How much lag resides in the lagging indicator known as core CPI? It’s a potent question on a day when the Labor Department reported that the core rate of inflation (less food and energy) in June rose by 0.3%–the fourth straight month at that pace, which is above the Fed’s comfort zone. On a year-over-year basis, core CPI has now climbed by 2.6%, the first time the rate of increase has topped 2.4% since 2002, MSN Money reported.
“With 2.6% year over year, it is a number that’s way too hot for the Federal Reserve,” Anthony Chan, chief economist of J.P. Morgan Private Client Services, told CNBC’s “Squawk Box.” via MSN Money. “It’s certainly out of the comfort zone.”
Against the backdrop of that worrying trend were comments from Fed Chairman Bernanke, who today told Congress that the economy was slowing and inflationary pressures would therefore moderate going forward. If there was any question about Bernanke’s message that the past isn’t necessarily prologue when it comes to inflation, he offered this clarification: “The lags between policy actions and their effects imply that we must be forward-looking, basing our policy choices on the longer-term outlook for both inflation and economic growth,” he said, as reported by Bloomberg News.
Core CPI is, of course, a lagging indicator. Indeed, all economic data is lagging in the sense that it reflects yesterday’s trends. The question is how to project tomorrow from yesterday. It’s a thankless job, and one that economists tackle routinely, albeit it with less than perfect results. That’s the nature of forecasting, an art form that only slightly resembles science. The future, dear readers, is forever and always unknown.
Having proclaimed that revelatory observation, your editor is back to square one, namely, Now what? To be sure, we come neither to praise nor to bury core CPI, but to point out what should already be obvious: inflationary pressures have been bubbling in the recent past, raising the odds but not necessarily insuring that inflationary pressures will bubble in the near future.
If the Fed feels compelled to snuff out this bubbling, the message was somewhat garbled by Bernanke. “Bernanke’s comments on inflation make it seem [that] the Fed is really getting close to the end of its rate-hike cycle,” Jason Schenker, U.S. economist at Wachovia Corp., told Reuters today. “That is more than enough to give stocks a boost.”

Yes, indeed, stocks soared today, with the S&P 500 climbing by nearly 2% (as we write in mid-afternoon), which amounts to the biggest jump in weeks. Meanwhile, futures traders repriced Fed funds futures upward, effectively betting that rate hikes were a thing of the past, or at least that the last hike would come at the next FOMC meeting on August 8.
To be sure, Bernanke isn’t blind to the uptick of inflation of late. He said as much in Congressional testimony today. But Mr. Market is inclined to look for clues that bolster the case for an end to rate hikes. It’s hard to know if Bernanke understands this bias, or even if he thinks it’s relevant. In any case, Wall Street is falling over itself to find an excuse to buy stocks and bonds, and Ben (either by design or accidentally) satisfied that search.
Only time will tell if the new-found bullish aura now sweeping the Street will prove to be timely or something less. The answer awaits in the next CPI report, due for release on August 16. Till then, we can only debate just how much lag resides in the core CPI, and if that lag is about to sag or surge.
The argument for predicting that it will sag finds comfort in the fact that the lion’s share of June’s rise in core CPI comes from housing costs. “About 70% of the overall acceleration [of core CPI] was accounted for by the larger increase in the index for shelter,” the Labor Department reported. “Shelter costs, which rose 2.6 percent
in all of 2005, have risen at a 4.3 percent annual rate in the first half of 2006.”
It’s been widely reported that the formerly red-hot real estate market is cooling. Making the natural leap of faith, one could surmise that the cooling process will moderate future increases in core CPI. Of course, that assumes that the other components of core behave themselves.
There are no easy answers when it comes to economic forecasting in 2006, in part because there’s no shortage of moving parts that combine to deliver the macro trends. But for the moment, at least, there’s a surfeit of optimism. Even Wall Street deserves a break every once in a while.