Why We’re Celebrating an Unsurprising Inflation Number

Estimated reading time: 5 minutes

Usual Suspects

In previous columns, I’ve written about the market’s attention shifting from inflation to jobs. I’ve also written about shelter as a sticky component, and more recently car insurance as a newer inflation driver (no pun intended). 

After October’s Consumer Price Index (CPI) came out this week, I wish I could say things have changed and those pesky components are less eh… pesky. But that wouldn’t be true, as shelter and car insurance once again are the two pieces of CPI that are keeping it elevated.

The good news is this reading came in bang on expectations at a time when the market seemed to be bracing for a hotter print. The fact that we are celebrating an unsurprising inflation reading, only because we were worried about an unwelcome surprise, is a real mind bender – but then again, so are markets.

Core CPI (ex-food and energy) came in at 0.3% month-over-month and 3.3% year-over-year, both exactly as consensus expected. The more interesting part of the data is shown in the chart below.

Isolating car insurance and shelter shows how much they’re adding to the overall number. More importantly, if we look at pre-pandemic readings of the two we can see how much larger they are now than in 2019. In fact, if we adjust each down to where they were in December 2019, Core CPI would be 2.0% and perhaps we wouldn’t be talking about inflation at all.

But that’s not the world we’re living in. Although these components are affecting the cost of living for consumers, both of them are remnants of what was going on in 2021-22, not what’s going on today.

That’s important for two reasons: 1) Both will take an extended period to come back down to more “normal” levels, 2) the Fed can de-emphasize them in policy decisions because the price elevation can still be explained as transitory. 

Bottom line: I don’t expect the Fed to change its tune on inflation due to either of these problematic pieces. Other components of CPI would need to reignite in order for the Fed to become concerned enough and lose confidence that they were on track to achieve their 2% inflation target.

Expectations vs. Events

In the land of markets, expectations often matter more than events. In this case, the Treasury market seemed to be positioned for CPI to come in higher than expected and throw a wrench in the Fed’s cutting plans. When that didn’t happen, markets had to undo what they’d done in anticipation of this “unexpected” event.

Seems like a lot of unnecessary drama to me. The 2-year Treasury yield fell 10 bps on the data, which is a big move in any circumstance, and the Volatility Index (VIX) fell as well. Stocks let out a sigh of relief and we all carried on with our mornings.

The broad story hasn’t changed: Inflation has come down, growth remains robust, earnings are coming in strong, the labor market is steady, and the market is enthusiastic about policy changes that may come in the next administration. Yet we create these mini heart attacks over data prints.

Despite the market’s positive momentum and the economy’s positive fundamentals, we remain in an environment of short-term trading that can trick many investors into reacting to a one day or even one hour move. 

Resist the urge to act on impulse – stay the course through year end unless something materially changes.

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