VTI - July CPI: More Good News But Inflation Winds May Be Changing

2023-08-10 09:55:11 ET

Summary

• Headline and Core CPI were in line with expectations.
• Volatile one-off items helped keep core CPI down.
• Disinflation has been very bullish for stocks. However, going forward, CPI may cease to be a tailwind for the financial markets.

Summary Data and Analysis

A summary of key data and analysis for this month's CPI report is provided in Figure 1.

Figure 1: Change, Acceleration, Expectations, and Surprise

Core CPI and All items were both in line with expectations and with no change on a MoM basis.

Analysis of Core and Non-Core Plus Key Sub-Components

In Figure 2, we break down the analysis of change and acceleration of CPI into Non-Core and Core components. We further analyze two key subcomponents of non-core CPI and three key subcomponents of core CPI. Although all five columns in the table provide important information, we recommend that readers pay special attention to the rightmost column (Cumulative Contribution to Acceleration), as it reveals exactly what drove the MoM acceleration/deceleration in CPI during the current month compared to the prior month.

Figure 2: Analysis of Key Aggregate Components of CPI

As can be seen in the table above, Core Goods and Energy both deaccelerated significantly, accounting for all of the overall deacceleration in All Items CPI. Yet every other major category accelerated.

Core Services except Housing - the indicator the Fed is currently paying most attention to - accelerated slightly and has been running at an annualized rate of less than 2.0%.

We now proceed to analyze the CPI report in greater depth. For more detailed information on how to read and interpret the tables and graphs in this article, please see the following Seeking Alpha blog post .

Contributions to Monthly Change in Core CPI

In Figure 3, we provide a bar chart that highlights the major positive and negative contributors to the MoM percent change in Core CPI. These contributions take into account both the magnitude of the MoM change in each component as well as the weight of each component in CPI.

Figure 3: Top Contributors to MoM Percent Change

Once again, Owner's Equivalent Rent was the most important positive contributor to the monthly change in CPI. And for the second consecutive month, Used Cars & Trucks contributed negatively to the monthly change in CPI after being a large positive contributor for multiple months. Real-time indicators suggest that this trend in the used car market may continue.

Most importantly, it should be noted that real-time indicators suggest that there will be significant disinflation in the housing components of CPI for the remainder of 2023.

It should be noted that without the impact of used cars and airline fares -- two highly volatile components, -- monthly core CPI would have registered 0.3% rather than 0.2%.

Contributions to Monthly Acceleration in Core CPI

In Figure 4, we provide a bar chart that highlights the major positive and negative contributors to the MoM acceleration in Core CPI. These contributions take into account both the magnitude of the MoM accelerations in the components as well as the weight of each component in CPI.

Figure 4: Top Contributors to MoM Acceleration

It's worthwhile to examine this table carefully, as it's likely to include most or all of the items that caused deviations from forecasters' expectations of Core CPI.

The most notable changes are the contribution to deacceleration from Used Cars & Trucks and the contribution to acceleration from Telephone services.

For the complete breakdown, please see the following CPI Breakdown table posted on our site each month.

Top Movers

For general interest purposes, in Figure 5 we highlight the CPI components (most granular level) that exhibited the largest positive and negative change during the month. The YoY change in these particular components is displayed to the right.

Figure 5: Top Movers MoM Percent Change

In July, uncooked beef and poultry increase made the largest price increases. Egg prices continue to fall, after experiencing a prolonged period of high inflation. The decline in airline fares was very notable.

Implications for Economy

I have been emphasizing for many months that the U.S. would be undergoing a process of disinflation for most of 2023. This is a supportive environment for the macroeconomy.

The data are supportive of a "pause" by the Fed in interest rate hikes. However, the data are not supportive of complacency. The inflation data, taken in combination with tightness in labor markets, suggest that the Fed will need to keep interest rates high for a significant period, unless the economy slows substantially.

Implications for Financial Markets

The implications of disinflation for financial markets have been bullish. However, investors should be cautious about the next few months. First, energy prices are rising significantly, and there is a risk of further rises in the oil and gas markets. Second, there may be significant pressures on food prices in the coming year due to the weather impacts of a severe El Nino. Third, due to the impact of several "one-offs," core inflation is positioned to rise back into the 0.3% range.

All of this suggests that CPI data may no longer act as a "tail-wind" for financial markets in the next few months. Indeed, I believe risks are now skewed toward the prospect of CPI acting as a headwind for financial markets going forward.

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