Headline inflation measures are declining, is that a positive sign?

Inflation data for the month of May was released last week.  Prices continued their downward trend and the last three months have set record lows (Core CPI declined for three consecutive months for the first time ever and the annualized three-month trend in Core CPI is the lowest ever).  Looking below the surface, we can explore the details of the release and see what is driving the declines.

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Many of the areas that have experienced significant declines have been areas impacted by the shutdowns or have seen decreased activity.  Categories reporting the largest monthly declines in May were vehicle insurance (-8.9%), airline fares (-4.9%), apparel (-2.3%), and used cars and trucks (-0.4%).  Services CPI increased by 2% year-over-year (y/y) in May, which was a nine-year low.  CPI excluding energy, food, and shelter increased by 0.30% y/y in May, a 17-year low.

Source: FRED.

Producer prices, which measures the sales price changes for goods and services has also been declining.  Services prices declined by 0.20% month-over month (m/m) and 0.80% y/y.  Excluding food and energy, producer prices declined 0.10% m/m and increased just 0.30% y/y, which is the lowest amount since December 2015.

Source: FRED.

The reason to focus on the pricing data for these areas of the economy is that they can help identify the supply and demand for different types of goods and services.  The declining trend in prices across all these different parts of the economy is an indication that demand for these goods and services is falling.  Some of the decline could be temporary and tied to an inability to access these areas due to mandated restrictions.  As more of these restrictions are lifted, demand should return, and prices should start to stabilize and increase.  By watching these trends, it can help determine the pace and magnitude of the recovery. 

Another reason to monitor these price trends is that they are a guide to profits and profit margins for companies.  If demand is declining and sales prices are dropping, it is typical to expect lower profits and margins, unless companies can reduce more expenses.  This is part of what contributes to the continued above average amount of initial jobless claims.  Another data series to watch alongside prices is inventories.  During the shutdown, orders/sales declined significantly faster than existing inventories.  This has led to a large increase in the inventory to sales ratios (through April). 

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If companies have a large amount of inventory on hand, they will have to work through their current supply before they can order more, which will delay the recovery in activity for their suppliers.  The other option is to sell the inventory at a discount, which will negatively impact profit margins.  If they decide to sell at a discount, it will be reflected in the pricing data and the downward trends will likely continue into the summer.

One area that has reported large increases in prices has been food and food production.  A combination of a sizeable increase in grocery demand as consumers have been eating at home more frequently and some disruptions to certain supply chains has caused CPI and producer prices for food to increase in the last three months.  Food CPI had the largest two-month increase since February 1990 and protein prices are increasing at double digit rates (with certain meat types increasing 10-20% y/y). 

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Source: FRED.

Source: FRED.

If food prices continue to increase, it will negatively impact consumer spending and work as a drag on the recovery.  This problem could worsen if existing fiscal policies on unemployment and loan forbearance are removed before the labor market heals and consumers regain their prior wage levels. 

 

The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance.  The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.