The Consumer Price Index (CPI) fell 0.2% in May, which was a greater decline than the 0.1% decline expected and the 0.1% decline in April. Year over year, headline inflation is up 2.0%, but almost all of that came in 2009, not in 2010. Over the last three months, the CPI is falling at an annualized rate of 0.7%, and over the last six months it is rising at a rate of just 0.3%.
Much of the recent weakness in the headline CPI is due to energy prices, but then again they were the source of most of the inflation earlier. Energy prices fell 2.9% in May following a 1.4% decline in April, but are up 14.7% year over year. However, over the last three months energy prices are falling at an annualized rate of 16.2% and are down at a rate of 2.8% over the last six months.
Even within Energy, the big moves have been in just energy commodities like gasoline, and not in energy services, like electricity. Energy commodities prices plunged 4.8% in May on top of a 2.1% decline in April and a 1.0% decline in March, but are still up 27.0% year over year. Energy service prices have been down 0.5% in each of the last two months and are up just 1.1% year over year. Food prices have been relatively well behaved, unchanged in May and up 0.7% year over year, although in both the last three and six months, they are up at a 1.8% annual rate.
Because food and energy prices can be very volatile, they complicate matters for using inflation to guide monetary policy. That is why core inflation — or inflation excluding food and energy — is important, not because food and energy are not things that people need to buy. Core inflation rose by 0.1% in May after two months of being unchanged. It is up just 0.9% year over year, and over the last three to six months, the annual rate does not even round up to 0.1%.
Cost of Housing Weighing Down
One of the most important factors in holding down inflation is the cost of housing, which makes up over 31% of the overall index and over 40% of the core CPI. The biggest part of that is owners equivalent rent (OER), which is what you would pay if you were renting the home you own to yourself. OER has been unchanged in each of the last two months after a 0.1% decline in March, and is down 0.3% year over year. Regular rent, which tenants pay to landlords, has also been unchanged over the last two months and is down 0.1% over the last year.
High vacancy rates are keeping rental rates down. That is a pretty nasty double whammy for the apartment-oriented REITs like Equity Residential (EQR) and Apartment Investors (AIV).
Where Does Inflation Exist?
Just about the only area showing any significant inflation is in the price of used cars. They rose 0.6% in May and are up 16.2% from a year ago. But even there the upward momentum is slowing, up at a 11.7% rate over the last six months and at a 5.0% rate over the last three months.
New cars, on the other hand, were up just 0.1% in May and are up just 1.9% year over year. The relatively slow rise in new car prices should put a cap on the rate of increase in used cars, unless people are starting to think that it is better to drive around in a 2003 Ford (F) Taurus than in a 2010 Ford Fusion. Somehow I doubt that is the case.
The other area showing robust price increases is tobacco, where prices rose 1.3% in May and are up 7.8% year over year. In part, that is good news for the likes of Altria (MO), but some of that increase is due to higher taxes.
Health care inflation continues to run hotter than overall inflation, but in a historical perspective is also relatively well behaved. Medical commodities (i.e. drugs) were up 0.1% in May and up 3.4% year over year, while Medical services (i.e. office visits) were unchanged in May and are up 3.4% over the last year.
Inflation Clearly Not a Problem
People, especially policy makers, should just get it through their thick skulls that inflation is not a problem. The overwhelming problem in the economy right now is that it is running too cold, not too hot. The advice that some have had — including influential people like Kansas City Fed Chief Tom Hoening suggesting that the Fed should raise rates soon — is not just bad, it is downright dangerous.
There is more danger of the economy tipping into deflation than there is of runaway inflation. If anything, the Fed should be taking more moves to loosen up monetary policy, not tighten it. However, with the Fed funds rate already at zero, the Fed would have to resort to unconventional means to loosen things further. The most direct means would be to simply turn on the printing presses. Well, not so much literally, but to buy longer term T-notes, which sort of amounts to the same thing.
The other way to provide more stimulus to the economy — which is what it needs given the high rate of unemployment and the low rate of capacity utilization — is to have more fiscal stimulus. While that would require the deficit to go higher, it would have relatively little impact on the long-term picture.
If the economy continues to be weak, then so will tax revenues. As it is, weak tax revenues are the major cause of the current budget deficit. In the first quarter, Federal tax receipts were running at just 15.76% of GDP, up from a low of 15.36% in the second quarter of 2009. The long-term average since 1947 is 18.04%.
Prior to 2009, federal tax receipts have been below current levels as a share of GDP in only 8 quarters since 1947, and just once since 1950. Those who claim that the Federal government is choking the economy with overly high taxes should actually look at some data sometime rather than just repeat what is said at a local Tea Party meeting.
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