This week, the Bureau of Labor Statistics (BLS) announced there wasn’t any inflation during May. The Consumer Price Index (CPI) was flat. The Producer Price Index (PPI) was slightly negative, and Import and Export Prices saw even larger declines. In essence, prices were pretty much down across the board, in aggregate.
But were they really?
At the risk of sounding either cavalier or cynical I’m here to tell you something: your personal experience at the grocery store, dress shop, mechanic or restaurant doesn’t really matter. If you are now buying bone-in chicken thighs instead of boneless, skinless breasts because you can’t afford the later, less power to you. If your financing costs have gone through the roof, well, tough luck.
The government calculates inflation. It employs legions of people to track prices. It has its methodology. As such, it pretty much sets the rules, and what it says goes.
So, if the BLS says there isn’t any inflation, guess what? There isn’t any inflation, and your monthly budget be derned.
With that said, I have noticed, that while prices remain uncomfortably elevated for a lot of items, they aren’t going up as rapidly as they once were. Believe it or not, that means inflation is coming down. This is because inflation is relative even if prices are absolute. That is why the American consumer is having a hard time believing economists who argue “inflation is coming down” or that “it isn’t the problem it once was.”
You buy items with actual dollars, not relative ones. That is, unless you are sponging off your relatives. Ba dum tss.
This is important, because the official, government-compiled data ultimately influences monetary policy, not what Karen spends at Kroger. Obviously, this means the various Federal agencies theoretically have the ability to manipulate the numbers for political purposes. I would be lying if that thought hasn’t crossed my mind when analyzing a “too good to be true” release or marveled at the timing of another. However, to date, I don’t believe anyone has been able to prove the BLS, or others, have nefariously tampered with any report to intentionally benefit one party or the other.
That doesn’t mean it hasn’t happened. However, the long-term loss of credibility would seem to swamp whatever short-term gain there might be in fudging the numbers.
With this in mind, this week’s inflation data certainly blazes a clearer path for the Federal Reserve to cut the overnight lending target before the end of the year. If June’s numbers are similar to May’s, a rate cut will be a certainty by the September meeting, and an additional one by the end of December a real probability.
The Fed’s concern is, and has been, prematurely cutting the overnight rate might cause inflation to reignite. Obviously, that would be in both relative and absolute terms, and could cause the U.S. economy to slip into recession in real terms. Clearly, no one wants that to happen, but you might wonder whether the Fed’s cure is worse than the ailment. After all, the consumer and potential homebuyers need relief yesterday! Not in a few months, if at all!
The thing with inflation is this: once it gets into the system, it generally doesn’t go quietly. You can think of it as an infection. Your physician gives you a course of antibiotics to take to definitively kill the bacteria in your system and keep it from recurring.
So, do you stop taking it before the prescription is finished? Do you take it for a day or two and figure that is adequate? Do you not take it at all and continue to swim at the water treatment facility? By the way, you need to quit doing that.
The thing is, if history serves as a guide, complaining about inflation while pleading with the Fed to cut interest rates is analogous to having an infection and refusing to take the medicine the doctor has given you.
To be sure, your illness might go away on its own. However, an effective pharmaceutical regime should work more quickly and take less of a toll on your body.
It makes even less sense to complain about the Federal Reserve not cutting rates IF you believe the government is underestimating the CPI and other inflation gauges. The higher prices are, the more you want and need the monetary policies to squash them. While a short-term period of higher prices could indicate an increase in consumer demand, a long-term period will usually erode an economy’s purchasing power and ability to invest correctly.
In other words, a little inflation isn’t always a bad thing, but you don’t want it hanging around forever. Price stability is almost always preferable as it allows consumers, investors and businesses to plan their cash outlays more effectively and confidently. For this reason, price stability is one of the Federal Reserve’s two mandates, the other being full employment. Psst…price stability should be the Fed’s only mandate, but that train has already left the station.
As such, the Fed would, could and should err on the side of caution in deciding when (or if) to cut the overnight rate. It can always flood the markets later with cash if deflation gets to be a problem. That seems to work nicely, and appears to be much easier than draining excess liquidity from the system. Not surprising. After all, which do you think would be more difficult: giving a child a lollipop or taking it away from them?
In the end, monetary policy is arguably a product of the official inflation gauges. The government calculates the CPI, and others, so it is in control of the official definitions of inflation. As a result, agencies like the BLS are indirectly responsible for the Federal Reserve’s actions. It doesn’t matter what the average consumer’s experience is.
IF this seems a little too interrelated, it sort of is. However, it is the best system we have, and the only one we will likely ever have. So, if the BLS announces all measures of inflation are in remission, like it did this week, go ahead and accept it at face value. Sometimes you just have to quit worrying and learn how to love the BLS.
Have a great weekend.
Thank you for your continued support. As always, I hope this newsletter finds you and your family well. May your blessings outweigh your sorrows on this and every day. Also, please be sure to tune into our podcast, Trading Perspectives, which is available on every platform.
John Norris
Chief Economist
Please note, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as well as those of our Investment Committee, is subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the rest of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.