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When and How Much Tariff Effect?
As we look forward to the CPI report next week, the monthly-repeating theme is ‘when will the tariff effect show up?’ The answer, so far, is ‘not yet,’ but economists who had forecasted the end of life as we know it when the Trump tariffs went into effect have been befuddled.
I’ve already admitted in this column that I was educated in the tradition of ‘tariffs bad,’ but that over the years Trump’s insistence otherwise has made me carefully re-think of which ways tariffs are truly bad, and which ways they’re not so bad. Naturally, if tariffs were uniformly bad – which seems to be the orthodoxy – then it would be really hard to explain why almost every country levees tariffs. Maybe forty years ago we could blame the benightedness of those poor policymakers in other countries, who clearly just didn’t understand how bad tariffs are. But now? Heck, all someone in one of those countries needs to do is ask ChatGPT ‘are tariffs bad,’ and they’ll learn!
… Conclusion: Tariffs can be useful tools in specific, limited circumstances — like protecting vital industries or responding to unfair trade practices. But long-term, high or broad tariffs often do more harm than good, especially in highly interconnected global economies. (ChatGPT, July 9, 2025 query ‘Are tariffs bad’)
But it seems every country has these specific limited circumstances! It’s evidently only bad when the US does tariffs. And that is what made me ask whether maybe there is some nuance. My 2019 article “Tariffs Don’t Hurt Domestic Growth” was really good, I thought.
Even as there has been some small movement in the economintelligencia, though, about whether tariffs are all bad there has been very little movement in the notion that they are clearly inflationary. No doubt, implementing a tariff will raise prices at least a little, but how much is the important question. And regardless of that answer, tariffs are a one-time adjustment to the price level even if that effect is smoothed over a period of time. (This is why it’s weird to hear Powell say that the Fed can’t ease because they’re waiting to see the effect of the tariffs on inflation. That’s economic nonsense. The Fed can’t possibly believe that keeping rates high is the proper response to a one-time shock.)
On this question, I thought I’d share something I wrote in our Quarterly Inflation Outlook from Q1 (in mid-February), in which I roughly estimated the effects of a 20% blanket tariff. I know the answer isn’t “right,” because that’s the wrong question – there isn’t a 20% blanket tariff. But I undertook the estimate to get an idea of the relative scale of effects. (I included in the piece some parts from that 2019 article mentioned above, because I’m not above stealing from myself!) I will add some concluding thoughts after this ‘reprint’ from our QIO – which, by the way, you can subscribe to here.
Tariffs as a Tool to Promote Domestic Growth and Revenue
In the President’s view, the fact that the U.S. has a very low tariff structure compared to the tariffs (and arguably VAT taxes) that other countries place on U.S. goods is prima facie evidence that the U.S. is being taken advantage of and treated unfairly on world markets. The U.S. has, for the better part of a century, been the main global champion of free trade and this tendency accelerated markedly in the early 1990s (as the familiar chart below, sourced from Deutsche Bank, illustrates well).
The effect of free trade, per Ricardo, is to enlarge the global economic pie. However, in choosing free trade to enlarge the pie, each participating country voluntarily surrenders its ability to claim a larger slice of the pie, or a slice with particular toppings (in this analogy, choosing a particular slice means selecting the particular industries that you want your country to specialize in). Clearly, this is good in the long run – the size of your slice, and what you produce, is determined by your relative advantage in producing it and so the entire system produces the maximum possible output and the system collectively is better off. To the extent that a person is a citizen of the world, rather than a citizen of a particular country – and the Ricardian assumption is that increasing the pie is the collective goal – then free trade with every country producing only what they have a comparative advantage in is the optimal solution.
However, that does not mean that this is an outcome that each participant will like. Indeed, even in the comparative free trade of the late 1990s and 2000s, companies carefully protected their champion companies and industries. Even though the U.S. went through a period of being incredibly bad at automobile manufacturing, there are still several very large U.S. automakers. On the other hand, the U.S. no longer produces any apparel to speak of. In fact, the only way that free trade works for all in a non-theoretical world is if (a) all of the participants are roughly equal in total capability, and permanently at peace so that there is no risk that war could create a shortage in a strategic resource, or (b) the dominant participant is willing to concede its dominant position in order to enrich the whole system, rather than using that dominant position to secure its preferred slices for itself and/or to establish the conditions that ensure permanent peace by being the dominant military power and enforcing peace around the world. We would argue that (b) is what happened, as the U.S. was willing to let its own manufacturing be ‘hollowed out’ in order to make the world a happier place on average.
The President (and many of those who voted for him) feel that (b) is inherently unfair, or has reached extremes that are unfair to U.S. citizens. Essentially, the President is rejecting the theoretical Ricardian optimum and pursuing instead a larger slice for his constituents. This is where reciprocal tariffs (where the U.S. matches the tariff placed on its exports by a trading partner, with a tariff placed on the imports of that product from that trading partner) or blanket tariffs (where the U.S. imposes a tariff on all imports of a product irrespective of source – e.g. aluminum – or on all imports from a given trading partner) come in.
Blanket tariffs are good for domestic growth,[1] but definitely increase prices for consumers. How good they are for growth, and how much prices rise, depends on how easily domestic un-tariffed supply can substitute for the imported supply and also on whether your country is a net importer or exporter, and how large the export-import sector is in terms of GDP. Because this is an inflation outlook, let’s make a very rough estimate of the impact on the overall domestic price level of a blanket 20% tariff (such as the one Treasury Secretary Bessent has proposed). We suppose the average elasticity of import demand in the U.S. to be 3.33[2] and the elasticity of export supply to be 1.0[3]. In that case, the incidence of a tariff falls about 23% on consumers: [1.0 / (3.33+1.0) ]. So, for a 20% tariff, prices for the imported goods would be expected to rise about 4.6% (20% tariff x 23% incidence). However, imports only account for about 15% of US GDP, which means the effect on the overall price level would be 15% x 4.6% = 0.69%.
So, for a 20% blanket tariff on imports, Americans should expect to see a one-time increase in the overall price level of something on the order of 0.7%, smeared over the period of implementation. This is not insignificant, but it is also not calamitous. It does affect our estimates for 2025 and 2026 inflation, shown in the “Forecasts” section (somewhat less than 0.7%, because we do not expect a blanket tariff but rather reciprocal and targeted tariffs). Also note that the retaliatory tariffs on US exports have no direct effect on domestic prices, so that whether or not trading partners retaliate is irrelevant to an analysis of first round effects, anyway.
Thus my wild guess back in February was that a 20% blanket tariff would result in a bit less than 0.7%, smeared out over 2025 and 2026. That doesn’t answer the ‘timing’ question, but the delays in implementation (so as to not affect Christmas 2025 prices of the GI Joe with the Kung-Fu Grip) and the importer/retailer initial reaction to try and absorb as much as possible for optics – presumably, easing price increases into the system later – mean that it shouldn’t be shocking that we haven’t seen a big effect yet. My point in the above calculation, though, is that we really shouldn’t expect to see a big effect, regardless.
For what it’s worth, the Budget Lab at Yale estimates that currently “the 2025 tariffs to date are the equivalent of a 15.2 percentage point increase in the US average effective tariff rate,” so if we take my 0.7% guess for 20% then we would be looking closer to 0.5% in total. And in fact, lower even than that since the 15.2% average will have less impact than a 15.2% blanket tariff, assuming that the tariffs will be highest where domestic substitution is easier.[4]
Wrapping this up, let me make one final observation. Current year/year headline CPI inflation is 2.35%. The inflation swaps market, specifically the market for ‘resets’ where you can trade essentially the forward price level, currently suggests that traders expect y/y inflation to rise to 3.29% over the next six months: almost 1 full percentage point from here. But that actually flatters what the market is pricing, because the shape of the energy curves suggests that rise is being dragged about 20bps lower by the implied moderation in energy prices (give me a break, inflation traders: I’m doing this in my head).
So, the market is pricing core inflation peaking about 6 months from now, about 1.2% higher than it currently is. Not all of that is the effect of tariffs; some is due to base effects as the very low May, June, and July 2024 numbers roll off of the y/y figure. But if we get that result, you can be sure that economists will put most of the blame on Mr. Trump, while Mr. Trump will put most of the blame on Mr. Powell. Either way, I think the interest rate cuts that the President would prefer are unlikely unless growth takes a significant stumble.
[1] …but bad for global growth! There is no question that unilaterally applying tariffs to imports is bad for all suppliers/countries providing those imports. If Ricardo is right, the overall pie shrinks but the domestic slice gets larger…at least for the dominant players who already have a large slice. If everyone raises tariffs in a trade war outcome, the less-productive countries suffer the most loss of growth and the most-productive countries likely still benefit. But prices rise for all.
