A 10-Chart Look At The Latest Inflation Data
Summary: The outlook for current and future inflation according to the latest economic data, Wall Street-based credit spreads, and surveys of both professional economists and American taxpayers is very consistent with the Fed's own expectations, according to the January Minutes of the Federal Open Market Committee. Although some headline measures of inflation have become elevated, core measures - which are the Fed's primary focus -- remain tame and in line with Fed expectations. The only potential hot spots in today's charts are the multi-year wide extreme in TIPS Spreads (representing Wall Street) and the University of Michigan household survey (representing Main Street), which has been steadily rising since early 2009.
"They agreed that it would soon be appropriate to return the maturity of primary credit loans to overnight and to widen the spread between the primary credit rate (i.e. the discount rate) and the top of the Committee’s target range for the federal funds rate.
Participants generally agreed that such steps to return the Federal Reserve’s liquidity provision to a normal footing would be technical adjustments to reflect the notable diminution of the market strains that had made the creation of new liquidity facilities and expansion of existing facilities necessary and emphasized that such steps would not indicate a change in the Committee’s assessment of the appropriate stance of monetary policy or the proper time to begin moving to a less accommodative policy stance."
From the Minutes of the Federal Open Market Committee, January 26-27, 2010
When the January Minutes were released at 2:00 PM ET on Wednesday February 17th, guest experts on financial television didn't waste any time in trumpeting that the 50 bps hike in the discount rate by the Fed marked the beginning of a new tightening cycle, and/or the official end of the financial crisis. However, these Minutes made it pretty clear that this was not the case, and the FOMC went though a lot of deliberation and effort to try to ensure the correct interpretation by the market.
You know what they say -- never let the facts get in the way of a good story...
The January minutes also contained a lot of information about the Fed's analysis and expectations for current and future inflationary pressures based on both headline and core data, and also several measures of inflation expectations by both Wall Street and Main Street.
In today's Commentary we take a closer look at these latest data, including the January Producer Price Index and Consumer Price Index data that were released at the end of last week, and how they line up with what the Fed is expecting. We also include some quotes from the January Minutes that pertain to each data series for some added perspective.
Producer Price Index
"Though headline inflation had been variable, largely reflecting swings in energy prices, core measures of inflation were subdued and were expected to remain so."
Headline producer price inflation for January came in at a much hotter than expected 1.4% following a modest 0.4% increase in December. The headline increase was led by a 5.1 percent surge in energy costs with gasoline up 11.5 percent.
Year-over-year (YOY), the red highlights on Chart 1 below show that headline PPI spiked up to +5.0% for January, double the 2.5% YOY change logged in November. The blue highlights also show that 5.0% is more than twice the 2.2% 20-year average for the YOY change in this series.
However, it bears mentioning that much of this big jump in the YOY data is attributable to technical factors as three months of negative YOY changes between October and December 2008 have recently dropped off of the back end of the equation.
Core inflation at the producer level (less food and energy) came in at +0.3% for the month of January, slightly hotter than the 0.1% expected. YOY, Chart 2 shows that core PPI for January was 1.0%, slightly higher than the 0.9% change in December, but still well below the 1.7% 20-year average for this series as indicated by the blue highlights.
Just like the Fed said in the quote above, headline inflation has largely been reflecting swings in energy prices, but core measures of inflation remain subdued.
Consumer Price Index
"Consumer price inflation was modest in December after being boosted in the preceding two months by increases in energy prices. Core consumer price inflation remained subdued."
Headline consumer price inflation in January (Chart 3) held steady at a 0.2% increase, matching December's revised pace (new seasonal factors). The headline number for January was a little below market expectation for a 0.3 percent boost. The gain in the headline CPI was due largely to higher gasoline prices, but a drop in shelter costs kept both the headline and core rate softer than expected.
The blue highlights on the chart show that, at 2.7%, the YOY change for January is right in line with the 2.8% 20-year average for this series.
