August Inflation: What It Means For Social Security, TIPS And I Bonds

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Includes: TIP
by: Tipswatch
Summary

Headline inflation numbers matched the consensus forecast, but core inflation ran higher than expected. Gasoline prices were down, moderating overall inflation.

With one month of data remaining, the Social Security COLA looks likely to increase 1.6% to 1.8% for January payments.

The I Bond's new variable rate, to be reset November 1, looks likely to be higher than the current rate of 1.4%.

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.1% in August on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, "headline inflation" increased 1.7%.

Those inflation numbers, down a bit from July, matched the consensus estimate. But there was an upside surprise in core inflation -- which removes food and energy -- with core inflation rising 0.3% in August and 2.4% over the last 12 months. The consensus estimate was for 0.2% for the month and 2.3% year-over-year.

Core inflation of 2.4% is clearly "moderate" inflation, which has continued at or above 2.0% for more than a year. But today's report seems to be having little effect on equity markets, with stocks up slightly this morning at the opening.

What this means: Social Security COLA

The Social Security Administration will set next year's cost-of-living adjustment based on the average inflation index for July, August, and September, using a different index: the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W).

For August, the BLS set the CPI-W index at 250.112, down very slightly from July's 250.236, and marking an increase of 1.5% over the last 12 months. But this is only the second of three months of data that will set the Social Security COLA for 2020. Because the SSA uses an average of three months, at this point the COLA would be 1.6%, with one month remaining.

The flat CPI-W reading for August broke the track I predicted would lead to an 1.8% increase in the 2020 COLA. At this point, however, it still looks like the increase will be in the 1.6% to 1.8% range. But anything can happen with inflation; it's very difficult to predict. Here are the numbers:

CPI-W and Social Security COLA

At this point, it's interesting to note that CPI-W is running 20 basis points lower than overall inflation (set by CPI-U) year-over-year. I have noted before that the SSA's complex formula and oddball index often result in the Social Security COLA lagging behind overall U.S. inflation. But the numbers could still balance out next month.

What this means: TIPS and I Bonds

Investors in Treasury Inflation-Protected Securities and U.S. Series I Savings Bonds are also interested in non-seasonally adjusted inflation, which is used to adjust the principal balances on TIPS and set future interest rates for I Bonds. For August, the BLS set the inflation index at 256.558, a decrease of 0.01% from the July number. Essentially, non-seasonally adjusted inflation was flat in August.

For TIPS. The August inflation number means that the principal balances of all TIPS will decrease -0.01% in October, following a 0.17% increase in September. Here are the new October inflation indexes for all TIPS.

For I Bonds. The August inflation number is the fifth in a series of six inflation reports -- from March to September 2019 -- that the Treasury will use on November 1 to reset the I Bond's inflation-adjusted variable rate. At this point, with one month remaining, inflation has increased 0.93% during this period, which translates into a variable rate of 1.86%, up from the current 1.40%.

But even if the inflation-adjusted rate looks to be higher in November, any potential investors in I Bonds should buy their 2019 allocation -- up to $10,000 a year, per person -- before October 31. Buying in September or October will capture the current fixed rate of 0.50%, which is the I Bond's "real return," meaning the return above inflation.

That real return of 0.50% is higher than any TIPS investment out to 23 years, and includes the I Bond's advantages of tax-deferred growth, better deflation protection and flexible maturity. The danger in waiting until November is that the Treasury is highly likely to lower the fixed rate on November 1. (I will be writing more about that in October.)

Here are the numbers so far, with one month remaining:

I Bonds and Inflation (Source: TipsWatch.com)

The September inflation report will be issued at 8:30 am EDT on October 10, and that will set the I Bond's variable rate, which eventually goes into effect for all I Bonds for six months.

The August inflation report

Increases in the costs of shelter and medical care were the major factors in the 0.1% increase in headline inflation, the BLS reported, outweighing a decline in the energy index.

  • Shelter costs were up 0.2% for the month and 3.4% over the last 12 months.
  • The costs of medical care services rose a sharp 0.9% for the month and are up 4.3% year-over-year.
  • Costs of used cars and trucks have been on a sharply upward trend, rising 3.6% over the last three months. But those costs are up just 2.1% year over year.
  • Food prices were flat in August and up 1.7% over 12 months.
  • Gasoline prices were down 3.5% and fell 7.1% over 12 months.

Falling energy prices continue to be a strong moderating force for overall inflation, hiding fairly strong inflation throughout the rest of the U.S. economy. Core inflation has remained at levels of 2.0% or higher over the last 12 months, which is a solid measure of "moderate inflation," despite global fears of deflation. This chart clearly shows core inflation trending higher, even as overall inflation is dampened by low energy costs:

12-month U.S. inflation (Source: Bureau of Labor Statistics)

What this means: Future interest rates

This report, which indicates continuing moderate inflation in the U.S. economy, shouldn't have much of an effect on stock markets or the Federal Reserve's plans to gradually lower short-term interest rates.

The Wall Street Journal this morning noted that "a separate report showed real average hourly earnings, a measure of inflation-adjusted earnings, increased 0.4% in August from a month earlier." That is a fairly strong number, and may be hinting at future higher inflation, as long as the U.S. economy stays strong.

I'd say, however, that core inflation at 2.4% (even though the Fed favors a different inflation indicator) would argue against the 50-basis-point cut this month being pushed by many in Washington and on Wall Street. The president tweeted yesterday "No Inflation!" but clearly, U.S. inflation is rising moderately.

A 25-basis-point cut is a lot more likely, and anything higher would set off alarm bells.

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.

Additional disclosure: David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he recommends can purchased through the Treasury or other providers without fees, commissions or carrying charges.