Same Same, but Different Different
This week’s big news story was, yet again, about inflation. January headline CPI came in above expectations but slightly below December. Meanwhile the month-over-month numbers were bang-on expectations. In my opinion, it was more or less a “non-event” since many were expecting a big surprise. Markets couldn’t make up their minds all day and the S&P saw six large intraday swings, moving from red to green and back again multiple times throughout the trading session.
But that’s not what I want to write about today, I want to write about the neverending new ways we find to measure inflation, and how pointless they may end up being at the end of all this. With each passing month and constant discussion over inflation, I find myself getting more and more frustrated by this topic.
Core no More
We’ve long had two main measures of inflation: headline and core. We’ve also had two different methods of measuring both: CPI and PCE. The Fed’s stated inflation target is 2%, and their preferred measurement has always been core PCE. Regardless of which one you use, inflation is still above target.
The theory behind core measures of inflation is that they remove the volatile components of food and energy, which are sensitive to outside events (e.g., weather, animal sickness, war, etc.). Although I understand the reason behind this, and agree the Fed should not change monetary policy in response to knowingly volatile numbers, the issue I’ve had with using it to declare victory or defeat is that consumers still have to buy food and energy everyday.
Moreover, this cycle has given birth to an even more nuanced measure of inflation, coined the “super core.” The measure strips out food, energy, goods, and shelter (a.k.a. core services ex-shelter). You might ask…what’s left? I’d respond, good question. Technically what’s left is services such as transportation, medical care, education, communication, recreation, water/sewer/trash collection and other household and personal services.
Again, I understand the theory here. Services inflation is sticky, less affected by supply chain issues that were transitory, and removing shelter costs strips out the delayed reaction that housing typically sees.
But the reality is that it strips out A LOT of the non-negotiable items we all pay for on a daily, weekly, or monthly basis. Not to mention, shelter is typically the largest expense for all consumers.
Good on Paper, Bad IRL
Highlighting the disconnects between what the market is watching and what happens on main street are not new, nor is my frustration with the concepts. But at this point in the data stream, things have gotten so murky and so over complicated that sometimes it’s important to over simplify in order to remember the bottom line.
The bottom line is that our economy doesn’t grow without the consumer. No matter which camp you’re in — soft landing, no landing, crash landing — US GDP is, and will continue to be, reliant on consumption in order to produce consistent growth.
The good news is that food and energy prices have come down considerably since their peaks in 2022, giving the consumer some breathing room. But they’re still elevated compared to pre-pandemic. Shelter has not come down, and services inflation continues to rise.
If consumers end up spending more than before on necessary expenses such as shelter, food, and energy, they naturally have less to spend on other items. On one hand, a drop in demand will serve to bring inflation down further, but it also ignores the chance that consumers overspend and end up in debt. Debt that carries higher interest rates than it has in decades.
Since early 2020, it’s true the consumer has built up a cash buffer, and has benefitted from wage growth. That’s provided unprecedented spending power, and judging by a rebound in retail sales and consumer confidence indicators, people are still spending in a big way.
But the liquidity candy bowl is gone and isn’t coming back any time soon. If we want to go buy our own candy, it’s more expensive than before. My intuition and common sense says there’s not a bottomless pit of savings to support this level of spending, and there’s not a bottomless pit of wage growth to keep it elevated enough to drive GDP indefinitely. I often wonder if the market is simply ignoring this possibility, or if I’m underestimating the strength of the consumer. Time will tell, but I still believe something’s gotta give.
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