January 19, 2006
RECESSION? INFLATION? GROWTH? DEFLATION? ALL OF THE ABOVE?
The casual investor can be forgiven for claiming ignorance on the topical subject of inflation's future path. In fact, enlightenment probably eludes the financial sophisticates as well.
Yesterday's update on consumer prices in December exemplifies the muddle that prevails. Top-line inflation, measured by the consumer price index, pulled back last month by 0.1%, the Bureau of Labor Statistics reports. December's 2.2% decline in energy prices was the big reason for CPI's drop, which follows November's even-larger descent.
But then there's the core rate of inflation, which excludes the volatile food and energy variables. By this measure, inflation advanced by 0.2% in December. In fact, core inflation has been advancing on a monthly basis for some time, as opposed to the up-one-month, down-another standard that reigns in top-line CPI.
It all adds up to a mixed bag. If you want to see inflation creeping into the system, you'll find it. But you can also make a case that inflation's no threat. Whatever you choose, here's how 2005 stacked up:
|Dec 2005 CPI:||-0.1%|
|Dec 2005 CPI-ex Food & Energy||0.2%|
|2005 CPI-ex Food & Energy||2.2%|
More than a few observers have concluded that inflation, whether top line or core, is a toothless beast, at least for now. Ed Yardeni, chief investment strategist at Oak Associates, writes in a missive to clients this morning:
Despite widespread fears that soaring energy costs might boost core CPI inflation in 2005, it was only 2.2%, the same as in 2004. We expect it will stay this low again in 2006. The core CPI goods inflation rate is near zero, and could turn negative. The CPI services rate ex energy finished 2005 at 3%, reflecting a surge in hotel costs. These costs tend to be volatile, and will likely move lower again.
David Resler, chief economist at Nomura Securities in New York, agrees. "Overall...the core rate shows little meaningful movement and seems to be 'well-anchored' in the 2% to 2.3% range it has been in for most of the last decade," he writes yesterday in a research note. He adds that the core CPI has risen by less than 2% in only two (2003 and 2004) since 1965.
The notion that pricing pressures may stay contained for the foreseeable future was given another shot of adrenaline this morning with news of a sharp 8.9% drop in housing starts, and single-family starts off by more than 12% for December relative to the previous month, according to the Census Bureau. Perhaps that's simply a reaction to the arrival of colder weather. Whatever the reason, a sign of cooling in housing suggests that the primary suspect in driving exuberance of late is under control, giving new life to optimism that inflation will stay contained.
But if you're a skeptical type who thinks pricing pressure is only dormant, you'll find reason to worry anew in another data point dispensed today. Initial claims for jobless benefits fell dramatically to 271,000 last week, according to the Labor Department. As a result, the 40-week moving average for jobless claims is now under 300,000 for the first time since October 2000, Resler notes. It was a burst of vigor that few expected. This too may be a reflection of technical issues, including the volatility of hiring after the holidays. But coming after yesterday's Beige Book review from the Fed, which advised that economic activity generally remained robust across the nation, there's reason to wonder if inflation may yet mount another run later in the year.
Not necessarily, the bond market effectively announced yesterday, courtesy of another sighting of an inverted yield curve. This time it was the yield on the lowly three-month T-bill inching above the 10-year Treasury. The inversion follows another instance last month, when the 2-year Treasury briefly topped the 10-year.
The traditional interpretation of such a lopsided state of money-pricing affairs is that it presages recession. But this time around there's much debate as to the value of an inversion's forecasting power. No less than Richmond Federal Reserve President Jeffrey Lacker yesterday dismissed the idea that an inverted yield curve predicts recession, or anything else. "Some of the reaction, some of the discussion, reminds me of Medieval times when the arrival of a comet would spark a sort of apocalyptic hysteria," he opined, according to Reuters. "Concerns about inverted yield curves are somewhat overblown."