[2] Kee, Nicita, and Olarreaga, “Estimating Import Demand and Export Supply Elasticities”, 2004, Figure 5, available at http://repec.org/esNASM04/up.16133.1075482028.pdf Your answers may vary!
[3] Estimates are wildly all over the map, depending on the exporting country and the product. In general the smaller the country, the more price-inelastic it is. We chose unit elasticity here (a 1% increase in price cause a 1% increase in the quantity supplied) just to be able to get a rough guess.
[4] To be fair, the Budget Lab at Yale also estimates the effect on PCE inflation of a whopping 1.74%. They must be really surprised at the impact so far.
Inflation Guy’s CPI Summary (May 2025)
Well, this was an odd one to sort out.
Going into the CPI announcement this morning, the economist consensus was for +0.17% (seasonally adjusted) on headline CPI m/m and +0.28% on core. Market changes this month have been very contained, partly because of the usual summer doldrums kicking in and partly (most likely) because of the degree of uncertainty surrounding all of the chaotic policy changes that have taken place in 2025. The effects of these changes (and more to come!) are still making their way through the system.
This is a calm surface over a roiling ocean. Economists continue to debate (and their analysis, to me, seems in many cases to be colored by the political lens they are looking through) about the impact that the current tariff structure will have, about the effect of future tariff changes – and what those will be, about the impact of the Most-Favored-Nation policy on pharmaceutical pricing and availability, about the effect the deportation of illegals (and self-deportations) will have on housing (rent inflation softer, but how much?) and labor supply (wages upward, but how much?) and Lodging Away from Home.
Actually, I’m overstating that a little bit. Most classically-trained economists mostly agree about how horrible this will all be, because tariffs bad. My own estimates have tariffs pushing inflation a little higher in the near-term, but not terribly. I also think that mass deportations would be very disinflationary because of the effect on rents but it is looking less and less like ‘mass deportations’ means tens or hundreds of thousands, not millions, and that effect likely won’t be huge.
Meanwhile, the Fed is keeping rates slightly above neutral but money supply growth has re-accelerated to a level that’s not likely to be consistent with inflation at 2%. Underlying trend median inflation is running about 3.5% or so, and is unlikely to fall a lot further given the current configuration of fiscal and monetary policy.
Let’s get into the data, then. The actual CPI was +0.08% (SA) on headline and +0.13% on core. That’s a significant miss, especially on core.
Core inflation has recently been missing low on a fairly regular basis, although most of the misses have been small. Median inflation in most cases hasn’t been confirming those misses, because they’ve generally been one-offs that don’t really wiggle median too much. It’s still a positive sign if the ‘tails’ are to the downside so that core CPI is below median CPI, but Median tells us not to get too excited. This month, though, Median also showed an effect. My estimate is that Median CPI will be the lowest since last July, at +0.25% m/m. It’s still difficult to see a major disinflationary trend here.
There’s more uncertainty than usual around my Median guess, but let’s take it as a given for now.
You don’t have to look too far to see one of the major culprits for the miss this month. Primary Rents were up +0.21% m/m, which is a lot slower than they had been running at.
Owners’ Equivalent Rent was also soft, and between those two surprises it’s probably roughly 5bps of the Core CPI miss. Let’s be clear – rents are not collapsing and indeed, we’ve just converged with our model.
Let’s be clear: if you are in the camp that we’re going to get back to 2%, you need this to not be an aberration. You need shelter inflation to continue to decelerate. But as you can see from the chart of month/month primary rents above, sharp movements in rents tend to be reversed in subsequent months. This looks a lot to me like last July’s surprise, which was reversed in August. We will see. But ex-shelter, year/year Core CPI rose, to 1.87% from 1.78%.
What is interesting to me as I write this, looking at some of the other commentary, is that folks don’t seem to be focusing on this. Of course it’s all tariffs, all the time, and everyone is scratching their heads over why we are seeing price declines in some of the categories where you’d expect the tariffs to help. Key example (and significant example) is autos, where the CPI for Used Cars and Trucks was -0.54% m/m after a similar decline last month, and New Cars were down -0.29% m/m. If there is one place that economists were certain we would see tariff-induced inflation, it was in autos. Not so much, at least yet. This might be because the lags are longer than we expect in a just-in-time manufacturing world, or it might be because demand elasticity is bigger than people thought.
But even with autos, Core Goods inflation accelerated to +0.3% y/y from +0.1% last month.
Remember, above I said that core goods ex-shelter had accelerated. I don’t want to fall into the trap of taking out all of the things that go down, to make the insightful conclusion that everything else went up – but that acceleration in core goods included the weighty autos contribution to the downside so you can tell that there are indeed upward pressures. Just not in the big things.
One place we saw increases was in Tenants’ and Household Insurance, which rose 0.84% last month, and in Motor Vehicle Insurance, which rose 0.68%. That helped keep core services inflation at +3.6% y/y, even with the slowdown in housing. On the other hand, Airfares suffered a third straight significant decline, -2.74% m/m. And while we are surprised to see auto prices decline, given the tariffs, we are also surprised to see Medicinal Drugs prices increase, given Trump’s new “Most Favored Nation” policy. Pharma prices were +0.54% m/m (although the y/y increase slackened some and is only +0.35% y/y). Core Services less Rent of Shelter (aka “Supercore”) is down to 3.11% y/y, and that’s good news even if it’s still quite a bit higher than it was pre-COVID. The trend is your friend, and this is a good trend for now.
As with the market itself, then, we’re seeing a lot of movement in both directions; it’s just all canceling out into a relatively tame increase in the overall CPI basket. That’s not likely to be the ultimate outcome. The last four year/year increases in Median CPI (assuming I’m vaguely right about the m/m, and we’ll know that in an hour or two) have been 3.53%, 3.48%, 3.46%, and 3.44%. That does not give the impression of a series that is in a hurry to get down to 2.25%-2.5%, which would be roughly consistent with sustainable core CPI around 2%. Again, you need to get shelter prices to really decelerate significantly further.
Now, even if that does happen, it isn’t going to keep y/y measures on a steady deceleration track for the next year. While we haven’t seen a major impact from tariffs yet, and my view is that it won’t be a huge impact in any case except for particular items, I am pretty sure we will see something and median and core inflation will see acceleration over the balance of this year and into next year. Thereafter, it depends on what happens with policy in the interim. On that score, while the current numbers still give the Fed no good reason to ease it also should pretty much remove any notion that monetary policy is about to get tighter. M2 growth is back to 4.4% y/y, and 6.4% annualized over the last quarter. That’s back to what was normal when we were experiencing the tailwinds of globalization and positive demographics. It is too fast now that those are headwinds.
But as I said, that’s the story for later this year and it could change. In the meantime, we keep waiting for the tariff effect. If three months from now we still haven’t seen an effect, then things will get very interesting.
One final announcement. If you’re an investor in cryptocurrencies (in particular, stable coins) and have a Telegram account, consider joining the read-only USDi_Coin room https://t.me/USDi_Coin where the USDi Coin price is updated every four hours or so…and where these charts are also posted shortly after CPI just as I used to do on Twitter before they changed the API to make auto-tweeting charts very difficult.
Inflation Guy’s CPI Summary (April 2025)
Before the CPI analysis, I always try to give some context for where we are in the ‘story’ about the evolution of inflation right now. It’s really difficult to do that, though, because of all of the massive policy changes that are happening – and often in opposite directions with respect to the effect on inflation. Here is the Baker, Bloom & Davis Economic Policy Uncertainty Index, which is derived by scraping news sources. Even strong supporters of President Trump’s have to admit that his Administration has been a whirlwind on economic policy (for many of them, of course, that’s a feature and not a bug).
Here goes, anyway. Remember that last month, core CPI crashed but Median CPI actually accelerated. This kept us from actively celebrating the great inflation news; we knew that the good news was concentrated in a few one offs. In particular, Airfares (-5.3% for March), Lodging Away from Home (-3.5%), Used Cars (-0.69%), Car and Truck Rental (-2.66%), and Medicinal Drugs (-1.30%). But, as Median showed last month, there was really no reason to think that inflation was behind us…even before any effect from tariffs.
Speaking of tariffs, prior to this month we hadn’t really expected to see any effect yet and most economists thought that we shouldn’t see that much impact in the April figures either since the big tariffs on everyone went into place early in that month. However, remember that Mexico, Canada, and China had all faced escalating tariffs prior to April, so if there is going to be an impact we should expect to see something soon. I don’t expect a lot in most categories, but some impact in a few. It will be hard to discern how much of any monthly price change is tariffs, of course. We will look at Apparel, where demand elasticity in the short run is not terribly low. Broadly, though, remember that demand elasticity and foreign content percentage are both important…and foreign content in most goods is pretty low. I’d also look to Medicinal Drugs, since a lot of APIs are China-sourced and the demand for many drugs is pretty inelastic in the short-run, but I didn’t expect a lot of impact there (pharma companies will have had inventories), and going forward it will be muddied by Trump’s announcement of the Most-Favored-Nation policy in pharmaceuticals.
