Bradley Prosper, CFA®, CFP® XPYRIA Team Insights
Over the last six months, we’ve seen the consumer price index (CPI) decline from a reading of 9.0% to 6.5% year-over-year. While this indicates a sharp slowdown, the year-over-year inflation rate remains at elevated levels. We prefer to look at the month-over-month data to get a timelier insight into the changing inflation landscape. As you can see in the table below, the month-over-month CPI change has dramatically declined from its January-June 2022 pace. This directly feeds into the year-over-year metric, albeit with a lag. For example, the January 2022 monthly increase of 0.84% will roll off the year-over-year calculation when the January 2023 inflation data is released. If monthly inflation in January 2023 increases by less than 0.84%, the year-over-year inflation rate will decline below its current reading of 6.5%. The January-June 2022 pace was 1.02% per month, while the recent July-December 2022 pace was a modest 0.03% per month. In the table below, we show the impact that a consistent 0.25% inflation rate would have on the year-over-year figure. We are not predicting that inflation will actually be 0.25% over the next six months, this is just a simple visual example of how the year-over-year figure can change.
We can also look at the monthly changes for the Core CPI measure, which excludes volatile food and energy costs, in the below table. As you can see, the core measure is much less volatile month-to-month than the headline measure.
Although CPI grabs the headlines because it’s the broadest form of inflation, the Federal Reserve (Fed) prefers to use a different methodology when setting monetary policy. The Fed prefers to use personal consumption expenditures (PCE), particularly the Core PCE measure that excludes food and energy costs. As the Fed has raised interest rates by 4.25% over the last twelve months in order to stamp out inflation, the Core PCE measure bears monitoring for the anticipation of any potential future rate hikes.
Once again, you can see that the Core PCE measure is less volatile than the headline figure. Given the calculation behind the Core PCE data, there are still “sticky” measures impacting inflation. For example, inflation in 2021 was mostly caused by demand for goods, while inflation in the last few months of 2022 was driven by surge in the demand for services. Demand for services, which includes shelter costs, is often a stickier inflation component. As we continue to monitor the economy, inflation, and the Fed’s monetary policy stance, we wanted to share an alternative way of viewing the inflation data and the potential for the year-over-year readings to decline in the coming months due to base effects.
*Source: CPI and Core CPI were sourced from the U.S. Bureau of Labor Statistics. PCE and Core PCE data were sourced from the U.S. Bureau of Economic Analysis (BEA). All data is as of January 16, 2023. Anything written in red text signals an estimated figure, which may not be reliable or accurate.