We recently came across a provocative headline that asked, “Did you realize core US consumer price inflation is at 10-year highs?” Against the common market narrative that inflation remains low and markets expect the Federal Reserve to ease again later this month, that seemed worth further examination.
First, the data:
- True enough, core CPI was +2.4% in both August and September 2019.
- The old decade highs were in April 2012, February 2016 and July 2018 at 2.3% in each case.
- Core CPI has ranged between 1.6% and 2.3% since mid 2011.
Next, let’s talk about what’s driving core inflation now:
- Surprisingly, tariff-related items like apparel (4% of core CPI) are seeing actual deflation to the tune of -0.3% over the last year.
- There is also little in the way of commodity inflation, which includes items like motor vehicles, medical care items, alcohol and tobacco. The current annualized inflation for this category (25% of core CPU) is +0.7%.
- The key driver of strong core inflation is “Shelter”, both owner occupied and rentals. Owner’s equivalent rent (how the CPI captures homeowner shelter inflation) is +3.4% year-over year. Rent is +3.8% over the same time period.
- Given the weightings of OER and rent in the CPI calculation (24% and 8% respectively), these are the actual consumer expenditures pushing measures of core inflation higher.
Since owners’ equivalent rent is driving the core inflation bus, let’s see how that is trending. Here is a chart with the data back to 1984:
What we see here:
- OER inflation has been relatively stable since 2015, rising 3.0% – 3.5% annually.
- While it has been historically volatile because of economic/interest rate variations, current OER inflation is broadly in line with long term trends.
Finally, we should examine long term trends in core CPI inflation to see if that “10-year high” really signals that something is fundamentally changing. Here is a chart back to 1958:
What we see here:
- Long-run core inflation looks much like you’d expect. Large spikes occur during the 1970s driven by loose monetary policy and the spill over effects of the 1973 and 1979 oil shocks. After that, core inflation has been in structural decline.
- Past 2000, core inflation tops out at 2.6% – 2.9% (2000, 2006) and more recently the aforementioned 2.3% – 2.4%.
- Yes, core inflation is at 10-year highs but that decade includes the lowest readings back to the 1950s as the above chart clearly shows.
- The root cause is shelter inflation, which is not accelerating.
- We are not yet at prior cycle peaks for core inflation, and if the current economic slowdown persists then we would expect to see lower levels in the near future.
Bottom line: nothing here stands in the way of another Fed rate cut later this month. Fed Funds Futures put the odds of such a move at 85%, and that seems about right given a backdrop of slowing economic growth.