Speaking of that announcement, this month’s review of changes in inflation swap levels is seriously polluted because that announcement combined with the 90-day pause on China tariffs caused a massive crash in 1-year inflation expectations.
Despite the drop in tariff rates on China (for now), remember average tariffs remain the highest since the Great Depression (ominous music)! Of course, back then the US was a significant net exporter, so reciprocal tariffs were a bigger problem. Imports were only about 2-3% of GDP.
(Chart above is from https://www.stlouisfed.org/on-the-economy/2019/may/historical-u-s-trade-deficits)
(Chart above is from https://www.stlouisfed.org/on-the-economy/2020/march/evolution-total-trade-us)
There you go. That’s the context. Now onto the number.
CPI for April was expected to be +0.25%, and +0.27% on Core. The actual prints were 0.221% and 0.237%, respectively, so a mild surprise lower (although it turned the +0.3%/+0.3% rounded expectations to +0.2%/+0.2%, looking more dramatic a surprise than it actually was). Core is right about where it has been for the last 6 and 12 months (0.244% and 0.229% average, respectively) with the big January spike and the March plunge basically offsetting each other.
Amazingly, of the eight major subgroups only Housing, Medical Care, and “Other” increased on a m/m basis. What is especially surprising in that light is that Apparel – where the tariff canary in the coal mine lives – was down on the month.
Core goods continues to hook higher, now at +0.13% y/y. Remember, this is before any tariff effect has really been felt. In my mind, this is more the underlying ‘deglobalization’ effect: as I’ve said for a while, the deep deflation in core goods that we saw was a partial retracement of the COVID spike and we should expect going forward to see a small positive inflation in goods. Core services is decelerating nicely, and it will need to continue to do that if we’re ever going to see downward pressure in median inflation from where we are now.
Speaking of Median CPI, my early estimate is +0.308% m/m, putting the y/y at 3.43%. That’s about where we’ve been, and where we’re likely to be going forward.
Looking at some of those one-off categories from last month, Airfares fell another -2.83% m/m after that -5.3% prior decline. Some of that is jet fuel, some is tourism I suspect. Lodging Away from Home went flat (-0.1% m/m) from -3.54% prior. I think we’ll see continued downward pressure in that category, as hotels in some big cities are gradually emptied of illegal migrants and get added back to the stock of available rooms, but March’s drop was just too big. Used Cars’ decline (-0.53%) surprised some people, because the private surveys showed that prices advanced last month, but the seasonal assumption was a decent hurdle this month that wasn’t cleared. However, if you were worried about how the spike in car parts tariffs would cause car prices to spike…because that’s what the news was hyperventilating about…you needn’t have. New Car prices were also slightly down, -0.01% compared to +0.1% last month.
As for shelter, it continues to flatten out, with Primary Rents 3.98% y/y and OER at 4.31% y/y. Actually, Primary Rents were flat on a y/y basis compared to the prior month, and have basically converged with our model, which is around 3.7%. From here we should expect very slow deceleration, but rents should stay above 3.25% or so on a y/y basis.
Supercore is looking great. This is about the best news in the report, because if Shelter is just about tapped out and Core Goods is trending just above zero we’d need Core Services to continue to dive.
That’s the good news. The bad news is that the spread of median wages over median prices has returned to its long-run average, which means that it will be hard to see additional sharp declines here…it isn’t going to come from squeezing wages further.
Outright, the Atlanta Fed Wage Growth Tracker – the best measure of wages in my opinion – is at 4.3% y/y. That’s right where it was in November. It’s going to be very hard to squeeze services prices lower if wages don’t decelerate further.
Finally, let’s circle back to pharmaceuticals. I’m going to point you again to my article from 2020, which is the first time that the President mooted the idea of a Most-Favored-Nation clause affecting the pharmaceutical industry. https://inflationguy.blog/2020/08/25/drug-prices-and-most-favored-nation-clauses-considerations/ The upshot is that even if the MFN policy takes place exactly as the President states, retail drug prices are unlikely to decrease anything like as much as he has said. In fact, there could even be some circumstances in which drug prices rise because companies stop selling in foreign countries at levels lower than in the US (because they face a more-elastic demand there) but which contribute to the total profit of the drug company. There may be others in which the drug company stops selling the drug at all in the US. Furthermore, drug prices overall have only risen 7% since pre-COVID, compared to 23% for core prices generally (the black line in the chart below is the overall CPI for Medicinal Drugs; the blue is the core CPI price level – both normalized to December 2019).
By the way, if I was concerned about importing APIs from China and wanted the US to start producing more of them, I don’t think I’d be trying to crush end-product prices and reduce the incentive to spin up production of the APIs. So there will be a lot of exceptions to the MFN policy, and you can tell from the performance of pharma companies yesterday after the news (big up with the market, not down!) that investors don’t expect any important impact on the bottom lines of pharmaceutical companies. I agree. I think Medicinal Drugs going forward will probably decline a bit for some celebrated cases, but not in a big way that pushes CPI lower significantly.
The big conclusion here is that inflation continues to run at about 3.5% or so (Median), and there is no sign of a significant further deceleration to come. As long-time readers know, this has been my theme for a couple of years, that we will end up in the ‘high 3s, low 4s’ on median inflation, because the overall backdrop of deglobalization and demographics argue for a higher floor. If the Fed keeps money growth very low, my opinion could change (and I’d already amend my target to ‘mid to high 3s’ as the mode), but I am not very optimistic on that.
However, I also don’t think there is anything about the inflation picture that argues the Fed has a lot of room to drop rates significantly. I said last month “The right answer to uncertainty from a policymaker perspective is to increase the hurdle for taking action. The right answer is to make no changes to policy. I am not confident that the Federal Reserve will correctly separate the ‘price of risk’ effect from the ‘economic growth’ effect. They are correct to note that tariffs by themselves are not inflationary in that they are one-off effects. If they believe that, and they think there’s a big recession coming, they’ll cut rates. That would be a mistake, especially given the uncertainty.” I still think that’s the case. At the moment, there is no reason to cut rates any further than the ‘let’s help Biden’ cuts did, except to appease the President and I see little urgency from this Fed to do that. I wouldn’t expect any big moves from the Committee, any time soon.
One final announcement. If you’re an investor in cryptocurrencies (in particular, stable coins) and have a Telegram account, consider joining the read-only USDi_Coin room https://t.me/USDi_Coin where the USDi Coin price is updated every four hours or so…and where these charts are also posted shortly after CPI just as I used to do on Twitter before they changed the API to make auto-tweeting charts very difficult.
Inflation Guy’s CPI Summary (March 2025)
Before we get started on today’s CPI, let me add a few wise words from an old market observer:
- The stock market is not the economy. The stock market is the (private real economy) times (price per unit of the private real economy). When the stock market goes down, sometimes it’s because the real economy is contracting, and sometimes it’s because the price people are willing to pay to own a piece of that is declining. Often, it’s both. Furthermore, the first part of that equation is really (real economic performance) times (capital share vs labor share vs government share) The tariffs will affect corporate earnings, especially for multinationals, and in the short term for domestic firms that single-source from a foreign source. But the effect on the economy will not be dramatic, even though we will see a technical recession because of the huge swings in the trade balance in Q1 and Q2 as imports surged ahead of the tariffs. So the main thing we are seeing in equities is a multiple effect. Stocks were way overpriced, and some of that is unwinding. Bottom line: if a bear market in equities causes you serious angst or damages your long-term financial goals, you’re too long equities. If a bear market in equities causes you serious damage to your short-term financial goals, you’re too long equities. It’s okay. A bear market does not mean we are headed for a depression.
- The amount of complaining about how the Administration didn’t consult Wall Street or think about how their actions would affect big equity holders and firms is amazing and the complainers are missing the point. That isn’t a bug of the policy, and most of the country doesn’t see it as a bug. It’s the main feature. Because if you consult those guys they all would have said “yeah, go get China with a 2% tariff and of course don’t touch anyone else.” These are the same guys who freaked out when Trump slapped tariffs on China in his first term…which were obviously in retrospect way too small to matter. The experts and Wall Street mainly want to make sure no one rocks the boat. But rocking the effect here isn’t a side effect. It’s the main point.
I have a third observation, but it’s inflation-related with all the rest so I will save it for the end. Let’s get into today’s number.
