October CPI Is 3.2%

Overview

Today, we got the September Consumer Price Index (CPI) report which showed an overall increase of 3.2% in the last year and 0.0% vs last month. This was below expectations of 3.3% for the year and 0.1% for the month. The Core CPI which excludes food and energy was up 4.0% for the last year and up .2% from last month. Those were both .1% below expectations, and the annual number is still double the Fed’s 2.0% target. Let’s go through the details:

CPI starting to fall back to 2Q levels. The Fed still needs to cut the red line in half.

Real interest rate (fed funds - CPI) holding at 1.6%.

Food:

Food inflation came in at 3.3%. Food at home was up 2.1%, and I continue to insist that anyone who believes that number hasn’t been inside a grocery store in years. Food away from home was up 5.4%. That’s not great. I’ve been skeptical of this part of the CPI for the past two years. It seems understated to me. My grocery bills are up more than 3% from last year, and many of the restaurants near me charge higher prices than you see on the menus because it’s too expensive to keep updating constantly. Every single person I talk to who does the grocery shopping for their household is telling me the same thing. Most of them think their food bills are up more than 20% in the past year.

Energy:

Energy continues to be the primary reason the CPI has come down so much this year. It’s not that energy prices are cheap; but rather, that those prices are being compared with last year’s spikes. Total energy prices were down 4.5% with gasoline down 5.3% and fuel oil down 21.4%. It will be interesting to see what happens to fuel oil prices during the winter when homes in most of North America and Europe need heating.

The White House has gotten away with its political strategy of draining the Strategic Petroleum Reserve (SPR) for the second straight year. Russia and Saudia Arabia have continued their large production cuts. Between encouraging more production in Iran and Venezuela, and reduced demand for gasoline, energy prices have remained lower than many (including DKI) expected. Stock market bears are saying that’s because we’re entering a recession. Others point out that with work-from-home continuing for many workers (for at least a few days a week), Americans are commuting less leading to lower demand for gasoline. Either or both are possibilities.

Vehicles:

New vehicle pricing was up 1.9% and used vehicle pricing was down 7.1%. These have been volatile categories. We’d also note that the decrease in used car pricing is off of a huge increase. I’m also reading reports of skyrocketing numbers of auto loans going delinquent which will lead to more supply of used cars and lower prices in the future. The now-common $1,000 monthly auto payments aren’t an option for most. There’s clear improvement in pricing for now, but prices are still well above the pre-pandemic levels:

Still expensive but improving.

Services:

Services prices were up 5.5%; a slightly smaller increase than last month, and still very high. This category is an issue for the Fed because much of the increase is caused by higher wages. Labor is still in demand. While unemployment has risen, there are still millions of unfilled jobs. The Fed is actively trying to restrict wage growth and raise the unemployment rate to take pressure off of this part of the CPI.

Shelter (a fancy word for housing) costs were up 6.7% and represents the largest category of the CPI. Much of today’s CPI increase is due to this category alone. Housing has remained strong as people are reluctant to sell their homes and move when higher mortgage rates mean a new smaller home might have higher monthly payments. This has kept supply off the market and prices high.

Last month, there were some reporting on a coming AirBnb housing bust claiming that hosts were going to have to sell their multiple leveraged properties at a loss. DKI pointed out in the subsequent version of the 5 Things that this hadn’t happened yet and that we couldn’t find evidence that searches for selling an AirBnb had increased. This future housing bust led by the short-term rental market may still happen, but it hasn’t as of now.

This data is reported on a multi-month lag, and housing hasn’t gotten more affordable since the last update.

Analysis:

The futures market is up in pre-market trading as investors correctly realize this report means the Federal Reserve is highly-unlikely to raise rates again this year.

The CPI is increasing at a slower rate, but most consumers just see higher prices.

Energy prices have been volatile all year, and this month’s large decrease could be normal fluctuation or a sign of an imminent recession. If there’s a recession, that’s not going to be a positive for stock prices. If there’s a pickup in economic activity, we’ll likely see fuel prices rise again.

Conclusion

There are already calls out by analysts insisting that this report means the Fed made an error and over-tightened. (That means raised interest rates too much.) I agree that Fed policy acts on a long lag with exact effects impossible to predict, and that means critics of the Fed could be right on this. My view is that a 5% (or so) fed funds rate didn’t break anything. Any business that can’t handle interest rates above zero was already dead and just hadn’t failed yet. This is why they’re called zombie companies. Like the mythological undead, they are still operating, but the inevitable failure is baked in as interest rates normalize.

Two other points. First, the market has been overreacting to .1% moves against expectations for the past year. When the CPI comes in .1% above estimates, the market immediately falls. A day like today with the CPI .1% below expectations, the market rises. If you check the first chart in this piece, you can see that the headline CPI has been rising and falling, and the core CPI has been sticky and less volatile. One month of these indexes being .1% from expectations isn’t an indicator of the whole economy nor is it proof that the Federal Reserve Governors are brilliant or incompetent. This is especially true because the market is reacting to a system that can’t be measured so precisely. I don’t think the US Bureau of Labor Statistics is capable of measuring national inflation in a country this large to anything approaching .1% accuracy.

Second, as DKI has pointed out many times, Congressional overspending has a big role in all of this. Congress is taking on more than $2T of additional debt a year as it sprays stimulus into the economy. This is a big reason the GDP reports have been so strong recently. The other side of this is all of that excess spending causes an increase in inflation. As explained in this week’s 5 Things, last week’s Treasury auction had a 5bp tail meaning the government had to lower prices from pre-auction levels to get bond market participants to buy. Congressional overspending and the reaction of the bond market are now in charge. We’ll continue to watch the Fed, but moving the fed funds rate .25% in either direction is no longer where the big economic lever is. Congress will spend us into higher inflation and higher interest rates.

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