US inflation in the eye of the beholder

US inflation came in lower than expected yesterday. It is probably getting better, but I’ll also note that you can see what you want in the numbers. If your view is that inflation is heading for deflation, then look to goods falling at an annualised rate of 3.5% over the last quarter. If your view is inflation will remain high, look to services rising at an annualised 7.3% over the last quarter.   

See tables below:

Food inflation

energy inflation

goods inflation

services inflation

Given some technicalities in calculating rent inflation, services inflation is unlikely to decline quickly.  

How should we look at inflation reversion?

There are two ways to consider reversion:

1. While central banks will force inflation back to 2%, prices will remain structurally higher. 

2. Prices have been temporarily shocked, but will return to the prior trend 

Goods are probably more likely to be in the second category, services more likely to be in the first. Given the Ukraine war, gas prices are likely to be in the first category. Oil is more transportable, and so probably has a chance for either. 

The shape of future inflation or deflation depends on how many things you think will fit into each profile. 

Going forward

The way the maths are at the moment, annual inflation is going to remain high for some time. If inflation went immediately to a 2%p.a. rate, by April next year both core and headline inflation would still be above 4%:

inflation paths

 

The stock market reaction was a lot more muted this month. My expectation is still that central banks want to jump up and down a few times on the corpse of inflation to make sure that it is truly dead before reversing course. With that in mind, I’m expecting very low inflation or deflation by mid-2023. But, even with that expectation, the headline annual inflation figure will stay high for at least six months.

Will markets celebrate inflation falling over the next few months? If so buy equities now. Or is this a buy the rumor of lower inflation, sell the fact as earnings get hit by weaker demand? If so sell.