Heading into the number, the general consensus was that core CPI would be generally in the range it has been, around 0.25% or so, and headline would be soft due mainly to energy that was weaker than the seasonal adjustment accounts for. This month’s CPI, though, is a sidelight in the same way that the FOMC minutes are a sidelight when something really big happens subsequent to the last meeting: it isn’t March inflation we are interested in but rather inflation over the next 3-6 months as tariffs go into effect and begin to bite. The inflation swaps curve is sharply inverted, and has gotten increasingly so over the last year, as short inflation expectations (1y, 2y, 3y) have been rising while the long end of the curve has actually come down a bit.
Actually, long-term inflation expectations have been pretty steady, even in the recent market volatility, which is one way that you know that (a) this is a market-price event and not an economy event and (b) there aren’t big liquidity issues out there like we had in the GFC. 10-year inflation breakevens have been between 2.20% and 2.30% over the last week despite the record-breaking series of large equity swings. Anyway, back to CPI.
Some people thought we might see a little hint of the first tariffs in this data. Welp, we didn’t. Headline CPI actually declined – prices fell on average (but wait for it) – by -0.05% m/m and headline inflation is only 2.41% over the last year. More surprising was that core inflation crashed lower, and was only +0.06% m/m to bring the y/y down to 2.81%. That was far below expectations.
Unfortunately, it’s here I have to tell you to hold your horses. Because when we estimate Median CPI, we don’t get even a whisper of the same effect. In fact, my early estimate has m/m median inflation the highest it has been in about a year. (This month, several regional housing subcategories are clustering around the median so my estimate of +0.35% is subject to being off by a few basis points depending on how the official seasonal adjustment affects the actual m/m increases in those subgroups, but it will not be far from +0.35%).
The fact that median doesn’t really show any of the deceleration that core does tells us that this is different from the deceleration last May/June/July, when rents had a brief but temporary lull. In March, Owners’ Equivalent Rent was +0.40% m/m, and Primary Rents +0.33% – both of which are faster than last month’s +0.28%/+0.28%. The y/y numbers are still declining but at a decelerating rate. Still right on schedule, and still zero sign of deflation in housing. Sorry!
If rents accelerated last month, how did we get a big dip in core but nothing in median? That tells you that we must have gotten large moves in low-weight categories. Which is exactly what happened.
Medicinal Drugs, -1.30% m/m (last month, +0.18%)
Used Cars and Trucks, -0.69% (last month +0.88%)
Airfares, -5.27% m/m (last month -3.99%)
Lodging Away from Home, -3.54% (last month +0.18%)
Car and Truck Rental, -2.66% (last month -1.25%)
These are, sadly, most of the ‘usual suspects’ when it comes to surprises in either direction. When they all surprise in the same direction, it means we get a core number that is way off. And that, my friends, is why we look at Median CPI. Of this list, the Used Cars one is the only one that was actually a surprise in the sense that people nowadays pay attention to that subcomponent and the private surveys anticipated an increase. I’ve written previously about what I think is happening in Medicinal Drugs, and even had a podcast episode recently to discuss it (Ep. 137: Drug Prices and the Most-Favored-Nation Clause). This is not going to continue, with 100%+ tariffs on China, where most of our Active Pharmaceutical Ingredients come from. I do wonder whether the decline in airfares (more than would be expected from jetfuel prices) and lodging away from home could partly reflect a decline in tourism to the US – both the official kind and the unofficial ‘tourism’ that has been reversing recently with the help of INS – which means it won’t soon be reversed. Not sure on that.
The net effect of these big moves in small categories is that core goods has not yet turned positive (but it will, once the tariffs go into effect, although not by a huge amount) and core services dropped sharply to 3.7% y/y from 4.1% y/y.
Supercore looks great for the first time in a while. Month/month it fell -0.24%, the sharpest decline since COVID. And the y/y dropped towards 3% as if though it was going to miss the bus if it didn’t get there soon.
Before we all get excited, I’ll point out that the three spikes on the m/m Supercore chart below were all March and April numbers. I suspect that part of what we are seeing is due to the changing placement of Easter, along with Spring Break…and if so, those parts will be unwound in the next month or two.
That doesn’t explain the sharp fall in car and truck rental prices. That is a bit of a head scratcher.
There is a little bit of bad news here, but it is away from core. Food Away from Home (which is in supercore) was behaved at +0.36% m/m vs +0.39% m/m last month, but Food at Home was +0.49% seasonally-adjusted compared with +0.01% last month. It wasn’t just Eggs, which rose less than 2% last month at the retail level and are declining at the wholesale level. Milk, Cheese, and Meats/poultry/fish all saw meaningful increases. The proletariat (of which I am one) notices these things, so if we were weighting the index by salience instead of dollars spent they would get a heavy weight. Now, there’s a reason that we take out Food and Energy…the noise generally outweighs the signal. But take administrative note of the small but noticeable acceleration in food prices on a y/y basis.
Overall, even though this was the second pleasant Core CPI surprise in a row it was also the second Core CPI surprise that shouldn’t get you very excited. In both cases, the fact that Median CPI will not echo the deceleration tells you that this is happening in the small categories that tend to mean-revert. They didn’t mean-revert this month, but I suspect they will. Unfortunately, that will happen at the same time that 10% broad tariffs, and large tariffs on Chinese goods, are kicking into effect. We might have a whopper of a Core CPI coming up here in one of the next few months.
In the broader picture, inflation is settling in the mid-to-high 3s (measured by Median CPI), but there are clouds on the immediate horizon from tariffs. But as the stability in the longer-term inflation measures suggests, the market isn’t really yet concerned that another upswing is on the way. Tariffs are a one-off effect, and a reasonably small effect overall although significant in the specific categories where they are leveed. Remember, though, that core goods, where the tariffs mainly fall, is only 19.4% of the overall consumption basket.
The longer-term picture depends on how long the uncertainty lasts. As I have pointed out before, economic policy uncertainty – which is off the charts right now – manifests itself in downward pressure on monetary velocity. I expect that the uncertainty will largely be past us in 6 months, and in the meantime the upward pressure on prices from tariffs that shows up in core goods will probably dominate the downward pressure from policy uncertainty (which causes consumers to keep more precautionary savings, causing the velocity decline). Those effects will probably wear off at roughly the same time so that we will only notice it at the micro level.
Uncertainty also, obviously, lowers the price of risky assets (I’ve also written about this!), in a healthy way. But I am not one of those people who worries that uncertainty will have a large effect on the underlying economic activity. Yes, CEOs may delay making big plans for a month or two. But the uncertainty won’t last forever, and then they’ll make their plans. CEOs who can’t make decisions under at least mild uncertainty aren’t going to be CEOs very long. The domestic economy will be just fine, especially as we continue to produce more of our internal consumption needs, domestically.
And for the Fed? The right answer to uncertainty from a policymaker perspective is to increase the hurdle for taking action. The right answer is to make no changes to policy. I am not confident that the Federal Reserve will correctly separate the ‘price of risk’ effect from the ‘economic growth’ effect. They are correct to note that tariffs by themselves are not inflationary in that they are one-off effects. If they believe that, and they think there’s a big recession coming, they’ll cut rates. That would be a mistake, especially given the uncertainty.
Inflation Guy’s CPI Summary (February 2025)
Look, I know that traders sometimes think their job is to overreact. And media folks benefit from overreacting. And political strategists have been genetically bred to overreacting. But a bit of rational analysis here is probably worthwhile.
The obvious backdrop to the CPI release this morning is the somewhat-greater-than-usual volatility in the equity market,[1] and some concerns that the economy might finally get that recession that I and others have been expecting for so long – although don’t get too chippy on that, since the Q1 contraction would be mostly due to a surge in imports from front-running tariffs. The narrative has shifted back to the question of how soon the Fed might ease, even if inflation is still a little problem, since Unemployment has risen to the nosebleed level of 4.1% and stocks are in the crapper (technical term).
Geez folks, take a chill pill.
Similarly, don’t cue the trumpets just yet on inflation. The expectations coming into today’s figure were for +0.31% on headline CPI and +0.30% on core CPI. The actual prints were +0.22% and a delightful +0.23% on Core.
Sure, the chart shows this is definitely better than last month! And it’s even better than the average of the last two months (I’d said last month you probably should average between December and January figures). But…it’s also a little early to take a victory lap. Here is Median CPI (last point, as usual, is my estimate for today).
If it’s 0.29% m/m, as per my estimate, then we are at a 3.5% run rate. And that’s basically where we have been over the last six months. Oh, and while y/y Core CPI is down to 3.1%, it’s at 3.5% over the last three and the last six months. We are settling in at the mid-3s.
The culprits behind last month’s spike were used cars, health insurance, lodging away from home, pharmaceuticals, and hospital services. Of those, only Used Cars (+0.88% m/m) contributed very much to this month’s number. On the other hand, Airfares dropped -4% m/m. Here are the Major-8 categories.
