CPI Instant Reaction – Inflation is Not 5%!

Following the May 10 CPI report that shows inflation has dipped under 5%, Leland Abrams of Wynkoop, LLC and a portfolio manager of a fixed income fund at Catalyst, provides his initial reaction below:

Today’s Consumer Price Index (CPI) and core CPI readings came in at or below estimates and importantly, below some of the ‘whisper’ talk on the street. Bonds welcomed this positive news and are rallying across the curve.  Yields on the 10-year are lower by 9 bps, while the front end outperformed (2’s have rallied 15 bps on the day down to 3.88%).  The forward curve implied rate tumbled as well, erasing any chance of a hike in June.

While the statistical CPI number still shows headline inflation at 4.9% year-over-year, this is not the full picture – this is a highly lagged number, which does not reflect the progress made on inflation.  The ‘supercore’ (which excludes food, energy, and shelter) is a measure the Fed has told us they pay close attention to.  The second largest component of CPI is housing-related (shelter costs). It represents a 44.46% weighting on the core.  The way the housing data are represented are highly lagged and will not reflect reality for another few months (the reality is shelter costs have gone down).  The six-month ‘supercore’ average is +0.22% month-over-month and annualized, computes to roughly +2.6%.  However, if you include a negative number for housing, the core inflation is running at or below the Fed’s target of 2%.

The largest component of core CPI is services, which accounts for 61.59%.  This month’s read came in at +0.2% MoM change – a welcome reprieve from the high prints we’ve seen in the past.  Another large component, transportation, which accounts for 16.85% showed +1.2% MoM gain, which is likely a one-off print.  New car prices fell MoM, but used car prices, according to the BLS, showed +4.4% MoM change.  The most recent Manheim auction data shows used cars coming down in April -3.1%.  We believe next month’s CPI report will capture this.

For headline CPI, energy prices included a large increase of 3% MoM for gasoline, which will be reversed in next month’s headline CPI with a big negative. It is likely that the next CPI report will show negative headlines and closer to 0 core for MoM change.