Predicting This Week's Inflation Releases

by: David Andrew Taylor

We've got probably two of the most important releases of the year coming in tomorrow and the Wednesday. PPI and CPI are due this week respectively. I believe that these two pieces of data will be scrutinized more than any other data out there for the entire year. That important.

Why so important?

I'm figuring that everyone out there will base their trading decisions on these indicators, and their reflection on how this will affect the interest rate outlook.

My prediction:

PPI comes out tomorrow. For the past several months, the rate of growth for both the core and headline for PPI has been softening. Here are the charts for the two:

I expect this trend will likely continue. There's no real reason that I can figure that is likely to push the data that much higher. The headline may not increase as the overall price of energy has remained constant and even softened from April to May. But the core should continue to move slightly lower. It will likely be a somewhat mixed bag with an overall softening tone. That may be a huge problem.

PPI comes out before CPI. If there is a softening tone in the PPI, it may set the market up for a huge letdown if CPI comes out and shows a completely different picture.

CPI hasn't really been softening as much. In fact, they've been moving slightly higher. Here are the two charts:

Things are heating up at the pump and just about every other register that a consumer is likely to encounter. I see inflation as increasing, but not a huge problem. But, I'm not determining interest rate policies, so my opinion on that matter doesn't count. What I do see is a consumer that is slowing somewhat. That slowing is going to soften every level of demand out there. However, there has been a chorus of Fed speak out there that mentions that just because the consumer is slowing down, doesn't mean that inflation will fall in a timely manner. On one hand, the Fed agrees with me (or we see eye-to-eye on that aspect). On the other hand, the Fed looks set to be in a hurry to lower inflation. I'd be more inclined to believe they've done ample work to get the job done.

I've looked at the numbers out there for CPI core rate. There was one interesting aspect of last month's release that really stood out and made me ask a simple question: What happened last year at this time that made this year's numbers increase as much as they have?

That was an interesting question that I've really focused on to help determine this month's data. To begin, here's a look at all the core data for the past 1.5 years so you can see:

Dec-04

198.50

0.151%

2.130%

Jan-05

198.90

0.202%

2.196%

Feb-05

199.40

0.251%

2.244%

Mar-05

200.10

0.351%

2.291%

Apr-05

200.20

0.050%

2.286%

May-05

200.50

0.150%

2.246%

Jun-05

200.60

0.050%

2.140%

Jul-05

201.00

0.199%

2.120%

Aug-05

201.20

0.100%

2.118%

Sep-05

201.50

0.149%

2.114%

Oct-05

202.00

0.248%

2.094%

Nov-05

202.50

0.248%

2.089%

Dec-05

202.80

0.148%

2.136%

Jan-06

203.20

0.197%

2.166%

Feb-06

203.50

0.148%

2.128%

Mar-06

204.20

0.344%

2.089%

Apr-06

204.80

0.294%

2.134%

May-06

205.40

0.293%

2.264%

There are four types of data here for the core rate. The first is the date. Second is the actual number used in the inflation release. The third is the month/month change. The fourth is the column that I use, the month/month change based on the quarterly data. My data shows a slightly less inflationary outlook, but still increasing.

Also, notice that there is May data. I've done a projection for the May data. I've done an increase equal to the number increase that we saw last month. I figured that this would be practical on a few levels, but perhaps could be overstated. Energy prices have declined since April, and so has consumer expenditures. I think the CPI has a likely chance of softening from last month's increase.

Look at the data from the March - April timeframe in 2005. Notice the month/month increase of a whopping 0.050%. There is the culprit in the jump we've seen last month. There was barely any change from the month before in the 2005 timeframe, which showed up as a huge increase comparatively for last month. There are some consistent gains in inflation. However, last year at this time, the gains were muted. This is translating into a higher number for this year. I think that trend is likely to continue until the fall of this year if this consistency persists. We may continue to see 0.3% increases month over month, and I give this scenario about a50% likelihood of occurring.

There's another scenario that I'm thinking may be likely. Perhaps we get a 0.2% increase year-over-year. I give this scenario the other 50% likelihood. This is the one scenario that will throw the most wrenches into the system. It's smaller than last months. But, it's also much bigger than we've seen before. If this type of release comes out, look for the pundits to start talking about less inflation than expected. Just what the markets need, more ambiguity.

I'm not in the business of predicting indicators. Instead, I'm in the business of riding the moves once the indicators are released. These are the two scenarios that I think are most likely. I believe that the Fed has a firm grasp on the inflation front. I also see the prices of energy softening. The combined could soften the CPI release and throw more flip-flopping into the system.

Let's see what happens and go from there.