The
Consumer Price Index (CPI) for October rose by 0.3%, a little bit hotter than the 0.2% that was expected. If one strips out volatile food and energy prices to get the core consumer price index, prices were up 0.2%, also one tick higher than the 0.1% expected.
A rise in energy prices was not unexpected. Heck, one only has to see what the price of crude oil and natural gas have done over the last month or so. For the month, the price of energy rose 1.5% overall. The rise was sharpest among energy commodities, like gasoline and heating oil, which rose by 1.9%. Energy services, like electricity rose a more moderate -- but still steep -- 0.9%.
The rise in core consumer prices was a bit more of a surprise. However, the rising prices were very narrow, with almost all of the increases due to higher prices for cars and trucks, both new and used. For the month, the prices of new cars were up 1.6% while the prices for used cars jumped by 3.4%. That is very good news for
Ford (
F) as well as indirectly for the U.S. taxpayer, since we are now major stockholders at both General Motors and Chrysler.
The increase for used cars is also beneficial for the car dealers like
CarMax (
KMX) and
AutoNation (
AN). The Cash for Clunkers program continues to reverberate through the economy, even though it ended over two months ago. Every car that was turned in under the program was destroyed (at least the engine was, other parts could be stripped and reused). This reduction in supply helped support prices of the remaining used cars. This is the third month in a row of sharply higher prices for used cars, coming on top of a 1.6% increase in September and a 1.9% increase in August. I suspect that this effect is likely to wear off in the near future.
On a year-over-year basis, the overall consumer price index is down 0.2%, while the core consumer price index is up 1.7%, both of which are historically very low. The huge decline in energy prices happened a year ago and is in the process of rolling off. Thus look for the headline consumer price index to start to outpace the core consumer price index in the months to come on a year-over-year basis.
The divergence could become very large. The reason is that a very large part of the index is for Shelter, and the biggest part of that is rent -- both the normal rent that is paid by people who do not own their own houses, and "owners equivalent rent" (OER) or what it would cost you to rent an identical house next door to where you are living now. OER is how the government measures housing prices for inflation; what happens to the actual price of houses is totally irrelevant when it comes to measuring inflation. Thus, measured inflation was very much under control, even as the price of houses were soaring during the housing bubble, and the CPI did not decline as the bubble was bursting.
Together, regular rent paid to landlords and OER make up over 30% of the total consumer price index, and almost 40% of the core consumer price index. The overall price of shelter was unchanged in October, the second month in a row it was unchanged. Regular rent fell by 0.1%, over the last three months it is down at a seasonally adjusted annual rate of 0.7%, and it is unchanged over the last six months.
Since most people own rather than rent where they live, OER has a much higher weight in the index (24.4% of the total index vs. 6.0%). It was unchanged on the month, is off by 0.3% over the last three months and up by just 0.2% over the last six months. However, if the reports from the big housing-oriented REIT’s like
Apartment Investors (
AIV) and
Equity Residential (
EQR) are to be believed, then the decline in regular rents is significantly understated.
The data on OER us always suspect, since it is collected by the government -- calling people up on the phone and asking them what they thought it would cost them to rent an equivalent home in their neighborhood. I suspect the vast majority of people really have no idea, since in many neighborhoods very few people rent, and owners are not regularly calling on rental agents to find out what the prices around them are.
The final part of the shelter component is lodging away from home, otherwise known as the price of a hotel room. It rose by 0.4% on the month, but that follows a 1.5% increase last month. Perhaps there is a glimmer of hope for the hotel chains like
Marriott (
MAR).
Overall, the report suggests that inflation is well under control, especially outside of Energy prices. As the first blue graph shows, we are coming off a very rare instance of actual deflation at the headline level. Even at the core level, the change in prices over the last year is near its lowest point on the graph which goes back to 1983, and I removed the earlier period from the graph since inflation was so high then that one could not make out the more recent trends. This is particularly true if I am right that the effect of Cash for Clunkers on auto prices is going to wear off soon.
This means it is clear sailing for the Fed to keep interest rates low. The problem the economy faces is high unemployment and low levels of production. There is zero danger of the economy overheating and pushing inflation into overdrive anytime soon. Yes, there is a danger that continued easy money could form a bubble in asset prices, but it does not look like we are there yet.
Think of easy money as air being pumped into a tire. When the tire is flat air simply makes the tire usable again; when the tire fills with air, you run the danger of the tire popping from being overinflated. We are nowhere close to the tire popping. (Perhaps the more interesting question is if the tire has a big hole in it, so pumping more air does nothing as it just leaks out.)
Keep in mind that the way up in an asset bubble is a lot of fun, so if that is happening, enjoy it while you can. I think it has a ways to go before it pops. Heck, the tire is still looking pretty flat.
The second green graph presents the same data, but on a continuously compounded annual rate of change basis. It shows a few things of note. The first is that the huge decline in the overall consumer price index happened a year ago as energy prices crashed. That, however, is about to roll off, which should mean that the year-over-year change in the overall CPI should be headed back up in the near future (notice on the top graph that it is already becoming far less negative). Also note that the core consumer price index is very stable from month to month, unlike the headline numbers that can really swing big time, and that it is still on a gradual secular decline path.
While we may be seeing more inflation at the gasoline pump in the near future, in part due to the weak dollar, we are seeing downward price pressures elsewhere in the economy. In other words, there is a change in the relative price level of energy (food prices are being well behaved, rising only 0.1% for the month), not a rise in the general price level. The Fed should not be tightening in response to changes in relative prices, only to changes in the overall price level. For investors, changes in relative prices are very important, and the data suggests that energy stocks are a good place to be parking your money these days.
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