Core consumer price inflation fell at a 0.1% monthly rate in January (Chart 4), following a 0.1% uptick in December. The market was expecting a 0.1 percent rise for the core CPI, which was pulled down by a 2.1 percent drop in lodging while away from home and by a 0.1 percent dip in owners' equivalent rent. The January CPI report was much softer than the PPI, with the CPI housing component making most of the difference
The YOY change in the core CPI dropped to 1.5% from 1.8% in December which, as the blue highlights on the chart show, is appreciably below the 2.7% average YOY change over the past 20 years.
Personal Consumption Expenditures Data
The Fed's favorite inflation data for January is due to be released on March 1st. The December data, which was released on February 1st, showed that headline PCE was up just 0.1% following monthly increases of 0.3% in both November and October.
The red highlights on Chart 5 show that the YOY change for December spiked up to 2.1%, following a 1.5% change in November, but a look across the past year of data (not shown) indicates that this jump is attributable to technical factors as three months of negative YOY changes between October and December 2008 (just like in the headline PPI data shown in Chart 1 above) have recently dropped off of the back end of the equation.
This technically-driven bump in the YOY change puts headline PCE above the Fed's 1.4% to 1.7% expected range for these data in 2010 (according to the January Minutes), but the blue highlights show that it is still below the 2.3% 20-year average for this series.
Core PCE inflation in December firmed incrementally to a 0.1% increase, exactly what was being expected by the market, following no change in November. The red highlights on Chart 6 show that core PCE rose by 1.5% on a YOY basis in December, up slightly from the 1.4% change in November and October, but still right in the middle of the 1.1% to 1.7% that the Fed is expecting in 2010 according to the January Minutes.
Moreover, the blue highlights show that the December 1.5% YOY change is well below the 2.3% 20-year average for this series.
INFLATION EXPECTATIONS-RELATED DATA
For years the Fed has consistently referred to "inflation expectations" as a key consideration in setting monetary policy, in some instances even stating that these expectations are potentially more important than inflation itself. The Fed uses both market-based and survey-based measures of these expectations to determine what different segments of the population are thinking and feeling about inflation.
Market-Based Data: The 10-Year TIPS Spread
"Survey measures of expected future inflation were fairly stable, but some market-based measures of inflation expectations and inflation risk (like TIPS Spreads) suggested continuing concern among market participants about the risk of higher medium-term inflation, perhaps reflecting large fiscal deficits and the size of the Federal Reserve’s balance sheet."
TIPS spreads, which are the difference in the yield of Treasury Inflation Protected Securities and the yield of equivalent nominal Treasuries, indicate the level of inflationary pressure that Wall Street is expecting (and, more important, is betting on).
Through February 19th the 10-Year TIPS Spread had widened to 231 bps, which is essentially a 16-month wide extreme. This means that investors in these securities are expecting YOY headline consumer price inflation to average 2.31% over the next 10 years, which is actually pretty close to the 2.7% January headline CPI number shown in Chart 3.
However, it is equally important to note that Wall Street's expectations for inflation tend to be much more volatile than the other inflation data displayed in this report.
Chart 7 displays the 10-Year TIPS Spread in the upper panel (black line), quarterly overbought and oversold extremes within the TIPS spread in the middle panel (red line), and the yield of the US 10-Year Note in the lower panel (blue line). The pink vertical highlights between all three panels point out that quarterly overbought extremes in the TIPS Spread, the most recent instance which is taking place right now, have historically coincided with a narrowing in the spread and a coincident decline in 10-Year Treasury yields.
The reason for the relationship between the TIPS Spread and nominal yields is that as expectations for future inflation abate, expectations for rising interest rates (to combat inflation) typically abate right along with them.
So, even though the TIPS Spread is currently at a 16-month wide extreme, the messages of this are that:
- Wall Street's expectations tend to oscillate back in forth between high and low extremes within a quarterly time frame, and
- the latest of these extremes suggest that Wall Street may currently be overstating the likelihood of future inflation -- pending a quarterly adjustment downward (narrowing) -- which is likely to be accompanied by a decline in benchmark US interest rates.
If history repeats and TIPS Spreads narrow over the next one to several months as expected, this will take away one cause of inflation-related concern by the Fed while taking Wall Street's expectations for future inflation back down to a level that would be more consistent with the relatively benign core inflation data shown in Charts 2,4 and 6.
