November CPI: high inflation is on the way out
For the 5th straight month, inflation as measured by the CPI declined on a YoY basis, with YoY growth falling to 7.1% in November. The last two months have seen a particularly notable fall, with YoY inflation declining by more than a full percentage point.
The significant deceleration over recent months can be better seen via the use of 3- and 6-month annualised changes. On a 3-month annualised basis, CPI growth has fallen to 2.1%, while on a 6-month annualised basis, CPI growth has fallen to 3.7%. This marks a significant divergence from the more lagging and smoothed 12-month measure.
Reviewing the key points from my CPI preview
Last week I published a CPI preview for November. In that report I noted several key items that will present as important factors to watch.
They were:
durables prices;
food at home prices;
energy commodities;
health insurance; and
rent based measurements.
Let’s now revisit each of these items to ascertain what actually played out.
Durables prices PLUNGED in November
After seeing significant price declines over the past two months, including the 2nd largest decline EVER recorded in September, I have noted that after leading inflation higher, durables prices are now leading inflation lower.
Given 1) historical seasonality and 2) the recent trend of durables prices declining decline by more than their historical average, I noted that one should expect durables prices to decline again in November, and by an amount greater than its historical average November decline. While another decline occurred, the strength of the decline was a BLOWOUT, with prices falling by OVER 1%. This was far above the historical level of seasonality that is typically observed.
In the 803 monthly CPI surveys of durables prices, on only 3 occasions have durables prices fallen by over 1% — 2 of those 3 occasions have happened in the past 3 months!
Before this blowout number, I noted that durables prices were on track to close in on a YoY growth rate of 1% in December, reach near breakeven in January 2023, and see a YoY decline in February. While this already represented a major deceleration from the peak YoY growth of 18.7% in February 2022, and aligned with my expectation for lower inflation ahead, the 1% decline in November significantly increases the rate of deceleration/decline ahead.
The YoY growth rate for durables is now likely to fall well below 1% in December and turn NEGATIVE in both January and Feburary 2023. Note that this is simply based upon the average durables price change recorded from December - February from 2010-19. Remember that the durables index has recently been recording MoM movements significantly in EXCESS of historical changes, and to the downside. This extrapolation thus looks likely to prove CONSERVATIVE.
Food at home prices see a major MoM downshift
For sometime now I have been stating that on account of the historical correlation to the UN FAO Food Price Index, food at home prices should begin to imminently decelerate. A deceleration would be particularly likely in November given that it has historically been a seasonally weak month.
A significant downshift is what ultimately occurred in November, with the downshift largely in-line with historical levels of seasonality. This saw November record a NEGATIVE MoM price change. This marked the first negative MoM change since November 2020.
While this decline was a very positive sign, it is important to note that November’s price change remained ABOVE its historical average for November. This indicates that CPI food price growth continues to remain above levels that are consistent with historical food price growth.
While predicting food at home prices over the months ahead is likely to be difficult, and the length of time required to achieve 2% food price growth remains unclear, the key point still remains that food prices should continue to decelerate over the months ahead, given the movements that have taken place in the prices of major food commodities.
Food away from home also comes in lighter
While my focus was on food at home prices and not food away from home prices given that the former is more highly concentrated to price changes in underlying food commodities, interestingly there was also a significant MoM deceleration in food away from home prices.
What makes it even more interesting is that the food away from home index was NOT subject to the same seasonal variation in November as the food at home index.
While also still elevated, it will be important to monitor this index moving forward to see whether November was a once off, or the beginning of a new trend. If it is the latter, it will be useful to compare it to the ongoing price changes in the food at home index, as this will help paint a picture as to whether potentially decelerating food away from home prices are occurring as a result of the movement in food commodities, or if it is instead indicative of a lessening in demand or the broader array of price pressures that impact food away from home establishments like restaurants.
Energy commodities fall in-line with changes in gasoline
More straightforward, and as expected, was the fall in energy commodities, which largely occurred along the lines of the decline seen in gasoline prices as per EIA data during November.
Importantly for December, the average DECLINE in gasoline prices so far this month is a whopping 10.1% versus November! Should this continue, then it will result in a MAJOR disinflationary impulse for December.