The optimistic view is that there isn’t any one category that looks out of control on a y/y basis. That’s also the pessimistic view, because it speaks of a broad – if not particularly high – inflation that is still percolating out there. Core Goods this month was still -0.1% y/y, but Core Services dropped from 4.3% to 4.1% y/y. Pharmaceutical prices, which just had their largest monthly rise in history last month as drugmakers tried to get their licks in before the Trump Administration forces them to lower prices, rose only +0.18% m/m this month. Both Primary Rents and Owners’ Equivalent Rent were +0.281% m/m. These are also settling in, on schedule.
“Settling in” is what is happening in shelter. And that again is both good news and bad news. A lot of the forecasts we have seen over the last couple of years that called for inflation to steadily return to trend depended on the assumption that the rent declines we have seen for new rents in a few cities would become a broad-based trend in all of shelter. But it’s not, for two reasons. On the rental side, costs keep rising for landlords (that’s the basis for our model in the prior chart). And on the home purchase side, there’s just still a big deficit in homes available for sale.
While that could change – it seems to be changing in the Washington, DC area but the people leaving Washington still need homes elsewhere – if deportations pick up a lot, there is no sign yet that shelter is going to do the heavy lifting of getting inflation back to 2%. Neither is SuperCore, although this month it was +0.22% m/m and in general is looking a little better.
But none of this looks exciting. None of this looks like it’s going to be the start of a Fed victory lap on inflation. Even the Enduring Investments Inflation Diffusion Index looks like it’s settling in, and like all of the other stuff we have looked at, it’s settling in at a level higher than pre-COVID.
And while we’re talking about distributions, here’s another one I haven’t run in a while. This is the distribution of y/y changes by the lowest-level CPI components. The big spike in the middle is obviously housing. There is a cluster between 1% and 4%. But look at that big left tail. 20% of the basket is actually deflating, y/y.
What’s interesting about that column on the left is that it is a whole bunch of little things. Breakfast cereal. Pasta. “Other meats” (shudder). Potatoes. Tomatoes. Soups. Snacks. Window coverings. Dishes. Men’s shirts. Audio equipment. In other words, a whole lot of things that are so small, consumers don’t really notice them so much and so they don’t really affect their sense of inflation being high. But they notice eggs.
So this is good news…in that a lot of things are deflating…but also bad news is that a lot of these are things that tend to mean-revert. You’ll notice that some of the categories I just listed are core goods, which are still in deflation…but which are also the things which are going to rise in price when the tariffs start to hit. The largest single piece still in deflation is New Cars, at a 4.4% weight or so. Unfortunately, that’s not going to be in deflation when tariffs hit auto parts and slow the import of non-US vehicles.
So let’s wrap this up.
The conspiracy nuts will say that Trump cooked the numbers, because it was better-than-expected about something that was a campaign promise of his. But this is normal variation, and the bottom line is that the inflation figures look to be converging on 3.5% or so, before the effects of tariffs kick in. The near-term effects on inflation are definitely upwards. Peace in Israel and Ukraine, if it comes, may put a small damper on energy prices but the bigger effect there is US energy being unleashed again, which will take some time. But outside of the peace effect, there are few good near-term trends but also few really bad near-term trends other than the (relatively small) effect of tariffs. Inflation is settling in.
The funny thing is, I don’t think the Fed cares. I think they’re satisfied enough with the progress on inflation, and they still think that recessions cause disinflation (they don’t) so that they feel they can focus on the growth part of the mandate, for now.
[1] Dubbed a ‘crash’, or ‘freefall’, or some other appellation by observers who can’t remember the last time we saw a 10% pullback. Which is only about 6% if you look at the equal-weight, or a 60-40 blend of stocks and bonds. If this warrants the “what do you say to Americans who now can’t retire because they’re seeing their retirement accounts collapsing” line, my answer would be “I would say those Americans probably shouldn’t have been invested in stocks at all if this causes them to delay retirement.”
Inflation Guy’s CPI Summary (January 2025)
We finished 2024 with a slightly soft reading, but we began 2025 with a hot reading. Now, my admonition last month about the volatility of December data applies also to January data, although less so in CPI than in some other indicators. However, averaging December and January is probably the right approach.
It still doesn’t look great even if you do that.
Let’s start with the market changes over the last month. You can tell from the table below that short inflation expectations as measured by the column on the far left have come up some, although not as much as you might have expected given all of the concern about tariffs. (For what it’s worth, in this table you can ignore the huge increase in 1-year breakevens – there really isn’t any such animal per se, and Bloomberg’s choice of bonds to use for the 1-year can change that a lot. Focus on the inflation swaps, which is a purer measure.)
The consensus estimates coming into today were for +0.30% on Core CPI and +0.29% on headline CPI. That represented an acceleration over the nice inflation data we saw in December (the best core inflation print since July!), but was expected to be attributable to one-offs such as wildfire effects. In fact, the number printed at an alarming +0.47% on headline and +0.45% on Core CPI, the worst since April of 2023. Here are the last 12 months.
But we are jaded these days because we’ve seen higher figures. Let’s back out a bit. Prior to COVID, we hadn’t seen a Core CPI number this high since 1992!
Okay, so some of these are one-off causes. And it is a January figure after all. Median CPI will be better. My calculation had it around 0.35%, but since the BLS changed weights for the new year in this report I am less confident in my estimate than usual. It should be close. And since last January was a big median print, that means the y/y median would drop to 3.66% or so on base effects. But there certainly doesn’t look to be any really marked improvement here.
Speaking of the reweighting of the CPI: this always sparks conspiracy theories even though the reweighting is very transparent. And the changes are pretty small year to year. Here are the changes from last January’s weights.
The BLS also announces categories that are being dropped or added or renamed. I never point those out because it’s really boring. At least, it is normally. This year, the BLS announced that the series for “Pet Food” has been renamed to “Pet Food and Treats.” Because who’s a good boy? That’s right, you’re a good boy.
Let’s look at some of the main culprits for the upside miss this month.
- Used Cars SA +2.19% m/m – We all expect some upward lift after the wildfires, but I am not sure this is due to that. New Cars CPI only rose +0.04%. But this is the highest m/m increase in Used Cars since 2023
A bigger concern with Used cars is the upward tilt in the overall price level. Remember that the spike during COVID (which happened thanks to the geyser of money that sprayed American consumers who had little else to buy, and few new cars being produced) was a big bellwether and/or driver (mathematically speaking) of the increase in core CPI post COVID. The unwinding of the spike in used cars pushed Core Goods inflation lower and lower, and dragged down Core CPI. But now it looks liked used car prices are again headed higher. This seems a good time to mention that M2 is also inflecting higher. The money supply is 40% bigger than at the end of 2019. Used car prices are only 32% higher. I think the deflation in used cars is over. (I’ve included M2 on this chart.)
AS a consequence of this, and despite apparel being -1.4% m/m (that’s one place tariffs could bite since we don’t produce any apparel in the US…on the other hand, there are lots of suppliers of apparel globally so absent a blanket tariff, we might not see a big effect), Core Goods CPI y/y went to -0.10% from -0.50%. As I’ve noted previously – ad nauseum, probably – to get inflation to 2% you need core goods inflation to stay negative, and pretty decently so. Core Services dipped to 4.3% y/y from 4.4% y/y, but obviously if that part is over 4%, and it’s the bigger part, you need Core Goods to stay flaccid.
- Health Insurance rose +0.74% NSA. Health insurance inflation jumps sometimes in January, so this is not something I’m worried about (plus, the health insurance number is really only calculated once a year and smeared out over the year). But it’s worth noting.
- Lodging Away from Home, +1.43% SA. Normally this is one of those categories that jumps around a lot and so we would expect a reversal next month, but with the wildfires in California I’d expect this to be buoyant for a while even if it is just the Western US being affected. But don’t forget that there are lots of people without homes still in North Carolina. On the other hand, if deportations ramp up a lot more than they currently are this is one place where pressure on prices could be relieved since many illegal aliens are housed in hotels at the expense of the local/state/federal government. That disinflationary effect, though, is months away at best, I think.
- Pharma had a huge month, rising 1.4% m/m SA. That’s the biggest monthly gain in decades. I suspect some of that is because pharmaceutical companies know that they are ‘on the X’ of President Trump’s ire after actively working against him in 2020. The President has recently been talking about how upset he is about US drug prices relative to the same drugs sold in other countries. This is a real threat – in his prior term, he talked about implementing a “Most Favored Nation” clause when it comes to pharmaceuticals (I wrote about it here: https://inflationguy.blog/2020/08/25/drug-prices-and-most-favored-nation-clauses-considerations/ ). So it strikes me as possible that pharmaceutical companies were raising prices in January partly so that they can cut them with great theatrics to show their ‘support’ for the President (and hold off most-favored-nation as long as possible). I do not expect to see this repeated next month, unless tariffs affect APIs (active pharmaceutical ingredients) in the near-term.
