Inflation Is MIA But Not Dead

by: Markos Kaminis


The most recent report of consumer prices implied inflation is lagging.

However, closer inspection supports the Fed's view and mine that transitory factors came to play in recent months.

Inflation is only masked therefore in recent data.

On the day of the Federal Open Market Committee (FOMC) decision, investors were given a controversial Consumer Price Index to think over. It was yet one more point of contrast for the Fed to explain as it raised interest rates (NYSE: BOND) despite still below target level inflation; not that there's anything wrong with that... But inflation is only missing in action folks, not dead, and I believe it is all definable and indeed transitory. So I agree with the Fed's decision this month, because inflation is indeed lurking.

The Consumer Price Index (NYSEARCA:CPI) for May showed headline consumer prices (NYSE: XLY) declined 0.1% month-to-month, against economists' consensus expectations for no change in May. On a yearly basis, consumer prices were up 1.9%, short of expectations for 2.0% and down from April's 2.2% increase.

Because of the volatility of food and energy prices (NYSE: XLE), the Bureau of Labor Statistics breaks out a number clean of the two factors. The Core CPI for May was up 0.1%, versus expectations for a greater increase of 0.2%, so this figure was also light on inflation. It was also consistent with the 0.1% sluggish rate of core price increase in April, and so solidified concerns about lagging prices. On a yearly basis, Core CPI was only up 1.7%, short of expectations for 1.9% and under April's measure of 1.9%.

What had happened was...

Looking more closely into the details of the data, we find that the key killer of prices was a monthly decrease in energy prices (NYSE: OIL) of 2.7%, driven by a 6.4% drop in gasoline prices. "And what's wrong with that?" asks every American. The BLS noted key dampeners of core prices were found in apparel (NYSE: XRT), airline fares, communication (NYSE: VZ) and medical care services.

I think you can see here how attempts to clean the data can be imperfect and also how competition in our developed markets matters. For instance, when the price of jet fuel goes down perhaps it gives airlines more flexibility with pricing. So maybe the drop in airfares is transitory too, if you believe energy prices will eventually increase on supply/demand balance or some other catalyst.

We have been told the decline in communications prices is due to a timely development in the competitive wireless services sector (NYSE: T). Can we say this is transitory too, or is it just the product of healthy competition in a developed economy? Whatever the case, it looks to have played an integral role in both April and May's price softness.

As I reviewed the data, it was clear to me that the anomaly of a 6.3% drop in communications prices pulled the rug out of Core CPI again in May, like in April. And as we pull last April and May out of the yearly data, we get decreases in the annual rate of price increase. So there you have it.

In case you're interested, apparel prices fell sharply in May too, down 0.8%. New vehicle prices (NYSE: GM) dropped 0.2%, and used cars and trucks dropped by the same figure. Shelter prices (NYSE: XHB) rose 0.2% helped by higher rents; transportation services prices rose 0.3%; services less energy services rose 0.2%; medical care commodities rose 0.4%.

Given the communications industry anomaly, I understand why the Fed is looking past recent price softness. I agree with the Fed's decision to raise interest rates, but the market (NYSE: SPY) (in other words you) also needs to believe in this thesis. That's how long rates will normalize.

Perhaps the stock market (NYSE: VTI) is figuring it out, declining again slightly Friday, though that may also have something to do with the investigation in D.C., which took a new twist today. Your key takeaway here is that inflation is only MIA folks, not dead. Stay tuned to the column here at Seeking Alpha for more of my musings.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.