The Devil In CPI Headlines
CPI in the USA rose by the most in almost 9 years! Anyone reading that very impressive sounding headline in the media could be forgiven for thinking that the US economy is back to firing on all cylinders. But is it really?
The US CPI data point being referred to is that for March 2021. This is very important, because March of last year is when the CPI started falling because of global Covid lockdowns. Changes in the CPI are calculated on both a month-on-month (MoM) and year-on-year basis (YoY), which makes March of 2020 the base from which the March 2021 YoY CPI change is calculated from.
This means that the YoY change in CPI for March 2021 is affected by “base effects”. This is when a data point is calculated off an abnormally low (or high) base, thereby giving the impression of massive change, when in truth the degree of change might not have been that large.
Looking at the data points, CPI was higher by 2.6% in March 2021 YoY, while the YoY change for February 2021 was 1.7%. Unfortunately for us, while we know that some of this large 0.9% increase is due to base effects, we don’t know by how much.
This brings us to the MoM number, which is attracting all the attention. It came in at 0.6% for March, versus 0.4% in February. The advantage of looking at the MoM number is that it avoids the base effects of March 2020, which is illustrated in the not very large 0.2% difference between Feb and March ‘21. This in turn gives us an approximate idea of how much base effects influenced the YoY number.
However, more important than base effects are long term trends, and the context they provide when interpreting data points.
From this chart of MoM changes in the CPI, we can see that 0.6% is just about the upper end of the range, at least for data spanning the last 16 years. The last time MoM CPI rose higher than 0.6% was in June 2009, as the US economy started to emerge from the wreckage of the Great Financial Crisis.
In other words, a somewhat similar economic situation to what we are seeing now, with massive monetary and fiscal stimulus packages being thrown around. The difference lies in magnitude, with much more government and central bank expenditure in 2021.
On a YoY perspective, however, the inflation situation looks more bleak.
What is obvious from this chart is that annual change in CPI has improved drastically in the short term, that is over the last 12 months. This is where the effects of the US government’s multiple trillion dollar stimulus packages can be seen, and more importantly, where the effects of broad economic reopening after two waves of Covid show up.
It also reflects the supply problems that are currently plaguing producers, with higher commodity prices, energy prices, and shipping costs; not forgetting the cold snap that incapacitated Texas in February, which compounded existing shortfalls in oil production.
Unfortunately, the longer term picture is not as rosy, and from this standpoint, inflation just isn’t picking up in a manner that can be sustained over the Fed’s target rate of 2% , even with multiple iterations of QE. This is where the long term inefficacy of fiscal stimulus and the Fed’s policy of ultra low rates show up.
As such, there is much more going on than what the headlines suggest, and a more nuanced perspective is needed if one is to figure out how the CPI data point fits into their trading or investing time horizon.
Don’t just focus on the headlines!
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