You can see whatever you want to see (or not see) in the global economy of the 21st century. Rather than drawing hard and fast conclusions from any analysis perhaps we should think of it as a dismal science Rorschach test. Maybe someone can study the correlations between personality types and economic prognostications. No matter, the future will probably surprise the hell out of everyone, as it usually does.
Meanwhile, we can all deconstruct the data to pass the time.
Posted by jp at January 19, 2006 9:10 AM
Don't like the CPI trend? Well neither does Uncle Sam.
"Next month, the Bureau of Labor Statistics will update the market basket on which they compute CPI changes."
January 18, 2006
~ Michael F. Bryan
For a refreshing change, the December CPI report had a bit of good news this morning for both consumers and inflation worry-warts like me. For consumers, many of the items that posted price declines in November continued to do so in December, including energy, men’s apparel, footwear, and new and used vehicles. To these were added falling prices on women’s apparel, beverages, dairy products, and bakery goods. In fact, when you add them up (and I did), 35 percent of the consumer’s market basket showed either no change or a price decline last month, compared with about 25 percent a month earlier. Likewise, only a little more than 13 percent of the CPI basket posted price hikes in excess of 5 percent (annualized) in December, compared with about 24 percent in November. So whatever sleep I lost in the days immediately following the November CPI report, I hope to recoup starting this evening.
Sure, the “core” measures of inflation, reported in the following table, weren’t great, but they certainly didn’t worsen, seeming content to remain in the neighborhood of 2 to 2½ percent. (More detail can be found in the Cleveland Fed’s median CPI press release.) Any whiff in the November data that prices were poised to break the upper 2½ percent threshold seems to have vanished in December.
Now, if you’re like me, you might be more comfortable if the CPI trend was closer to the lower end of that 2- to 2 1/2-percent range. Well, we might be getting some help from the BLS beginning with next month’s CPI report.
Here’s a puzzle for you: If a good’s price goes up, and you don’t buy it, has your cost of living risen? [Actually, this is a question that most economics majors are asked on an examination at some point in their undergraduate studies.] The intent of the question is to get students to think about the theoretical difficulty of measuring changes to our cost of living. Here are two rules in measuring cost of living, and if they seem in conflict, well, that’s because they are. Rule one: When you gauge price changes, you must fix the market basket. One can’t make any conclusion about the cost of living by comparing the price of the oranges I bought yesterday to the price of apples I bought today. And rule two: Once you fix the market basket, it immediately becomes outdated!
It turns out that there is no right answer to the question above. You can either price the oranges you don’t buy today, or the apples you didn’t buy yesterday. Most economists have concluded that it’s most useful to value the items you bought in an earlier period using the prices of today—as long as that earlier period wasn’t too long ago. Next month, the Bureau of Labor Statistics will update the market basket on which they compute CPI changes. The basket will reflect consumer expenditure patterns over the 2003-2004 period, compared to the 2001-2002 basket of goods they use today. Can the market basket really change that much in just a few years and, moreover, is it likely that the new market basket give us a higher or lower reading? Well, yes, the market basket can change quite a lot. And I’m not just thinking about ipods, Xboxes, and high-definition TVs. Whenever prices move, people change their expenditure patterns—generally moving away from the goods going up in price in favor of goods where prices are relatively more favorable. So yes, we can anticipate that when the market basket is updated, changes in the cost of living will be more moderate than they would have otherwise been. How big a change is this likely to be? We’ll know next month. But to give you an idea, consider the figure here, which compares the “core” CPI to the “core” CPI on a chain-weighted basis.
The chain-weighted CPI is an experimental measure which updates the consumer market basket more frequently that the conventional CPI. Over time, the chained CPI has averaged about 4/10ths of a percentage point below the conventional measure, an indication that updating the basket could have a significant effect on our CPI reading. So, if you are like me, and would like to see the CPI trend closer to 2 percent than 2 ½ percent—the BLS might just have what you are looking for in next month’s report.
Posted by: jill at January 21, 2006 10:43 AM