Survey-Based Data: The Survey of Professional Forecasters
"Mr. Hoenig was concerned that, under these improving conditions, maintaining short term interest rates near zero for an extended period of time would lay the groundwork for future financial imbalances and risk an increase in inflation expectations."
The Survey of Professional Forecasters is the oldest quarterly survey of macroeconomic forecasts in the United States, and one that the Fed has mentioned by name as a means to gauge inflation expectations according to economists. The survey began in 1968 and was conducted by the American Statistical Association and the National Bureau of Economic Research. The Federal Reserve Bank of Philadelphia took over the survey in 1990. The survey indicates these economists' expectations for headline CPI inflation 1 year and 10 years from now.
Chart 8 plots the quarterly survey results for inflation expectations one year from now since 1981. The blue and red highlights show that the most recent data point, taken in January, is at 1.79% inflation. This represents a slight uptick from the 1.63% reading for Q4 2009, but is still well below the 2.41% 20-year average for this series as indicated by the red highlights on the chart
We also note that, at 1.79% for Q1 2010, these expectations are just slightly above the 1.63% all-time low for this series logged in January 2004 (green highlights).
According to the economists in this survey, so far Mr. Hoenig's fears appear to be unfounded.
"With substantial resource slack continuing to restrain cost pressures and with longer-term inflation expectations stable, inflation is likely to be subdued for some time."
Chart 9 plots the quarterly survey results for inflation expectations 10 years from now since 1991 (when this 10-year series began). The blue and red highlights show that the most recent data point, taken in January for Q1 2010, is at +2.39.%.
Like the 1-Year data shown in Chart 8, this represents a slight uptick from the Q4 2009 survey results of 2.26%, but is still appreciably below the 2.55% 20-year average for this series as indicated by the red highlights -- and actually, much closer than the 2.30% all-time low for this series logged in January 1999 (green highlights)..
These data concur with the quote from the January Minutes above by suggesting that longer term inflation expectations are stable and subdued.
Survey-Based Data: The University of Michigan Inflation Expectations
"According to survey results, households’ expectations of near-term inflation increased in January; in addition, median longer-term inflation expectations edged up, though they remained near the lower end of the narrow range that has prevailed over the past few years."
Our final chart, Chart 10, displays the monthly University of Michigan Inflation Expectations survey (below), which is a survey of households to determine by how much American consumers expect prices to rise over the upcoming year. This is another survey that the Fed has mentioned by name in previous FOMC minutes, and is clearly being referred to in the quote above.
It is used to determine to what degree Main Street is feeling the effects of price inflation.
The chart shows that, through the latest data point in January, American consumers were expecting prices to rise by +2.8% over the upcoming year. This is a much more aggressive expectation for inflation than that of economists over the same period as shown in Chart 8, and a much more emotionally-based one as it is coming from the average American who doesn't study economic trends - but feels the pinch in his wallet.
The apprehension shown in this survey is understandable considering that here in Chicago gas prices are hovering around $2.75 per gallon and almost 10% of the country is out of work. Meanwhile, Washington can't seem to get anything passed to help the situation and politicians like William Goodling (R-PA) are telling their constituents that "gridlock is good". No wonder these survey participants are nervous.
Despite all of this, the red highlights on the chart show that, at 2.8%, this survey of American households is still below its 3.0% 20-year average.
Conclusion & Investment Implications
The outlook for current and future inflation according to the latest economic data, Wall Street-based credit spreads, and surveys of both professional economists and American taxpayers is very consistent with the Fed's expectations according to the January Minutes of the Federal Open Market Committee. That is, although some headline measures of inflation are elevated, primarily due to a jump in energy prices, core measures remain tame, in line with Fed expectations and well below the 20-year average for these series. It's worth noting that even the elevated headline numbers are still in line with their 20-year average of YOY changes.
The only potential hot spots in today's charts are the multi-year wide extreme in TIPS Spreads and the University of Michigan household survey, which has been steadily rising since early 2009. We expect TIPS Spreads to narrow over the upcoming months as they unwind their current technically-overextended condition, but the U of M Survey data could become a cause for a concern by the Fed if it continues to creep higher from here.
Disclosure: No positions