It has a familiar ring to it: top-line inflation is surging as the core rate (less food and energy) remains eminently well behaved. As such, investors are still stuck with the recurring conundrum: which gauge of inflation holds the truth?

Casting one’s lot with one side or the other promises to be no trivial decision given the stark difference between the two measures of inflation. The top-line consumer price index advanced at 1.2% in September, the Labor Department reported today– more than double August’s 0.5% advance. Ah, but extracting food and energy from the mix reveals that consumer prices were barely moving last month, registering a mere 0.1% increase, a fraction of the top-line’s growth.
Looking at the annual rates of CPI’s change doesn’t mitigate the disparity between top-line and core rates of change. The unadjusted CPI rose by 4.7% for the year through September 2005, or more than double the 2.0% rate for core CPI. (For perspective, the latest report shows the U.S. economy growing at an inflation-adjusted annual rate of 3.3%, which is obviously well below the rate of top-line CPI’s advance.)
How does the enlightened investor interpret the variance? Very carefully. Indeed, there is no obvious consensus. Rather, partisans on either side of the debate are actively recruiting for their respective outlook. The pessimists, of course, warn that inflation’s on the march. Recent CPI reports, they say, confirm the obvious. It’s time to take defensive action now, they counsel. Indeed, many already have, as the rising price of gold in recent years suggests.
Then there are the optimists, as we shall call them, a plucky group that holds fast to the belief that energy (which is the primary variable driving top-line CPI skyward) is a temporary phenomenon that long-term investors needn’t fear. A combination of technology, new oil- and natural-gas field discoveries, development of alternative energies, enhanced conservation will save us, along with an enlightened group of central bankers. What’s more, in the shorter term, energy is a bubble, we’re told. A slowing economy will pare marginal energy demand, setting prices for oil and other petroleum products on a downward path. In fact, the price of a barrel of crude oil in New York futures trading has been slipping since the end of August, giving aid and comfort to the notion that the cycle shall soon set us free by putting more discretionary spending income in our pockets through lower fuel costs.
Both the bond and stock markets this morning seemed all too eager to align themselves with the cause of the optimism. In the wake of the CPI’s 8:30 a.m. release today (New York time), all the major equity indices were modestly up at 10 a.m. The bond market too was inclined to see the sunny side of the inflation report (such as it is) and chase the 10-year Treasury Note, thereby pushing its yield down slightly by mid morning relative to yesterday’s close. Even gold traders appeared on the fence this morning, with the price of the precious metal off slightly in early trading. The triumph of the optimists resigns supreme as we write.
But what does it say about either optimism or pessimism on the matter of the future path of inflation when no less an informed player in the financial system than the president of the Federal Reserve Bank of Kansas City is less than confident about what’s required of the central bank for the foreseeable future to nip any inflationary pressures in the bud. “My goal is the maintenance of a stable price environment, with low and stable inflation, because I think that is essential to having sustainable growth,” Thomas Hoenig told Reuters yesterday via The Washington Post. “And I think that we need to do what is required in order to achieve that goal.” So far, so good. And what, if we may be so bold as to inquire, might that task entail? “What is required to achieve that goal,” Hoenig continued, “is still open to analysis, to the collection of information and to the application of judgment on the day that the decision is required, which is Nov 1,” he said in reference to the next interest-rate-setting Federal Open Market Committee meeting.
No matter what Hoenig says, or doesn’t say, the fact remains that inflation’s at a 25-year-high in the United States. Some might see that as a sign. In an earlier time, such news would suggest an obvious response. No more. This is the age of financially correct speaking (and thinking?). The question before the house: What’s it going to cost us in the long run?