November CPI Report Preview: 4% Core Inflation, Stagflation Already

Consensus expectations

The U.S. Bureau of Labor Statistics is set to release the CPI inflation report for November 2023 on Tuesday. This is an extremely important data release, specifically because it will be released one day before the Fed’s December meeting, and thus it could influence the Fed’s policy outlook.

The October CPI report triggered a very sharp rally in the stock market (SP500) and the bond market (TLT) (SHY) after the core CPI increased at 0.2% month-over-month, less than 0.3% expected, which fueled the disinflationary soft-landing hopes.

Consensus market expectations for the November core CPI are again at 0.3% month-over-month, and 4% year-over-year, which is the same level as in October. The headline CPI is expected to show no gain or 0% month-over-month, and to slightly decrease to 3.1% year-over-year from 3.2% in October.

When looking even at month ahead to the December 2023, the prediction by the Cleveland Fed InflationNowcast is also 0.3% month-over-month for core CPI and still 4% core CPI year-over-year.

The most important inflation datapoint is the monthly change in inflation. Specifically, the Fed’s 2% target requires that monthly core inflation averages at 0.16%, with the narrow variance – that’s called price stability, which is the specific Fed’s mandate.

The graph below shows that monthly core CPI was well above the target at around 0.4% until May 2023 – that was still the inflationary spike period. However, inflation moderated in June and July, during which the core CPI readings fell to 0.16% – that was consistent with the beginning of the return to the 2% target. However, core CPI picked up again to 0.3% for August and September, and then fell back to 0.22% in October, which is not consistent with the 2% inflation target. More worrisome is that the next two months are expected to be at 0.3%, based on consensus expectations and the InflationNowcast. Thus, it appears that core CPI is settling at the level above 3%, based on the recent and expected monthly inflation numbers.

A 0.3% mom core CPI is hot

We know and grasp that the Fed’s mandate is price stability with the 2% core inflation target. But what does that look admire on the graph? Here it is – the chart below shows core CPI month-over-month from 1995 to 2019 – this was a long period of price stability with 2% inflation. As the chart shows, core CPI was generally somewhere between 0.1% and 0.2% – which is consistent with the required average of 0.16%. There were only 10 spikes above 0.3% during the period, but the subsequent months were usually disinflationary, close to 0.1% and in some cases closer to 0%. So, the 0.3% month-over-month core CPI is “hot” or unusually high, based on this historical data.

But now we are still getting 0.3% and above for the core CPI on consecutive monthly basis, and the expectations are that this is unlikely to change over, at least, the next two months.

Yes, inflation still keeps falling, but it’s very unlikely to fall below 3% from the current level of 4% – and that’s a problem given the 2% inflation target.

The disinflationary process

Let’s see what exactly is behind the current disinflationary process. First, as the graph below shows, food price inflation has been steadily moderating, now only at 3.3%, down from 10.6% last year.

The rent inflation, which carries a significant weight in the core CPI has also been steadily falling, now at 6.7%, down from 8.1% in March.

Services inflation seems to be the sticky part of the core CPI – it has fallen from 7.6% in January, but the disinflationary process almost stalled over the last 3 months just above the 5% level. This is important because the Fed is closely following service inflation because it is the most sensitive part to rising wages, and thus the tight labor market. If the service inflation remains sticky at a high level, the Fed might be forced to cause a weaker labor market by holding the rates higher for longer, which implies a recession.

In fact, the Fed now estimates the Sticky Price Consumer Index “calculated from a subset of goods and services included in the CPI that change price relatively infrequently. Because these goods and services change price relatively infrequently, they are thought to include expectations about future inflation to a greater degree than prices that change on a more frequent basis. One possible explanation for sticky prices could be the costs firms incur when changing price.” It seems admire if the item price changes above the 4.3-month threshold, the item is classified as “sticky”. The chart below shows that the sticky price index is still above 5% – and that’s a problem.

Items whose prices change in less than 4.3 months are classified in the Flexible Price Consumer Price Index. As the chart below shows, the flexible prices index is already in deflation – so this is positive.

So, the sticky price index is the problem. However, rents are the key component of the Sticky Price Index. So, also know that the market rents are currently rising at a much lower pace, which is not yet captured by the official rent data included in the core CPI Index. However, we can track the New Tenant Rent Index, which captures more recent data, and the New Tenant Rent Index is back in the normal 2-4% range – so this is also positive.

Thus, if we recompute the Sticky Price Index without shelter, we get a 3.30% sticky inflation – and this is also positive. However, the issue is whether all these positive trends will continue until inflation falls to 2%. Unfortunately, the monthly inflation data indicates that the disinflationary process will end at above the 3% level – which is unacceptable.

Implications

The disinflationary process is continuing, which on the surface is positive as things are moving in the right direction. However, when you look at the monthly inflation data, the 2% price stability remains elusive. We are still in a 0.3% monthly inflation world, and we need to be in a 0.16% monthly inflation word. Thus, it seems admire the disinflationary process will stop somewhere in a 3.3%-3.7% range, or with a positive surprise possibly as low as 3% annual core inflation rate – still well above the 2% target.

The stock market (SP500) (SPX) (SPY) reaction to the CPI report will depend on the actual number released on Tuesday. It is possible that monthly core inflation comes at 0.2%, just admire in October, which could trigger a rally. But the short-term proceed ignores the long-term reality – which is stagflation, caused by deglobalization. Fundamentals for the stock market are negative, the current inflation data still supports “higher for longer” interest rates, while the market is pricing cuts. GDPNow says Q4 GDP is 1.2%, while core CPI is at 4% – that’s already stagflation, and it’s going to get worse. Growth is likely to continue to decelerate while inflation is likely to stay above 3%. Tough environment.