Last week’s U.S. Consumer Price Index (CPI) data release came in below economists’ consensus expectations, and represented the fourth weak print in a row. Specifically, the headline CPI print came in roughly flat month-over-month, and at 1.6% year-over-year, while the core measure (excluding volatile food and energy components) resided near 0.1% month-over-month and 1.7% year-over-year.
The data resulted in a great deal of handwringing by many market commentators over the strength of the economy and the advisability of further Federal Reserve policy normalization this year. In our view, these arguments represent somewhat of an overreaction to the data and don’t grasp the underlying trend within U.S. inflation numbers: higher services inflation and actual goods deflation.
More accurate inflation measures
It’s important to recognize that measures of inflation considered more accurate than the CPI, such as Personal Consumption Expenditures (PCE) data, have witnessed price changes vary dramatically between these different broad components. Over the past 20 years, core PCE has increased at an average annual rate of 1.67%, with core services and goods components averaging annual changes of 2.51% and -0.48%, respectively. Core services represents nearly three-quarters of the PCE consumption basket today, with goods taking up the final quarter.
The underlying trend of higher services inflation and relative goods deflation has been in place for 20 years and largely continued with last week’s inflation data release. This isn’t surprising, since this dynamic is largely driven by major secular changes to the United States’ demographic profile and by profound technological changes, including technologically inspired competition. Thus, we find ourselves in a world in which CPI core services (ex-energy) is growing by roughly 2% to 2.5% and CPI goods sectors are deflating by -1% to -2% on average.
Benefit to consumers
Perhaps even more importantly for the trajectory of the economy, the goods deflation we are seeing today can be considered a net benefit to consumers’ spending power, particularly for lower- and middle-income households. We are seeing price weakness in food and grocery categories; in clothing and apparel; and in sporting goods and department stores, all areas where these households spend a meaningful amount of their disposable income. For example, year-over-year, the food subcomponent of CPI has only increased by 0.9%, with “food away from home” the only area witnessing a meaningful increase.
Finally, we are encouraged to see price stability in some areas, such as furniture and shelter pricing, that underscores strength in the U.S. housing market. The bottom line: It’s very easy to fixate on headline inflation numbers that appear disappointing at first glance, but digging deeper and looking at the data in broader context often reveals more to the data than meets the eye.
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