Inflation Peek-a-Boo

Inflation continued its game of peek-a-boo with the markets last week. The consumer price index (CPI) print came out above expectations for the first time in five months, giving the markets a little surprise. CPI rose 1.9% year-over-year and beat 1.8% market expectations. Excluding food and energy, the so-called core CPI rose 1.7%. Shelter costs rose the most since 2005, driven by a 4.4% rise in lodging away from home; most of that came from a 5.1% rise in hotel costs, the largest gain since 1991. We expect the data to offer even more surprises over the next few months due to the recent major hurricanes, which can distort the numbers.

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While this little game is fun, it does have serious implications. The Fed is looking at inflation data as one measure to determine the speed of rate increases. Lower CPI prints over the last few months have the markets believing the Fed will be dovish, that rate increases will be slow and that it is still safe to bid up the price of risky assets. Stock markets have recently reached new highs and treasury yields are lower this year. After last week’s CPI data the odds for a December rate increase rose to slightly over 40%, and treasury yields ticked up a few basis points. 

Last week reminds us that while inflation is currently tame it is often a lagging indicator, usually showing up very late in the economic cycle. The recovery from the last recession has been very slow, so we should not be too surprised by stubbornly low inflation data. Yet low unemployment with a tightening labor market, a continuing and synchronized worldwide economic recovery and ten years of massively stimulative central bank accommodation should lead to higher inflation and continued Fed rate increases in the future. 

Like everyone, we are closely watching this game of peek-a-boo to get some sense of how fast central bank accommodation will be withdrawn. We currently believe the process of rate normalization will be as slow and as steady as the now long-lived economic recovery. So the game continues.

Source: Bureau of Labor Statistics, Bloomberg, The Financial Times