Summary
- Investors responded enthusiastically to news that the October CPI numbers came in slightly lower than expected, causing the market to surge by as much as 5%.
- But looking at only the headline number is a mistake that the Fed will not make.
- We drill down here to see how the constituents making up the composite October CPI figure are behaving and see some troubling trends.
After today's release of the CPI numbers, which came in slightly lower than forecast, the market went wild. As I write at 10:32 AM on November 10, the Invesco QQQ ETF ( QQQ ) is up 5.23%, and the SPDR S&P 500 Trust ETF ( SPY ) is up 4.02%. The market was expecting the overall CPI to come in at .7% for October. Instead, it came in at .4%. The Core CPI, which ignores Food and Energy Costs, came in at .3% instead of the expected .5%.
Treasury rates came crashing down, too, as you can see from the chart below.
Clearly, investors are acting as if inflation is now under control and that the Federal Reserve will now have to bring down interest rates. I believe this is a huge mistake.
That is because when considering what is going on with inflation, wise investors will ignore the headline numbers reported in the financial press and go to the source to get a fuller picture of what is really going on.
The source is the Bureau of Labor Statistics. Their website greets us with this chart:
Already we see something very troubling. Food is up 10.9%. Energy is up 17.6%. These are the two completely non-discretionary categories. Everyone, no matter what their economic condition might be, needs food, light, heat, and transportation.
But this chart turns out to be just a summary. If you click on the individual category bars for Food and Energy, further charts are revealed.
Breaking Out Food Inflation
Clicking on the Food bar gives us this sub-category chart:
Here we see that the rise in the cost of food eaten at home has risen far more year-over-year than the cost of food eaten at restaurants. The cost of Food at home is up 12.4% year-over-year since last October.
Another chart found on the Bureau of Labor Statistics website puts the food inflation number into even more disturbing perspective.
This is the chart :
This chart shows you that food inflation has leapt ahead of inflation as a whole since January of 2022. It also shows you that food inflation has come down less than the overall inflation number that the financial press concentrates on.
One factor that stood out to me with this chart is how inflated food prices already were more than a year ago. While the overall inflation rate was still low in October of 2020, as you can see from the graph, food prices had surged during the COVID lockdowns. Though they moderated over the next year, they began to rise again in the spring of 2021 and have continued to surge ever since, as you can see from the line graphing food inflation on the BLS chart below.
By October of 2021, food prices overall had already risen year-over-year by 5.3%. Graphing Food away from home reveals that in October of 2021 it had risen by the same amount.
So what this tells us is that while the inflation over the past year of the price of food away from home, which is a discretionary expense, has moderated slightly, bringing down the total figure for the Food category. The price of food bought at home -- which is the food people must consume when they can't afford to eat out -- is not moderating at anywhere near the rate that the CPI as a whole is. Add together the inflation already experienced over the months from October 2020 to 2021, and you see that Americans are now paying 17.7% more for the food they feed their families than they were 24 months ago.
Breaking Out Energy Inflation
The CPI number for Energy is up 19.3% year-over-year in October of 2022, a horrifying increase. The BLS breaks it down further into Energy Commodities and Energy Services, Overall Energy Commodities, i.e., gasoline, Natural Gas, and Electricity.
Drilling down more deeply, we then see this chart :
Several things stand out here. One is how much more volatile than food Energy prices have been historically, especially Gasoline and to a lesser extent Natural Gas. But we can see that the rise in the price for Electricity throughout the decade graphed has never been so high in October as it is now. It has currently surged 14.1% year-over-year. The only time it rose at a rate anywhere near that high was in January and February of 2006, when it reached 15% and 15.4%. 2006 was an extremely cold winter . We have not begun to experience winter temperatures this year and are already dealing with Energy inflation near its 20-year historical peak.