Health insurance prices to keep falling until September 2023
Something that has received a fair level of attention from the last two inflation prints, is the sharp decline in health insurance prices. While many point to this being “technical” in nature and thus look to discount it, many seem to not fully understand that this dynamic will CONTINUE until September 2023. This is because the BLS makes a single annual revision to health insurance prices, with this revision fairly evenly spread over the course of the following year. The impact of the revision in October 2022, as well as in prior years, can be seen in the below chart.
The MAJOR shift from an average MoM growth rate of 2.1% in the prior year, versus ~4% monthly DECLINES that will occur until September 2023, is a significant and virtually guaranteed contributor to a lower CPI over the year ahead.
Rent based measures see another hot print
Whilst all of the above factors contributed to a deceleration in inflation during November, rental based measures did NOT record a deceleration as I thought may have occurred. Instead, the MoM growth rate of owners’ equivalent rent (OER) and rent of primary residence increased slightly from October. This is despite market rents seeing recent MoM falls (and thus contributing to a closing of the gap between the lagging nature of the CPI’s rent based measures vs market rents), and the lower number of new leases that are typically signed over the cooler months.
Ultimately, whilst the gap is closing, November showed us that it continues to remain too wide for a trend towards even moderately decelerating MoM growth rates to begin (let alone a return to SIGNIFICANTLY lower MoM growth rates, which likely remains many months off).
Analysing inflation ex shelter & with market rents
Given that Fed Chair Powell recently articulated for the first time an approach to measuring inflation that excluded lagging shelter costs (indicating an awareness that conducting monetary policy based upon lagging rents may lead to major overtightening), it is important to analyse the change in the CPI by adjusting for the lagging shelter index.
One way to do this is to simply exclude the shelter index (which is primarily composed of OER and rent of primary residence). One can see that both the peak and subsequent decline in inflation has been greater in the all items less shelter index.
Now that both measures are at 7.1% YoY rate, with all items less shelter decelerating more quickly whilst lagging shelter costs continue to see significant growth, the two measures are likely to invert over the months ahead.
Given that shelter remains an important component and one which should not simply be excluded entirely, an arguably better way to measure inflation is to adjust the shelter component for spot market rents. That way, we can get a clearer picture of the underlying rate of CURRENT inflation, as opposed to an inflation rate that is impacted by lease agreements that were often signed many months prior.
Using this approach, we can see that the underlying market rate of inflation actually peaked in March 2022 at 12.5% vs the CPI’s peak of 9.1% in June 2022. Given the ongoing YoY deceleration in market rents, versus the ongoing rise in the CPI’s rent based measures, the gap between the two indexes has been completely eliminated over recent months. After earlier UNDERSTATING inflation since April 2021, the CPI is now OVERSTATING inflation. This overstatement is likely to continue for many months to come given the divergence that continues to exist between the CPI’s rental based measures and market rents.
Given that the level of overstatement is also likely to GROW over the months ahead, the manner in which the Fed analyses inflation, and the extent to which it is willing to exclude/adjust shelter costs, is very likely going to prove crucial in determining how significantly they overtighten monetary policy. This will have flow-on effects for economic activity and asset prices.
Time to prepare for a MAJOR decline in inflation
With the M2 money supply now recording MoM declines amidst the Fed’s significant tightening, inflation WILL continue to trend lower over the year ahead. November’s CPI report adds plenty of additional evidence to support such an outlook. Now is thus the time to prepare for a MAJOR decline in inflation. Given that M2 is falling, not only is inflation likely to fall, but so too is economic growth. Corporate earnings are likely to suffer in such an environment.
In 12 months’ time, instead of high inflation, the bigger topic of discussion is likely to be deflation. Such an economic scenario would yet again materially alter the investment environment. Whilst both stocks and bonds have seen poor returns in 2022, a return to low inflation (and the potential for deflation), as well as a potentially severe recession, presents an outlook in which many high quality government bonds are likely to generate strong returns in 2023 — I don’t think that the same can be said about cyclical risk assets like stocks.
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Great work. Really outstanding. Appreciate your insights.
Hey Steven,
great analysis as usual :-) I follow you on Twitter as well and you are without a doubt one of my favourite researchers on inflation and the macro outlook. Keep up the good work!