- Hospital Services were also high, at +0.95% m/m SA, but this is less unusual for that series which jumps around a lot like Lodging Away from Home. Still, that was the highest print since March.
On the good side – while Rent of Primary Residence was a little higher than last month (+0.35% vs +0.30%), OER was the same (+0.31%) and rents overall continue to decelerate. However, they are decelerating at a declining rate. It looks like the dip that I expected is never going to happen, as the growth rate of rents looks to be converging with our model in the high 3s. And it doesn’t need to be repeated, but I will anyway, that there is no sign of broad deflation in rents coming.
Food and energy were additive this month, although less than I expected. Food at home was +0.46% m/m, and I expected about double that. Eggs were +13.8% m/m (NSA), and +53% y/y, and are getting a lot of press. But that’s not an inflation thing, that’s a lack-of-chickens thing and egg prices will eventually come down (in, approximately, the time it takes a chicken to get to adulthood). Food away from home was relatively tame at +0.24%.
So what’s the big picture?
What we saw today was mostly the trend. I continue to think that the new ‘middle’ on Median CPI is the high 3%s, low 4%s area, with occasional forays above and below that level. Over the course of 2025, as tariffs are implemented, we are likely to see a slightly higher run rate. Tariffs are a one-off, and they aren’t a large effect unless applied in a blanket way to all imports. Remember (and review my recent blog https://inflationguy.blog/2025/01/29/trump-tactical-targeted-tariffs-a-reminder-of-the-impact-of-tariffs/ and podcast https://inflationguy.podbean.com/e/ep-131-how-tariffs-affect-you-three-things-you-maybe-didnt-know/ on the topic) that despite what some hyperventilating Congresspeople say, consumers do not usually pay the majority of a tariff except in narrow circumstances where demand for the good from that particular supplier is inelastic. If the Trump Administration imposes a blanket tariff of 20% on all imports, with no exceptions, it might cause an increase in inflation of 0.5%-1.0%. But that’s a one-time (level) effect unless tariffs keep being ramped higher, and the effect gets smaller the higher the tariff goes (a 1000% tariff will not raise prices any more than a 900% tariff, because at that point we aren’t importing anything). So, all else equal, we should expect slightly higher inflation in 2025 than we previously would have expected, and probably for the first part of 2026, but then the tariff effect will be over and the level of inflation we settle in at will be once again driven mainly by money growth.
On that score the news isn’t great, with M2 rising at a 5.8% annualized rate over the last quarter and 3.9% over the last year. 4% would get us to 1.5%-2% inflation in the long run, probably; 6% will get us into the high 3s, low 4s. Some think that if inflation ends up ratcheting a little higher, the Fed might raise interest rates again. But monetary policy has very little control over inflation that is caused by tariffs and it would make no sense to reverse course for that reason. This just accentuates how bad the box is that the Fed got itself into by making a nakedly political ease in the middle of last year. Tightening because of tariffs has no economic justification; it would look nakedly political again. I would be surprised if overnight rates went higher from here. Of course, I’d also be surprised to see them going lower especially since tariffs are also good for domestic economic growth.
So there will continue to be lots of economic volatility from here, but stasis appears to be high 3s, low 4s. Still.
Inflation Guy’s CPI Summary (December 2024)
It is important – and I say it every year – to remember that when we are looking at economic data from December (and in many data series such as Employment, January as well) there are massive error bars around the numbers. The government doesn’t report error bars, but they should. Frankly, when it comes to Nonfarm Payrolls, I barely glance at the number because it just doesn’t mean very much.
The problem isn’t so dramatic in CPI at the headline index level, because the main sources of volatility in the index also happen to be the ones that provide all of the seasonal adjustments, so we tend to miss estimates roughly as often in December as in other months. As we go through the numbers today, however, you’ll notice a bunch of things swinging one way after swinging the opposite way last month. That’s the sort of thing that can easily be caused by the placement of Thanksgiving, so you can see reversals from November’s number to December’s. I am not saying that everything in the CPI report today is infected by that effect; just keep it in mind.
Now, while I say the ‘problem’ of seasonal volatility isn’t as bad in CPI at the headline level, recognize that December sees the most-severe seasonal adjustment to the headline figure. Here are the seasonal adjustment factors for 2023 (they don’t change much). A number below 1.0 means that the seasonally-adjusted headline number will be higher than the nonseasonally adjusted number, because the seasonal pattern ‘expects’ the weakness, and vice-versa. You can see that December is the month furthest from 1.0. What you can’t see from this chart is that if you want to get technical about it, December is also the only month for which we could really reject the null hypothesis that the adjustment factor is 1.0…in other words, the only month where we are really confident that the effect is to cause the NSA CPI to be lower than the average month. November, maybe.
As an aside, this is why April maturity TIPS tend to have higher yields than January maturities. The January TIPS mature to an index that is an average of October and November CPIs, while April TIPS mature to an index that is an average of January and February CPIs. So April TIPS always get an extra December CPI in them, and if there’s one month you don’t want, it’s December. So April TIPS have to have a slightly higher yield to entice people to hold them.
Right, that’s a big prelude discussion. Summing up: don’t get too excited either way with this number. More important is that the overall market has been selling off. 10-year breakevens have risen 14bps, and 10-year real yields have gone up 26bps. How much of this is because of a fear that inflation is turning, is unclear. But in December, the overall data was pretty close to expectations. Core inflation came in at +0.225% m/m, compared to expectations of +0.25%, which is less dramatic than it looked when rounded and it printed at 0.2% vs expectations of 0.3%. A small miss lower, and to be fair the best core number since July.
Headline was only 0.04% NSA…which gets adjusted to +0.39% when the seasonally-adjusted number is reported. See what I mean? So we look at the y/y numbers, which basically replaces last December with this December (thus neatly avoiding the seasonality issue). Y/Y headline CPI rose from 2.73% to 2.90%, and Y/Y core fell to 3.25% from 3.30%.
You may notice that none of those numbers looks like it’s at 2%. Nor is Median CPI, which was (my estimate) +0.31% m/m, the highest since September. If I’m right about that print then the y/y would drop to 3.86% from 3.89%.
So on the macro side, top-down, this does not look like the sort of data that the Fed was expecting when it started easing in September. Since in my opinion this has been eminently foreseeable for a long time when you looked at what was driving CPI, the conclusion must be either that the Fed is just incompetent when it comes to inflation forecasts, or it doesn’t care about inflation, or the rate cut had nothing to do with economics and was just a political gambit to get Harris elected. None of those answers is flattering. I suspect answers #1 and #3 are the main drivers of the most-recent policy error.
The good news in the inflation figures is that there’s no one major group that still looks alarming.
When we drill down to the monthly data this month…that’s where you see the seasonal volatility. For example:
- Used Cars was expected to be roughly flat. It was +1.2% after +2.0%.
- Rents rebounded; OER and Primary Rents were +0.31% after +0.23% and +0.21% respectively last month.
- Lodging Away from Home was -0.95% this month; it was +3.16% last month.
- Airfares were +3.93% this month; they were +0.37% last month.
- Car and truck rental +0.58% this month; -2.99% last month.
- Baby Food +0.42% this month; -0.12% last month.
- Medicinal Drugs +0.08% this month; -0.10% last month.
- Doctors’ Services was lower, +0.06% vs +0.28% in November; but Hospital Services were higher at +0.23% compared to 0.00%.
A few broader observations. Core Goods and Core Services both continue to move back towards zero: goods from underneath and services from above. CPI for Used Cars is still -3.4% y/y, and I’d expect it to slowly recover from the spike and reversal stemming from COVID. But we now have an extra factor, and that’s the devastating California wildfires. There are two things you see burned out in every picture. Vehicles, for one. Used and New car inflation is going to turn higher, and maybe quite a bit, going forward as people in California need to replace their wheels. Over the medium term, the dollar’s strength would help keep core goods inflation tame and even slightly negative, but thanks to the wildfires we are likely to see core goods back above zero shortly.
And the other thing you see burned out, of course, are houses. Primary Rents have been slowly converging with our model, but rents are going to get goosed in California immediately and that effect will be smeared out because of local laws against ‘price gouging’ that prevent landlords from hiking their rents immediately to the equilibrium level implied by lots more demand and lots less supply. So they’ll hike, but it will take longer. This is mainly a California effect, naturally, but it will be large enough to affect the national numbers.
