This article is part of Wellesley Hills Financial’s Market Movements series, found in our weekly newsletter.
The U.S. Bureau of Labor Statistics released Consumer Price Index (CPI) data on Wednesday, confirming everyone’s suspicions surrounding inflation. Year-Over-Year CPI growth for the month of April rose 4.2%, the largest increase since 2008; however, inflation data is often misleading. While discussing inflation, it is important to keep two key principles in mind:
1) Inflation Happens In Segments
2) Year-Over-Year Metrics Are Susceptible To Base Effect
Inflation Happens In Segments
The Consumer Price Index measures inflation by monitoring price changes within a basket of consumer goods & services, such as food, energy, clothing, transportation, and shelter. While a headline of 4.2% inflation may be eye-catching, when looking at which goods and services were actually impacted, the headline is less meaningful. The highest levels of inflation were witnessed within: 1) the ‘Energy’ Segment, which was up 25.1% over April 2020, largely due to shifts in gasoline demand; and 2) the Used Cars & Trucks Segment, which was up 21.0% from April 2020 in response to the ongoing chip shortage. Goods and services such as food, shelter, apparel, and medical care services all experienced year-over-year increases between 1.9% and 2.4%, right in line with target inflation.
Year-Over-Year Metrics Are Susceptible to Base Effect
The Base Effect comes into play when the initial reference period, in this case April 2020, experiences higher or lower inflation than typically seen. While Energy Prices may be up 25.1% from April 2020, it is important to remember that in April 2020, energy prices were down 17.7% from April 2019. If we look at April 2021 energy prices relative to April 2019 energy prices, over the past 2-years prices have increased at an annual rate of 1.4%. This principle applies to the inflation data at large as well. Total inflation, as measured by the CPI, has only increased at an annual rate of 2.2% since 2019, which is within earshot of the Federal Reserve’s target of 2%.
While the April CPI headline was higher than expected, there are still no indications that the inflation being experienced is anything more than transient. April 2021 unemployment data (6.1%) reflected a slight increase from March 2021 (6.0%), which lessens the likelihood of demand driven inflation in the near term. The Colonial Pipeline Hacking and the irrational hoarding response, in conjunction with the Base Effect, will likely cause May CPI data to make headlines again and then increases in travel and dining prices will likely carry us through summer, but the data has yet to indicate any structural issues with long-term implications. With that being said, the danger of inflation is that it is often self-fulfilling and escalating. If people behave as if inflation is about to occur, it most certainly will.
