TIPS Market Skeptical of CPI Report

The CPI data this morning was surprisingly weak and the TIPS market reflect a degree of skepticism about the veracity of the data (or if not its veracity then the sustainability of such benign inflation reports). I just conversed with a portfolio manager and happy holder of some TIPS who notes that the breakeven spread in the 10 year sector has widened by 3 basis points today to 245 basis points. Since January, that spread has traded in a range between 220 basis points and 257 basis points. The wide end of the range occurred back in March when the financial world seemed to be crumbling. (As an aside, the wider the spread gets the greater the out performance of the TIP bond relative to the conventional nominal bond.)

The portfolio manager with whom I conversed said that many participants think that there was an overly aggressive seasonal factor applied this month which depressed the inflation rate. These same folks believe fervently in Milton’s dictum that “They also serve who only stand and wait” and they are happy to wait for the next round of data which they believe will manifest inflation in a more virulent form.

Against that background, one can observe that inflation is not just a US phenomenon as the Bank of England signaled that it is probably through cutting rates. The bank noted that it expects that inflation will trade above its 3 percent target for several quarters.

Here is a nice piece from economist Michael Feroli at JPMorgan which examines the entrails of the CPI report:

The April CPI increased 0.21% and the core measure (excluding food and energy) rose 0.10%, both increases coming in below market expectations. The three-month annualized rate on core CPI is now running at 1.2%, the lowest rate since 2003. Even after accounting for the volatile components that may have depressed today's number, the recent inflation news has been quite favorable and should give the Fed some comfort as it keeps policy in accommodative territory.

· Gasoline prices declined 2.0% in April. This is not a government conspiracy. The seasonal adjustment factors normally expect a big increase in gas prices in April. This year the seasonal was looking for a 7.7% increase, whereas actual pump prices rose only 5.6%. (The chart below plots the gasoline seasonal adjustment factors). On the flip side, these same seasonal factors will be looking for declines in gas prices starting in June. Right now, the gas futures aren't signaling that will happen and so we could see stronger gas CPI this summer.

· Like gas prices, food prices have been a highly visible inflation concern recently. Here, seasonal adjustment factors didn't camouflage that concern: food prices increased 0.9% last month, near a 20-year high. Prices for food consumed at home accounted for all the increase, rising 1.5%. Food away from home rose only 0.3%.

· The core measure was helped lower by a 1.9% drop in lodging away from home, a category that's fallen each of the past three months. Even excluding this drop, the core number was well-behaved, rising only 0.17%.

· The owners' equivalent rent [OER] category remained fairly well-contained, rising 0.21%. Tenants' rent edged higher to show a 0.30% increase. Rising utilities prices are continuing to put some downward pressure on OER relative to tenants' rent.

· The curious softness in medical prices is persisting in the April data; medical care prices increased only 0.15%. Unlike the past two months, however, today's number owed to weaker medical care commodities prices (prescription drugs) rather than to medical care services.

Comments

[ari5000]

Skeptical of data put out by the government?

What a concept.

[Lilguy]

I found interesting the little sidebar box in the BLS' CPI press release that noted the discrepancy in the gasoline price. Obviously, the reduced price of gasoline didn't pass the silly test, hence the need for an explanation.

The discrepancy points out, however, the problem in using seasonally adjusted numbers. Properly done, these numbers do reflect the changes throughout the year in the movements of measure. On the other hand, they do not catch structural changes as is occurring now in the petroleum and petroleum products markets. What actually occurred in April, contrary to the BLS report, is that the prices of oil went up so much that demand went down at a time when normal seasonality suggests it reaching its peak.

The same is true for almost all the other USG numbers, including the controversial recent issuance on first quarter GDP.

The numbers won't show the recession and inflation we now face until we are in the depths of the problems.

[User 130076]

Wow the Gov't. cpi numbers might be a political hack job, the next thing they will tell us is the belt way is honest.

[icandoitdon]

lilguy is spot on here....

the government is so slavishly devoted to the precision of their numbers, e.g. capturing historical seasonality effects even in the midst of structural changes, that they blind themselves to the reality of inflation.

i also wonder how errors like this are resolved. unless it is a self-correcting process, e.g. the error in the estimate is reversed the following month, it permanently distorts the true CPI.