The chart below shows the monthly annual increase figures for the three key Bureau of Labor Statistics (BLS) inflation figures for the past six months, all showing a steady rise month-on-month. The next month’s figures will be awaited with interest, with the Consumer Price Index (CPI) data due to be released on May 11th and the Producer Price Index (PPI) on May 12th, while the Personal Consumption Expenditure (PCE) index data will not be released until close to the month-end on May 27th. It will be interesting to see if there will be any sign that inflation, as measured by the BLS, will be starting to come down, or not.
In view of the latest US Federal Open Market Committee Meeting (FOMC) outcome, and immediate market reaction to it we should perhaps look closer at the make-up of the various BLS figures. Certainly the FOMC outcome was viewed favorably by the markets perhaps not being quite so downbeat as they had been suggesting, although we think the knee-jerk positive reaction, particularly in the equity markets was somewhat misguided. After all the post FOMC statements described inflation as ‘challenging’ and certainly implied the continuation of further 50 point Federal Fund interest rate increases to come at at least the June and July FOMC meetings.
We should look, therefore, at the compositions of the various indexes. Firstly the CPI is probably the most followed by the person-in-the-street. Still, even this may understate the true cost of living rise experienced by the average household consumer (see note on ShadowStats below). Even so, it is thus seen as the most widely used inflation measure and, in theory, follows the average change in prices over time that U.S. consumers pay for a typical basket of goods and services.
According to Investopedia, the CPI can adjust people’s eligibility levels for certain types of government assistance, including Social Security, and it automatically provides the cost-of-living wage adjustments for domestic workers. According to the BLS, the cost-of-living adjustments of more than 50 million people on Social Security as well as military and federal civil services retirees are linked to the CPI.
The PPI, on the other hand supposedly measures costs from the viewpoint of industries that make the products, whereas the CPI measures prices from the perspective of consumers and calculates and represents the average movement in selling prices from domestic production over time. One would think the two should be at similar levels, but the latter tends to track higher, and may actually may turn out to be nearer the reality being experienced by the average consumer, but still may be too low!
The third inflation measure, the PCE, has, since 2012, been the Fed’s preferred inflation measure. A cynic might suggest that that is because it tends to come in lower than the other inflation measures! It is a calculation of imputed household expenditures defined over a period of time. It is yet another measure of price changes in consumer goods and services exchanged in the U.S. economy. It is supposedly comparable to the Consumer Price Index (CPI), which also focuses on consumer prices, but the PCE tends to run around 1-2% lower as can be seen in the above table.
But the big question is, do any of the above-inflation measures actually capture the true inflation rate being experienced by the U.S. consumer today? According to economist John Williams (no relation) who publishes the ShadowStats subscription service which calculates statistics the way they used to be calculated by the BLS back in the 1980s and 90s, the answer is very definitely No! For example if we calculate the CPI now the way it was assessed in 1980, the inflation rate would be nearer 20%, rather than the already worrying 8.5% the BLS tells us it is today. I think the ShadowStats figure far better represents the kind of price increase levels the average U.S. householder is experiencing currently.
Of course, one couldn’t possibly make the observation that the overall inflation statistics were perhaps massaged downwards, not only to present a more positive picture of the underlying U.S. economy to the electorate, but also to save millions, if not billions, of dollars in Social Security payments.
Politicians would never condone such a sleight-of-hand would they?!
ShadowStats figures are also hugely interesting because one of the other statistics the service looks at, amongst several others produced by government bodies, is that for unemployment. It reckons this is, if calculated as it used to be, would be enormously higher than current data suggests at around 25%, which ties in better with many other observations than the BLS’s official 3.6% figure.
ShadowStats comments that its seasonally-adjusted Alternate Unemployment Rate reflects current unemployment reporting methodology adjusted for its own estimate of long-term discouraged workers, who were defined out of existence in 1994 in the official calculations. That estimate is added to the BLS figure for U-6 unemployment (its broadest unemployment measure - currently at around 7.1%), which does include short-term discouraged workers. (The 3.6% unemployment rate is the monthly headline number for March and is designated as U-3). The U-6 unemployment rate includes short-term discouraged and other marginally-attached workers as well as those forced to work part-time because they cannot find full-time employment.
What is particularly worrying here is that the Fed makes its decisions on these latest ‘official’ U-3 lower figures, which enables it to claim its ‘full employment’ level has been achieved, which some would claim lays little relation to reality.
For the equities investor, apart from perhaps those holding, or considering investing in, gold stocks, inflation, and Fed moves to control it, has to elicit a considerable degree of nervousness. If the Fed is seen by the markets as tightening too fast it is likely to see general equities continue on the downwards path they have been following broadly for the past six months. The 50 basis point rise, as announced yesterday at the culmination of the latest FOMC meeting is on the cusp of this.
Coupled with the running down of the Fed’s bond and mortgage security buying program this level of increase is pretty much borderline in precipitating a further downturn, or maintaining the status quo. Market reaction so far, though, has been positive for both gold and equities on the interpretation of Powell’s post-meeting statement, but whether it remains so given the likelihood of inflation continuing unchecked for the time being and probably at least two further 50 basis point rate increases ahead, remains to be seen. We suspect there will be further headwinds ahead – for equities in particular.