Inflation Pops in the US - Or Did It?

The Consumer Price Index (CPI) measures the average change over time in the prices paid by urban consumers for a market basket of consumer goods. And while the PCE (Personal Consumption Expenditure) is the Fed’s preferred measure of inflation, the CPI is the more well-known.

Besides being used by the Fed for monetary policy decisions, the CPI sets the Cost-of-Living Adjustment for Social Security payments going to over 60 million Americans, along with adjustments in labor contracts and private pensions for tens of millions more. It also sets the interest rate for half a trillion dollars of Inflation-Protected Treasury Bonds.

The CPI released for May was the highest in 13 years.

Consumers are returning to normalcy after the lockdowns and social restrictions of the pandemic, and a pickup in this data is expected. Between supply-side constraints and pent-up demand, prices for big-ticket items such as vehicles are rising sharply. Prices for used cars and trucks jumped 7.3% from April, driving one-third of the rise in the overall index. Indexes for furniture, airline fares and apparel also rose sharply in May.

Is the data as bad as it seems? The last time the CPI saw that kind of jump was in 2008 when oil prices pushed the index higher. However, the current number is being compared to the pandemic-related lockdown last year, and the numbers are, well, inflated. This distortion, referred to as the "base effect" takes into account the extremely low data from last year. This is expected to push up inflation readings significantly in May and June, and dwindle back starting in the fall.

Instead, if we compare the CPI from two years ago, overall prices rose just 2.5% in May and suggest that the current rise is due to transitory issues, as the Fed has indicated. However, outside of larger ticket items, food prices are seeing sharp jumps due to rising labor, commodity and transportation costs.

So which is the correct dialogue? Is inflation a real issue that the Fed needs to deal with, or is it transitory? While the print was higher than most consensus expectations, it had no noticeable effect on markets as stocks continued their upward trajectory.