Incidentally, you’ll also see these in Lodging Away from Home inflation not just in California but in the entire western US. And maybe further, since remote work makes it possible to temporarily relocate almost anywhere. Federal support of the displaced will ensure that is not a 1-month effect. So in shelter, January and February (and beyond) numbers are going to be a lot more important than today’s release.
I am sure that will be used later to argue that “this inflation in 2025 is all due to the wildfires,” but we should remember that inflation in 2024 was (at best) leveling out and possibly hooking higher again. Broad core inflation ex-shelter has now risen four months in a row. It isn’t alarming, at 2.12%, but it isn’t just shelter keeping inflation above target and the story in early 2025 won’t be ‘all about shelter and cars.’ Supercore is also improving, but it isn’t going to pull the overall CPI down to target if Shelter doesn’t keep decelerating and as Core Goods goes back positive.
Supercore is indeed looking better, but we still have wages rising at 4.3% y/y. Remember that wages and supercore are modestly cointegrated. Or, in English, supercore is where wage-driven inflation tends to live. Wage growth needs to soften a lot more in order to get supercore back to target-like levels.
Again, all of this is December and in January we have had a massive natural disaster that will affect inflation data as soon as next month – and for months going forward. This will obfuscate the fact that the Fed already made a second policy error (after the COVID-era error of adding too much liquidity and not pulling it back quickly enough), dropping rates prematurely and letting money growth re-accelerate (M2 y/y is at 3.7%, but annualizing at 4.7% over the last 6 months and 5.8% over the last quarter ended in November). The bottom line is that the December inflation data is just not very important. What happens next…and what is already happening…is the story that will drive inflation and markets in 2025.
(Admin note: I missed doing the CPI Report podcast last month but it will post this month again! In roughly an hour, I suspect).
Inflation Guy’s CPI Summary (November 2024)
(Administrative Note: There will be no podcast today.)
Last month’s CPI had set up an uncomfortable situation for the FOMC, where too-high inflation was colliding with a Fed that had launched too soon into ease mode – for what appears to be mostly political reasons although there is some mild weakness in economic growth. Preemptively attacking slightly soft growth, in a time of frothy markets and CPI that is sticky at a too-high level, might still turn out to be a clever policy move…but that’s a narrow window.
So the Fed would like to see softer CPI, which validates their professed confidence that it is returning to quiescence like an obedient puppy that has been scolded by the wise people in the Eccles building. Wouldn’t we all like that?
There is some cover provided by inflation markets. Before today’s number, here are the most-recent prints taken from the CPI ‘fixings’ market, showing that the market is pricing year-over-year headline inflation to be at 2.14% by April’s print (in May), before rebounding as those quirky low prints from earlier this year are pushed out of the average.
But is that all there is? If headline can only get to 2.1%, briefly, despite soft energy markets, then can the Fed really be very optimistic that core (in the mid-3s) and median (in the low 4s) will show inflation fully tamed? It’s hard to believe. So the Fed has a lot at stake here and needs inflation to keep decelerating. Not just on a y/y basis; the m/m numbers need to start looking better. We have had three straight uncomfortably high core CPI readings in a row after the it-now-seems-like-an-aberration-low blip earlier in the year, and four straight median CPI figures. Consensus before today’s report was for 0.26% on the seasonally-adjusted headline figure and 0.28% on core. Neither of those is what the Fed is really looking for. Worse, they didn’t even get that.
These are not alarmingly high, 0.31% when the market was looking for 0.26% or 0.28%, but keep in mind that our recent benchmark for alarm has been a bit skewed by a period of time when the forecasters were missing by 0.1% and 0.2% on a regular basis! It’s a modest miss. But it’s a modest miss on the wrong side.
Core goods continued to rebound slowly back towards 0%, now -0.6% y/y, while core services slowed further to 4.6% from 4.8%.
The rise in core goods was driven significantly by a second monthly jump in used car prices, +2.72% m/m after +1.99% last month. The lengthy mean reversion of used car inflation is over. That was one big factor keeping core goods prices submerged, and without it (New Car prices were +0.58% m/m also, for what it’s worth) core goods should go back to roughly flat or slightly positive. The strength in the dollar would normally keep core goods from getting too out of hand, but of course if you believe Trump’s tariff threats – and even if you don’t, but figure it implies more nearshoring – then you should expect Core Goods to be positive going forward. Core services has a lot to do with rents, which this month were much lower than last month’s change (0.23% m/m vs 0.40% last month on OER; 0.21% on Primary rents vs 0.30%). The deceleration here continues…although remember that last year we had been promised healthy deflation in rents this year. Never got even close to that.
Now, there is some good news here. Some of the overall miss this month can be traced to a 3.16% m/m rise in Lodging Away from Home. This means that Core Services ex-Shelter (“Supercore”) had a healthy deceleration and that’s good because that’s the sticky stuff. It’s still far too high, though.
Similarly, the more-well-behaved measure of Median CPI was up only 0.255% m/m (my estimate), which brings y/y Median to about 4.04% y/y (was 4.08%). This looks a little better? Anyway the lowest m/m since June!
I don’t want to make too much of this…the fact that Lodging Away from Home was a significant part of the miss doesn’t make this a great number. Nor does the continued deceleration in rents. 0.255% for twelve months would still leave Median CPI over 3%. And the major groups look alarmingly normal without four of the categories above target and four of them below target.
And I guess that leads us to our conclusion. I had said last month that I thought the Fed would find a reason to hold rates steady at this upcoming meeting, rather than continuing to cut. But markets don’t believe that, and market pricing implies a good chance of a further 25bps cut at this month’s meeting. To be fair, Fed speakers have been seeming to guide markets in that direction with expressions of concern about the weakening labor market. But I think there’s something worse than investors starting to be concerned that the Federal Reserve makes policy moves on the basis at least partly of political ideology. After all, that’s at best an every-four-years thing. What would be worse would be for investors to believe that the FOMC is content with inflation above 3%, and willing to focus on employment if there’s even a hint of weakness there. That’s the wrong approach, because employment is cyclical while inflation isn’t. While I don’t believe that ‘inflation expectations anchoring’ is a real thing we should be concerned about, ‘Fed credibility’ is. While inflation was decelerating, the Committee could, with some hand-waving, pretend that it was addressing both inflation and growth and merely getting ahead of the recession. If inflation is hooking higher again, that story will be harder and harder to sustain.
I don’t know that core or median are yet hooking higher. But they’re no longer placidly declining. My guess is that the Fed will pause the rate-cutting campaign shortly, but stop the balance-sheet runoff, and try to play both sides of the net. The game is getting much harder from here.
Inflation Guy’s CPI Summary (October 2024)
I said two months ago that I didn’t think the Fed should ease, but they would anyway. And they did, by cutting overnight rates 50bps. Then last month I said “Getting rates back to neutral, around 4% or so, is not a bad idea as long as quantitative tightening continues. It isn’t the best idea, but it’s not a disaster. But this raises the stakes for the next FOMC meeting… I suspect 25bps is the only choice they can make which will make almost everybody equally unhappy. There’s more data to come before that meeting, but the FOMC’s path has narrowed considerably as inflation remains sticky.” And the Fed, on cue, cut rates 25bps.
But the Fed is getting into an uncomfortable position now, because inflation looks like it has leveled off. As I have said for a while it likely would.
We will get to that. First let’s look at the number.
The economists’ consensus has been drifting higher in recent days, as data on used cars was suggesting that component would be an add in October. Consensus going in was for +0.21% headline (SA) and +0.28% on core. The actual numbers were +0.24%/+0.28%, so pretty close to the consensus with y/y headline inflation at 2.58% and y/y core at 3.30%. It doesn’t seem to me, though, that the chart of core CPI for the last year is particularly soothing. More and more it appears that May-June-July were the outliers, and we are hanging out around 0.3% per month on core inflation.
Also, my early estimate for median inflation is 0.296% m/m, leaving y/y basically unchanged at 4.09%.
Used Cars was indeed high, at +2.7% m/m. But the real problem with Used Cars isn’t this month. The real problem is that for two and a half years Used Cars has provided steady disinflation as the COVID spike (caused because new cars were not being produced as quickly thanks to supply chain problems, but the deluge of money meant that people had lots to spend and wanted cars dammit) ebbed…but that game appears to be about over.
So if you want to get inflation lower from here, it’s going to be a challenge to get it from core goods, which was steady y/y at -1% this month but only because Apparel had a large decline. Core goods is likely to head back to small deflation or small inflation (with the dollar’s recent strength, small deflation is the better guess), but higher from here. We have known this for a while. The heavy lifting is going to have to come from shelter, or supercore, going forward.
So as for shelter…OER was +0.33% m/m in September but +0.40% m/m in October. Primary Rents were +0.28% last month and +0.30% this month. The y/y disinflation is continuing, but still no sign of the hard deflation we were promised.