Another thing that stands out is that heating oil is not a factor included in these CPI categories. Residents in rural regions including New England where heating oil is a dominant form of winter heat are currently facing a 77% rise in the price of heating oil. Diesel isn't broken out, either, but its price corresponds closely to the price of heating oil, as the Diesel fuel used by the trucks and trains that ship our goods as both forms of petroleum are refined in a very similar fashion from similar forms of crude oil.
These issues are a part of the wider data picture that the board of the Federal Reserve will be considering when they next meet to talk about setting their rate.
Other Important Categories
Unlike the items we have looked at above, two important subcategories continue to see their rate of inflation rise. One is housing, which is called "Shelter" in the CPI report. The other is Services, a huge catchall whose constituents are not broken out into their constituents by the Bureau of Labor Statistics. I would assume they include everything from the cost of having your lawn mowed or toilet fixed to the cost of your personal trainer or shrink.
Though the rate at which the costs of shelter and services have risen year-over-year is not as high as the rate at which prices in the other categories we have looked at have risen, other the prices in other categories such as the prices of Shelter and Services are showing no signs that their prices will stop rising. This is very troubling. It is very likely we will continue to see them rising until they reach the levels that the other factors we have seen graphed have already reached.
Regional Differences Are Significant, Too
The headline CPI figures ignore the significant differences in prices in different regions of the United States. The chart below shows the overall CPI figure broken out by region.
There is a striking difference between overall prices in different United States regions. These differences have intensified over the past two years. In particular, inflation in Mountain states and the American South has risen far higher than it has in the Northeast and Midwest.
In March of 2022, the CPI in the Mountain region had reached 10.4%, while that in the Northeast was much lower at 7.6%. The Mountain Region's inflation is now still a worrisome 9.3%. In June of 2022, at its peak, the Southern region saw inflation reach 9.8%, while that in the Northeast was far lower at 7.6%, albeit that 7.6% is still dauntingly high. Though year-over-year inflation has come down steeply in the South, it was still over a full percentage point higher in October, at 8.1%, compared to prices in the Northeast which have declined to 6.8% (but don't take into account the huge rises in Electricity and Gas costs which have already been announced by utilities and heating oil companies and will start affecting November numbers and surge yet higher in December).
These regional differences are concerning, and you can be sure that the members of the Federal Reserve board will be paying a lot of attention to them.
Implications for Investors
The Federal Reserve has made it clear that they will be looking at more than a single month's worth of data when considering when to tighten or ease their policies. They certainly look at a lot more than the headline CPI numbers.
The continued persistence of high energy prices, which ripple through the economy and affect the cost of transporting raw materials and finished goods, as well as those of maintaining business premises, is likely to keep putting pressure on prices for goods and services. Currently, what we have seen in company quarterly reports is that companies are not only passing on their additional costs, but are raising their prices at rates that are often higher than overall inflation. Until this stops, inflation can't be controlled. The Fed sees the way to stop this as reducing demand, by raising the cost of money.
The upward trajectory of inflation for both Shelter and Services is a huge concern, too, especially the rise in the cost of shelter. Raising mortgage rates cools the overheated housing market and will cause the prices of homes to drop to a level closer to where it was three years ago, before COVID. This is another reason that the Fed may be reluctant to stop pushing rates higher.
The Fed has made it clear it believes it can only bring down inflation by decreasing consumer demand through raising rates as other approaches would require changes in "Policy." I.e., Congress would have to take action to curb corporate price gouging, which it has made it clear it won't do.
This tells me that we should not expect to see any moderation in the Fed's current plan to continue raising rates until inflation is truly under control. Until food and energy prices stop surging, that goal will not be met. Until shelter and services inflation shows signs of moderating, rates will have to keep on rising.
Keep an eye on the PCE data that will be reported on December 1. Pay attention to Food and Energy prices in that report. Check out the subcategories we have examined above. Unless they all drop significantly and stay lower for several months, expect the Fed to keep raising rates at the steady pace it has already laid out for you.
For further details see:
October CPI: Look Closely At The Data And Curb Your Enthusiasm