Who Sold My Inflation?

The May reading of the Consumer Price Index (CPI) printed below expectations. Headline inflation was up 1.9% year-over-year versus 2.0% expected and core (stripping out food and energy) was up 1.7% versus 1.9% expected. The month-over-month print was -0.1%, which means for the second month in the last 3 we have seen deflation. 

In March of this year we highlighted that headline and core inflation figures were diverging. This invited the question, would headline revert to core levels or would core inflation begin to follow headline figures higher?  At this point it would seem that the former trend is materializing, as both figures have started to decline in the last couple of months and headline has fallen from a high of +0.51 over core to just +0.14 ahead as of May (as reported last week). Oil prices have declined marginally this year and other steady contributors to CPI have started to fade, in particular Owners Equivalent Rent (see chart below). Meanwhile, retail sales for May were also weak and well below consensus, -0.3% month-over-month versus 0.0% expected, and have contracted month-over-month 2 of the last 4 months. This does not bode well for those expecting accelerating growth, as consumption accounts for around 2/3 of our economic output. The market reaction has been a flatter yield curve (see second chart below of the difference in yields between 2yr and 30yr US Treasuries) and a reversal in TIPs break-evens, a market-based measure of inflation expectations, to pre-election levels. 

Our outlook continues to be one of low and steady growth with little inflationary pressure, though the risk of deceleration in both is increasing as fixed investment and productivity remain poor and wages have not picked up materially despite a nearly decade long economic expansion.

Owners Equivalent Rent

2yr / 30yr Treasury Spread

Source: Bloomberg