The Fed disregards CPI in favor of the GDP deflator

Outlook: The top headline in the online FT is “Spread of Delta variant casts a shadow over Europe’s economic rebound--Economists fret over rising infections and return of pandemic restrictions.”

Funny, while many attribute last week’s whipsaw to Delta fear, you don’t see headlines like that in the major US newspapers. As for restrictions, aka lockdowns, forget it. Far too many in some states, including hotspot states like Missouri, would protest the guv’mint “taking away their freedom.” That the number of cases is up 47% in one week does not, apparently, deserve top headline notice.

Europeans are more sensible. ECB chief Lagarde, in an interview with Bloomberg, tempers optimism about growth and where the ECB can go with being “only ‘guardedly optimistic’ about the recovery prospects for the euro area with the Delta variant of the coronavirus posing a threat to efforts to return to normal life.” She did announce a revision to forward guidance at the next policy meeting on July 22, breaking with the tradition that the second meeting is always a dud. Still, she expects the current asset purchase program to run until “at least” March 2022.

As noted above, earnings season kicks off this week, along with G20 and trade meetings. G20 is going to cement that minimum tax proposal but we judge the probability of the US Congress going along at the same odds as a blizzard in Florida in August, so it will not be an FX factor (this time).

And it’s that time again for inflation data. We get CPI tomorrow. We also get PPI, industrial production, retail sales, and the Empire and Philly Fed manufacturing surveys. But the CPI is the headline winner, not least because the next day Powell deliver his semi-annual monetary policy report to the House Financial Services Committee (and to the Senate on Thursday). Powel has a tough row to hoe given higher numbers last time that can’t have come down much this time coupled with the Fed’s stance that they are transitory. Somebody in Congress might note that those wage gains to induce labor supply tend not to go down afterward—wages are “sticky” to the downside. 

In May, CPI rose 0.6% m/m and 5.0% y/y without seasonal adjustment. As we wrote at length at the time, you can get all kinds of different numbers depending on how you annualize, even the “proper” method using mean least squares. Whatever the annual rate or year-over-year rate, it’s not accurate because of the base effect and because of special one-time pandemic effects still in force a year ago. And never mind that the Fed disregards CPI in favor of the GDP deflator. The world watches CPI, the world watches the Fed target, and the CPI is far above the 2% target even if you give it a lot of wiggle room to overshoot. A number like 5% is more than an overshoot. Powell is going to have to tapdance hard. It’s possible that Biden added shipping to the pro-competition list of sectors specifically to help out the Fed.

Even the Atlanta Fed’s “sticky price” calculations are not all that reassuring about the transitory nature of current inflation. According to the website, the latest update from June 10 is 4.5%. We get the July update right after the BLS reports CPI tomorrow. 

“The Atlanta Fed's sticky-price consumer price index (CPI)—a weighted basket of items that change price relatively slowly—increased 4.5 percent (on an annualized basis) in May, following a 5.5 percent increase in April. On a year-over-year basis, the series is up 2.7 percent.

“On a core basis (excluding food and energy), the sticky-price index increased 4.3 percent (annualized) in May, and its 12-month percent change was 2.6 percent.

“The flexible cut of the CPI—a weighted basket of items that change price relatively frequently—increased 18.7 percent (annualized) in May, and is up 12.4 percent on a year-over-year basis.”

Bottom line, there’s no escaping that the US is experiencing inflation, and debate rages about whether is can go back down to the longstanding sub-2%. Debate also rages about whether the Fed is behind the curve. If inflation remains this high and unless Powell acknowledges it, there is some probability the bond market breaks ranks and gets another sell-off that lifts yields. This is probably dollar favorable but doesn’t’ count chickens.
 

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