QVMS - Unpacking The September CPI: What's Next For Rates And Markets For 2022 And 2023

Summary

• The September CPI, reflecting August 2022 inflation data, came in at 8.3%, which was higher than the consensus forecast but lower than the two previous readings.
• A 75-bp rate hike from the Fed is almost certain for September, and rates are likely to reach the 4% range by EOY 2022.
• Learn what's inside the CPI, and how the September reading on August inflation data is impacting markets.
• Investors should also understand "headline" CPI vs "core" CPI, as well as the limitations and criticisms of CPI as a prediction tool.
• The Fed is intent on cooling inflation; however, it's also intent on achieving a "soft landing."

What Is the CPI and How Is It Calculated?

The Consumer Price Index , or CPI, is a measure of the weighted average change over time in the price of a fixed basket of goods commonly purchased by U.S. consumers. The CPI is the most widely followed measure of U.S. inflation and is calculated by the Bureau of Labor Statistics, or BLS.

• Inflation data collection: The Bureau of Labor Statistics, or BLS, which is responsible for producing the CPI, begins by collecting price data for hundreds of goods and services, which are collectively referred to as the "market basket." Starting January 2023, the basket of goods and services will be updated by the BLS on an annual basis.
• Determining CPI basket components: The items sampled for the basket, as well as the index weights used to calculate the overall CPI, are determined by the Consumer Expenditure Survey, which is produced by the BLS for the Census Bureau.
• Where BLS gets the data: This CPI data comes from approximately 8,000 housing units and 23,000 retailers, service providers, and online outlets representing 75 urban areas around the U.S. Data on rents is gathered from about 50,000 landlords and tenants.

What's In the CPI?

The CPI is made up of a wide range of categories, subcategories, and specific items. The largest category in the CPI is shelter, which makes up nearly a third of the index. The largest single item in the index, at 22% of CPI, is "owner’s equivalent rent of primary residence," which is a sub-category under the shelter category, representing how much homeowners might pay if they were paying rent for their homes.

Consumer Price Index Category Components

Source: U.S. Bureau of Labor Statistics, via Pew Research

Headline CPI vs Core CPI

The BLS produces multiple CPI indexes each month, two of which include the "headline" CPI, which is All Items CPI for All Urban Consumers (CPI-U), and the "core" CPI, which is CPI-U for All Items Less Food and Energy.

• Headline CPI includes all consumer goods and services with a fixed basket, including food and energy. This is also called the "all items" CPI or CPI-U.
• Core CPI excludes food and energy because these expenditures are volatile and are subject to price shocks that are generally not impacted by monetary policy.

Recap of September 2022 CPI

The year-over-year (Y/Y) CPI data for all items, or headline CPI, was 8.3% vs 8.1% forecasted and 8.5% the prior month. The core CPI was 6.3% Y/Y vs 6.1% forecasted and 5.9% the prior month.

Key takeaways from the September CPI include:

• Increases in the shelter, food, and medical care components were the largest of many contributors to the all items headline CPI.
• The food index increased 0.8% over the month as the food at home index rose 0.7%. Most notably, the food index rose 11.4% Y/Y, with the food at home sub-category rising 13.5%, the largest 12-month increase since the period ending May 1979.
• These increases were mostly offset by a 10.6% decline in the gasoline index.
• The energy index fell 5.0% over the month as the gasoline index declined, but the electricity and natural gas indexes increased. The index for all items less food and energy rose 0.6% in August, a larger increase than in July.
• Other indexes declined in August, including those for airline fares, communication, and used cars and trucks.

Why Was the September CPI Higher Than Forecast?

The September CPI, which reported the rise in consumer prices for all urban consumers for August 2022, came in at 8.3%, which is slightly higher than the consensus forecast of 8.1%.

Key factors pulling the CPI higher include:

• Gas: 25.6%
• Airline fares: 33.4%
• Electricity: 15.8%
• Food at home: 13.5%
• New vehicles: 10.1%
• Food away from home: 8.0%
• Used cars and trucks: 7.8%
• Shelter: 6.2%
• Medical care services: 5.6%
• Apparel: 5.1

How Did the Market React to the September CPI?

September CPI sent stock prices down nearly 4%, which marked the worst day for stocks thus far in 2022. However, it's important to note that this price move represented a correction from an overbought market that erased the 4% gains from the prior week.

• On the day of the September CPI release, the S&P 500 held above the 3900 support level on below-average trading volume.
• Appearing to wait for new guidance from the Fed at its September 20-21 meeting, the market held the 3900 level again the day following the CPI reading.
• The market is now pricing in a certain 75-bp rate hike in September with a low probability of a 100-bp hike.

Limitations and Criticisms of CPI

The main limitations and criticisms of CPI are:

• Fixed basket: Since the CPI is based on a fixed basket of goods and services, it misses changes in prices that are outside the index.
• Excludes food and energy: The core CPI is even more limited than the headline CPI, as it excludes the volatile areas of food and energy.
• Can understate inflation: While some critics have claimed CPI overstates inflation, much criticism in the recent past has claimed that CPI understates inflation because of changes in the methodology used to calculate the CPI, which takes into account changes in the quality of goods and substitution. For example, consumers may substitute lower-cost items for higher-cost items in response to price changes. This changes the weighting of goods in the basket, which generally skews toward a lower inflation rate. Some argue that this change in methodology is a purposeful manipulation that allows the U.S. government to report a lower CPI.
• Not a standalone inflation gauge: Decision makers and investors are wise to supplement the CPI with other economic reports, such as the PPI (Producer Price Index), the CSI (Consumer Sentiment Index), and the PMI (Institute for Supply Management’s Manufacturing Purchasing Managers’ Index).

What's the Forecast for Rates and Inflation for EOY 2022 and Early 2023?

The Fed's current target rate stands at 2.25%-2.50%. Since rate hikes can take several months to work into the economy, the Fed may grow increasingly cautious as it reaches the elusive "neutral range," which now appears to be around 4.0%. This is likely to be accomplished by EOY 2022.

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