Chart of the Week : Dissecting the inflation puzzle

Click here to download this week's full edition of Macro Chartmania.

One of the most intriguing themes in the macro space in COVID-19 times is the evolution of inflation. The unexpected jump in U.S. inflation in August reinforced fears that inflation could derail in the medium- or long-term due to extremely accommodating monetary policies. The August CPI rose by 0.4%, reaching 1,3% while the core CPI, which excludes food and energy costs, increased by 0.4% to 1.7%. What is probably the most significant is that the median CPI calculated by the Cleveland Fed, which is usually considered as a better signal of underlying inflation trend, was also up, with a jump of 0.3%, at 2.7%. Higher inflation has been heavily concentrated in a few categories, especially in sewing machines and supplies (+15% on a monthly basis) while persistent downward pressure from housing and intracity mass transit has remained. However, it would be premature to see in this recent jump the indication that inflation is about to overshoot. What we have learnt over the past months is the pandemic creates a lot of data noise, especially due to habits shift in consumption. This also applies to inflation figures. For the time being, we don’t think that the evolution of underlying inflation can be properly measured and weighted in CPI. We better refer to CPI only as a way to capture what the pandemic has done in terms of changing consumer behavior. This is particularly salient when looking at change in durable consumption versus service consumption. For instance, we ate much more at home and spent less on transportation and eating out in these unusual circumstances while at the same time we have seen food prices jumping quite a lot for some items at the supermarket. Another reason not to worry much about rising inflation, at least for the moment, is that inflation expectations remain well-anchored. Expectations are standing at 1.9% in one year, only 2.1% in 10 years and the widely-watched five year, five year forward is at 1.9% (see below chart). We are not saying that there is no case for inflation overshooting in the long run but, at the present time, neither inflation figures nor forward looking market statistics confirm that the inflation trend is about to enter risk-zone territory.