Prieur du Plessis is the author of the Investment Postcards blog - subscribe here.
The US consumer price index rose significantly to 3.44% in May from a year ago and 0.2% from its April level. The increase was bang on target with my estimate. However, I believe that May’s figure on a year-ago basis approached a plateau in the current cycle.
My analysis indicates that changes in the CPI inflation rate on a year-ago basis and especially CPI ex shelter are explained by changes in the oil price compared to a year ago. It is particularly evident since the end of 2006 where more than 94% of the direction of the CPI ex shelter is explained by the year-on-year absolute change in the price of crude oil.
Sources: I-Net Bridge; Plexus Asset Management.
Shelter’s weight of approximately 32.3% in the CPI and the one-month lag between the change in the oil price and CPI ex shelter inflation enables me to make a reasonably accurate forecast. The change in the oil price is a known factor while the only unknown factor is the CPI shelter CPI. But with a more stable trend the CPI shelter CPI inflation rate that can be expected is fairly reasonably assumed.
Sources: Bureau of Labor; Plexus Asset Management.
The year-on-year change in Light Louisiana Sweet crude in May was .53 per barrel. The historical relationship between the change in the Light Louisiana Sweet crude and the CPI ex shelter inflation rate points to a year-on-year CPI ex shelter inflation rate of 4.77% in June given the said lag. That makes up 67.7% of the overall CPI inflation rate (overall CPI minus the 32.3% weight of the shelter CPI) and will therefore be 3.23%. If I assume a year-on-year change of 1% in the shelter CPI, May’s total CPI will add up as follows:
(67.7% of 4.77%) plus (32.3% of 1%) = 3.23% plus 0.32% = 3.55%.
The 3.55% inflation rate means that the consumer price index will drop by 0.1% in June. The first decline since June last year!
But where is CPI inflation heading?
Without taking a stab at where the oil price is heading, I looked at three scenarios where the price per barrel of Louisiana Sweet crude was kept constant at 0, 5 (current) and 0 respectively for the next 12 months. The monthly oil price was then compared to the price a year ago and depicted against the CPI ex shelter inflation rate lagged by one month.
Sources: Bureau of Labor; I-Net; Plexus Asset Management.
By applying the historical regression equation the trend of future CPI ex shelter year-on-year inflation is as follows:
Sources: Bureau of Labor; I-Net; Plexus Asset Management.
Assuming that the year-on-year inflation rate for shelter remains steady at 1.0%, the outlook for the overall CPI inflation rate is as follows:
Sources: Bureau of Labor; I-Net; Plexus Asset Management.
| Year-on-year CPI inflation Rate % | |||
| @ constant 5/barrel | @ constant 0/barrel | @ constant 0/barrel | |
| May-11 | 3.44 (actual) | ||
| Jun-11 | 3.55 | 3.55 | 3.55 |
| Jul-11 | 3.32 | 4.03 | 2.61 |
| Aug-11 | 3.15 | 3.86 | 2.44 |
| Sep-11 | 3.44 | 4.15 | 2.73 |
| Oct-11 | 3.01 | 3.72 | 2.30 |
| Nov-11 | 3.02 | 3.73 | 2.31 |
| Dec-11 | 2.85 | 3.56 | 2.14 |
| Jan-12 | 2.51 | 3.22 | 1.80 |
| Feb-12 | 2.11 | 2.82 | 1.40 |
| Mar-12 | 1.55 | 2.26 | 0.84 |
| Apr-12 | 1.35 | 2.06 | 0.64 |
Sources: Bureau of Labor; I-Net; Plexus Asset Management.
It is evident in the above that the US CPI inflation rate is likely to peak at 3.55% in June if the oil price maintains its current level or weaken. Even if the oil price spikes to 0 per barrel and maintains that level, the inflation rate will still top out in July this year. There may be a short further spike in September owing to a brief drop in the oil price in August last year.
