Today’s update on consumer prices for September looks like a poster child for biopolar disorder.
On the one hand, top-line inflation is conspicuous in its absence. Consumer prices actually dropped last month, posting a sizable -0.5% loss for September. Monthly plummets of this magnitude are rare for CPI, with only a handful arriving in the past generation on a month-to-month basis. But while top line inflation has, for the moment, vanished, core inflation (which excludes the volatile food and energy sectors) shows every indication of staying put.
Core consumer prices rose 0.2% last month, matching the pace in the previous two months. More ominously, the annual rate of core prices edged up to 2.9% in September vs. the year-earlier month, up from 2.8% in August. In short, core inflation is now running at the highest annual rate since 1996, as the graph below shows.
Rolling 12-month % change in core CPI
Source: Bureau of Labor Statistics
The reason for the divergence between top-line and core prices is an energy story. The sharp correction in oil and gasoline prices last month dragged down the broad CPI index. Energy prices dropped a hefty -7.2% last month, a tumble that helped pare transportation prices by -4.1% in September.
Alas, this kind of relief is probably as ephemeral as political promises in an election year. Energy prices have suffered big corrections relative to past months, but at some point a price floor will be reached, and we’re a lot closer to that floor today than we were a month or two back. Anything’s possible in the 21st century, but $20-a-barrel-oil exists at the outer edge of possibilities.
The inflation problem, in other words, isn’t going away. With core CPI continuing to inch higher, the Fed needs to prove that it can control price momentum. So far, that proof is lacking. Declining energy prices are no substitute for muscular monetary policy. For the moment, the distinction is lost on Mr. Market. But if core CPI continues to creep up in coming months, the markets will be forced to reprice risk.
The dilemma, of course, is that getting tough with inflation is risky at this point in the economic cycle. If the economy continues to slow, Bernanke and company will be faced with the thankless task of choosing between containing inflation and keeping the economy bubbling. It’s been said that central banks can have both, simultaneously. The record, however, is mixed, at best.
Mr. Bernanke’s big adventure has only just begun. The consensus believes that he’ll be able to pull a monetary rabbit out of the hat. Giving him the benefit of the doubt has been easy of late, thanks to declining energy prices. When that support fades, as it soon will, the crowd is likely to become less forgiving. The clock is ticking.


  1. KP

    Peak oil may yet be a long ways away, peak fiat may not. I fail to see how exponentially increasing the money supply for a population which grows in much more linear fashion or for a collection of purchasable goods and services that may be growing at an albeit fast rate(via globalization), but not exponential…can be anything but a serious problem in the making. It was shear arrogance that prompted the move to fiat in first place, IMHO. Inflation is just getting warmed up.

  2. anonymous

    Good analysis.
    In normal times, a rapid drop in the CPI of that magnitude is a rather bearish omen signaling a severe contraction is underway or even that we have entered a recession. In this instance, the current, against-all-fundamentals, rally would be the classic wall street puff-up before the decline.
    BB is still an unknown quantity. So far it’s inflation 3, BB 0. I expect the Fed to throw off the core CPI and PPI rules and go with the CPI this time. Whatever is most accomadative for the speculator banks.
    Who knows for sure what motivates the money men in this market. I have my suspicions and they coincide with the chilling recent history of speculator banks making their money “trading”. Hmmmmm ……
    I guess we’ll just have to wait and see if the bond market is smarter (a more honest game)than the equity market. The diemna for BB is how to get the speculative agressors to back off without having to punish the much larger, but less influential, citizenry. He sure as heck isn’t going to be helped by the regulative? agencies. In the spirit of tippy-toeing, hows about an 1/8 point increase.

  3. DJ

    Core CPI is up due to imputed cost of housing. Rental costs are up as landlords have to achieve higher returns to match higher interest income from alternate investments in T-bills etc. Thus, the Fed has created its own impact to raise the CPI and needs to take that into account and let rates stablize or begin to reduce them.

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