Why Inflation Should be Here Today
Demand-pull inflation – too much money spent chasing too few goods – should be present by now.
An increase in payrolls means more wages. More wages means more retail spending. All three are currently accelerating.
Inflation is not feeling the effects. Consumers are leveraging up a bit more, spending a lot more on credit cards, but inflation remains tame.
[See Also: Why "Missed Expectations" Are Not What They Seem]
Deflation in Goods, Inflation in Services
Looking closer at Core CPI, there’s clear deflation in goods (clothes, cars, etc.). The 12-month average is -0.8%. These are strongly price-elastic commodities and face global competition, which is only heating up. We have entered an extended period of oversupply. Europe is almost recessionary and slowing growth has hit Japan and China. In an effort to boost exports, they are exporting deflation by cheapening their currencies relative to the dollar, thereby making their goods cheaper in dollar terms.
Meanwhile, services inflation is shooting higher (airline fees, rent, etc.). The 12-month average is 2.5%. These are relatively inelastic and face minimal global competition. Airlines are raising fees because they can. Demand is strong (seat vacancies are low thanks to strong demand and constrained supply) and there is no competition. Lufthansa and Japan Airlines can’t come in and offer tickets to Joe Sixpack looking to fly from Chicago to Houston.
The Euro Determines U.S. Forward Inflation
Connecting all the dots, a global slowdown is underway.
- Germany’s January exports dropped the most in five months (-2.1%) and is flat Y/Y, despite a steady drop in the Euro (-12% in January). That’s flagging Chinese import demand. This is a trend, not caused by temporary factors like the weather or Chinese New Year. December exports were also revised down.
- Japan’s 4Q GDP revised down from 2.2% to 1.5%, and that’s after a 6% decline in the value of the yen.
- China official growth targets were lowered to 7% from 7.4%. Of course, with the massive debt overhang, domestic spending will be under pressure.
No wonder 20+ major countries have cut interest rates, with China being the latest.
Meanwhile currency devaluation is springing up everywhere. For example, the PBOC in China cut the bottom range for the yuan. Also, the ECB just started its version of QE.
The stronger dollar is driving deflation in all commodities. Here’s an example showing deflation in gas.
If the Fed is watching Core CPI, then it is watching the commodities deflation portion. The key to that deflation is global currency deflation. It’s really hard to picture inflation picking up in a few months given that the Euro devaluation has only just begun.