The good news here for 2025 is that if Trump’s plan for mass deportations happens, and if “mass” means millions, then some of the pressure on shelter that developed over the last few years as ten million additional heads needed roofs over them will abate. Then maybe we can get shelter inflation lower. There is a modest additional “if” part, though, and that is “if landlord costs can stop increasing.” Our bottom-up landlord-cost-driven model has primary rents eventually converging just south of 4%. Better, but still not great.
So that leaves supercore, which unfortunately ticked higher this month.
The problem there also remains the same. Stop me if you’ve heard this one, but wages are moving only slowly downward, and supercore is where the wage/price feedback is the strongest. The red line below is Bloomberg’s calculation of supercore and the other line is the Atlanta Fed wage growth tracker. And the problem is that median wages don’t tend to move drastically differently than median inflation, which as we have discussed is proving sticky.
If core goods is no longer declining, and shelter isn’t doing the heavy lifting of deflation, and if core-services-ex-shelter (supercore) is leveling off…then gosh, that looks a lot like high-3s-low-4s village.
As an aside: I have been saying ‘high 3s, low 4s’ would be where inflation settles in…and I’ve been saying that for a couple of years. Even I am a little amazed that I haven’t had to tweak that forecast much, other than to allow that we might briefly dip below that if housing followed the dip-and-bounce that our model had. I don’t want to put on false humility, because I was saying that inflation would stay sticky and too high long before anyone else was saying that, and I had the correct reasons and I think I’ve guided readers and clients well. But getting the landing spot right, that far in advance, also clearly involved some luck. I am saying that partly to keep the Fates on my side. But you should also know that someday, it might turn out that ‘high 3s, low 4s’ needs to be adjusted. And I’ll still consider this a pretty good call!
The Fed’s actions can clearly affect that eventual equilibrium level, but it doesn’t look like they are yet taking this seriously. The game isn’t over and there will be more CPI reports and more after that. But for now, this looks like a policy error – or worse, a blatant attempt to influence the election – and unless something unexpected happens with prices it looks like the Fed is going to have to choose between the right policy move (which means continuing tight policy) that appears to be political, or continuing to loosen policy so as to not appear to be political, and temporarily surrendering on inflation. I suspect that the FOMC will vote to keep rates steady at the next meeting.
By the way, if you care about the crypto space at all and haven’t read my column on stablecoins, you should, and you should be sure to circulate it. The column is here.
Inflation Guy’s CPI Summary (September 2024)
I already have my title for today’s CPI Report podcast (you can find all of my podcasts at https://inflationguy.podbean.com/ ). I’m going to call it ‘Inflation Peek-a-Boo.’ With today’s number being definitely on the ‘boo’ part of things.
First, a review: last month, August’s report missed higher. But the miss was mostly due to the quirky jump in Owners’ Equivalent Rent. Outside of that, CPI had been okay – not great, but moving in the right direction. The Fed eased 50bps anyway (at the time I said the miss in CPI wouldn’t deter that), setting up what will be the headlines for the next week now. Because of the strength in the Employment report, some people were already questioning whether the Federal Reserve made a policy error in starting to move rates back towards neutral so quickly. But as long as inflation was heading back to their target, neutral would still make sense even if the jobs market wasn’t weakening (as it still looks like it is, outside of government spending). The questions now get a little more pointed because today’s CPI miss higher was not due to a one-off.
The consensus of economists coming into today was for a +0.10% rise in the seasonally-adjusted CPI. Now, energy this month was expected to be about a -0.17% drag on the number (it turned out to be 13bps rather than 17bps), so this low m/m print was scheduled to be mostly due to last month’s slide in energy prices. Still, decent optics especially with the last CPI we’ll see before the election. Economists saw +0.24% m/m on core. The actual figures were +0.18% m/m on headline CPI and +0.31% m/m on core CPI. This is unfortunate, because the y/y Core CPI number rose, instead of being flat, to +3.26% y/y. Moreover, the overall shape of the monthlies…well…see for yourself.
We have to be careful about the cognitive bias that makes us see stories and trends where there aren’t any, which is why it’s so very important to not focus on one month’s number. Or two. But if you look at this chart, it sure looks like the outlier might not be August and September, but May and June. Doesn’t it?
Ditto that for the Median CPI (last point estimated by me at +0.33% m/m).
Again, it could be a cognitive error but this sure looks like we’re pretty steady around 0.3%. If sustained, that would be in the ‘high 3s’, and it is time for my monthly reminder that I think median inflation will settle in the ‘high 3s, low 4s’ although it could dip into the low 3s first. (It’s looking more and more like the dip into the low 3s may not happen, as we get further along in the adjustment of rents.)
So where did this high miss come from? It wasn’t from OER and Primary Rents, which were back into their slowly-declining mode. OER was +0.33% m/m, and Primary Rents +0.28% m/m. Year over year, Primary Rents are down to +4.8% y/y. My model has them eventually ending up around 3.8%, after dipping lower. But they should be dipping right now, and they’re not. They may simply be converging on that 3.8%ish level.
But here’s an interesting chart. Remember how I have been saying for a long time that a good part of the overall deceleration in inflation had come from Core Goods, which would not continue to plumb new deflationary depths? This month, Core Goods was only -1.0% y/y, versus -1.9% y/y the last time we got these numbers.
Now, that doesn’t look wildly inflationary but if core goods inflation goes merely back to flat, then core services needs to do a lot more heavy lifting. Core Services did drop to 4.7% y/y from 4.9% y/y. But flat on core goods and 4.5% on core services wouldn’t get us back to the Fed’s target. Not even close.
In the core goods category, there were rises in Used Cars (+0.3% m/m) and New Cars and Trucks (+0.15% m/m), but nothing terribly out-of-the ordinary. Similarly, in core services there wasn’t much out-of-the ordinary. The problem is, ‘ordinary’ looks like it’s not at the Fed’s target. Medical Care Services were higher, with Doctor’s Services +0.9% m/m and Hospital Services +0.57% m/m. Airfares rose +3.16% after +3.86% last month. Motor vehicle insurance continues to rise, +1% m/m, with the only good news being that the y/y figure on insurance is now down to ‘only’ +16%. But +1% per month still is a rate above 12% per year – not too exciting.
Car and truck rental was also +1.2% m/m. So, in transportation outside of the cost of energy itself, it was a rough month (but that’s what happens, I guess, when you try and force people to buy electric cars when they don’t want them). But it wasn’t just transportation goods and services, either. This is the time of year when the jump in college tuitions happens. And it looks like the jump in tuitions this year is the largest since 2018. The seasonally-adjusted numbers will smooth this out, but that means tuition is going to be adding a little more over the next 12 months than it added over the last 12 months.
This is also somewhat surprising. Normally, when asset markets are going gangbusters we tend to see smaller increases in tuition because endowments are doing well and the financial model for colleges is basically (exogenous cost increases we don’t really try to control, minus endowment contributions or federal support, divided by number of students). If markets are doing well and college tuitions are still accelerating, it implies an increase in costs. My guess is that insurance is part of that, but so will be teachers’ salaries. Provision of education is ‘labor intensive,’ and wages continue to refuse to slip back down to the old levels. This is also the reason that Food-Away-From-Home was +0.34% m/m and continues to hang out around +4% per year.
And, as a result of wages refusing to moderate, ‘supercore’ (core services ex-shelter) also continues to refuse to slip back to the old levels.
The bottom line is that this number is not high because of any weird one-offs. In the same way that last month’s number was generally okay in a balanced way, outside of rents, this month’s number is generally less pleasant, in a balanced way. I don’t think we are at the start of another spike higher in prices. But we continue to aim for ‘high 3s, low 4s.’
And this will be an unfortunate story for the Fed as they will be peppered with questions about a potential policy error. I will repeat here what I said last month:
“To be clear, I personally do not think the FOMC should stop quantitative tightening and there’s no hurry to cut rates. The fight against inflation is not only unfinished, it won’t be finished for quite a while…and an ease now will just make it harder later. But that’s what I would do. What I am saying is that the Fed is not likely to change course on the basis of this number.” As expected, the Fed did cut rates 50bps. I am not sure this is necessarily a terrible policy error, although starting with 50bps now looks like an obvious mistake. Getting rates back to neutral, around 4% or so, is not a bad idea as long as quantitative tightening continues. It isn’t the best idea, but it’s not a disaster. But this raises the stakes for the next FOMC meeting. If the Fed skips the meeting, it will be a tacit admission that the first move was a mistake. If the Fed piles on another 50bps, it will show they are terrified about growth or simply don’t care about inflation. I suspect 25bps is the only choice they can make which will make almost everybody equally unhappy. There’s more data to come before that meeting, but the FOMC’s path has narrowed considerably as inflation remains sticky.
