While deflation and negative interest rates have crammed the headlines over the past month, today’s CPI print threw some cold water on the idea that US inflation is weak. Core CPI made a new high on a YoY basis, moving up to 2.216%. As the table below shows it’s also up 2.296% on a six month basis and 2.537% on a three month basis. The +0.293% MoM is 3.571% at an annual rate, the strongest print since March of 2006! In short, core CPI is accelerating, and the case could be made it is accelerating sharply.
Of course, Energy prices continue to decline precipitously, and the USD makes most imported goods cheaper also. But the simple reality is that most US inflation is labor inflation driven by the cost of services.
The cost of services also features prominently in the table below, which shows the top 10 fastest rising and fastest falling components of CPI on a YoY basis. Education, medical care, and rent are all rising sharply, and as the chart above shows it’s no longer due to shelter costs alone. CPI for Shelter made a new post-recession high this month, but the real sharp moves up have been in health care inflation.
Of course, commentators will note that the Fed’s preferred gauge of inflation is PCE and that PCE has been much softer than CPI. This is true, but it’s important to understand this is mostly a housing phenomenon. In the chart below, we note the difference in QoQ annualized CPI and PCE; higher readings on the blue line (the sum of the bar charts) are consistent with CPI higher than PCE. As shown, housing is by far the most consistent driver. As we noted above, services and especially health care-related indices, not housing, have driven the recent acceleration in core CPI, and that’s important: health care has a higher weighting in PCE, so the uptick we’re seeing in core should be if anything stronger in PCE. We don’t think the Fed is “behind the curve”; the most recent minutes specifically noted a number of committee members wanted to see inflation rise, rather than expect it to, before tightening policy further. But today’s CPI print, in our opinion, is a strong signal that CPI – and the broad inflation picture – is accelerating. If this keeps up, it’s going to be a key plank in the platform of hawks on the committee that want to see multiple hikes this year. The market, mind you, currently sees that as a very unlikely outcome. Following the strong data prints recently, an adjustment of expectations is very possible in interest rate markets over the next few months.