Inflation Concerns Remain at the Forefront

Summary
Inflation concerns continue to be a significant point of discussion, especially as the overall inflation rate shows a persistent upward trend. The Consumer Price Index (CPI) for March exceeded initial forecasts, with the headline rate rising and the core inflation rate, which excludes volatile food and energy prices, remaining stable.

A considerable part of the increase in core inflation is attributed to shelter costs, which represent a major component. However, there are critiques regarding the current method of calculating these costs, suggesting it might not accurately reflect real-time changes. Critics argue that if real-time data on shelter costs were utilized, it would reveal that inflation is stabilizing around 2%, a figure substantially lower than suggested by traditional metrics.

Insight
Recent weeks have seen a surge in inflation concerns, with some speculations suggesting a rise from 3% towards a daunting 9%. However, this overlooks the disinflationary trend observed over the last 18 months, which shows inflation consistently decreasing. The final percentage points of decline are notoriously challenging, given the difficult comparisons month-to-month and year-over-year. Despite this, the overall trend remains positive, which is a primary focus for financial markets. Investors who overlook this progress risk their investment returns.

For March, the Consumer Price Index (CPI) was anticipated to show a 0.3% monthly increase and a 3.4% annual rise, with the core CPI (excluding food and energy) expected to rise by 0.3% for the month and to slightly decrease to 3.7% year-over-year. Contrary to these expectations, the headline CPI rose by 0.4%, with the annual rate nudging up to 3.5%, and the core rate increased to 3.8% annually. Despite this, the core inflation trend, closely monitored by the Federal Reserve, remains on a disinflationary path.

While some pundits may use the latest data to stir fears of reaccelerated inflation, higher interest rates, lower stock prices, and looming recession, it’s important not to succumb to such fearmongering. The Federal Reserve recognizes that inflation has been within its preferred 2% range recently, supporting strong stock market performance. Although the Fed has hinted at potential rate cuts, such caution is likely strategic to control financial asset price inflation.

Today’s report highlights that shelter costs, which reportedly rose by 5.7%, contributed significantly (60%) to the annual core inflation. It’s widely acknowledged that the Bureau of Labor Statistics’ (BLS) method for calculating shelter costs is outdated and flawed, using data that does not reflect current market dynamics. Private sector data, like that from Rental .com, showed a mere 2.5% increase in rent over the past year, indicating a much lower inflation rate of around 2%.

The Federal Reserve instead relies on the core Personal Consumer Expenditures (PCE) price index, which is less influenced by shelter costs and thus presents a more accurate picture of the disinflationary trend. As of February, the annualized core PCE rate was at 2.78%, and quarterly analysis during the latter half of 2023 showed it dipping to 2%.

Contrary to pessimistic views, fluctuating inflation between 2-3% is preferable to a sharp decline below 2%, which could trigger deflation concerns. There is no perfect monetary policy that fixes inflation at a constant rate.

Conclusion
The fight against inflation is largely won. The next anticipated move by the Fed is to reduce short-term interest rates, likely ensuring a soft landing and the continuation of the bull market into 2025.