.S. PPI increased by 0.5% MoM in April, following a downwardly revised 0.1% fall in March, which was much higher than forecast at 0.3%.
Stocks
- U.S. equities were in positive territory. Technology and Real Estate were the top performers, while Industrials and Consumer Discretionary lagged. Growth stocks led value stocks, and large caps beat small caps.
- International equities closed higher for the week. Emerging markets fared better than developed markets.
Bonds
- The 10-year Treasury bond yield decreased eight basis points to 4.42% during the week.
- Global bond markets were in positive territory this week.
- Corporate bonds led for the week, followed by government bonds and high-yield bonds.
