US CPI inflation: Expect 2.5% jump in March!

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January’s ISM PMI price indices for both manufacturing and non-manufacturing have risen to their highest levels since August 2008.

Sources: ISM; Plexus Asset Management.

It is evident that energy prices as measured by the absolute change in oil prices from a year ago are the main driver of the surge in the Price PMIs. I weighted the Price PMIs of manufacturing and non-manufacturing on a GDP basis.

Sources: ISM; Plexus Asset Management; I-Net Bridge.

The strong rise in the GDP-weighted PMI is likely to force the CPI year-on-year inflation rate higher and by the looks of it the inflation rate could soon jump to 4%.

Sources: ISM; Plexus Asset Management; I-Net Bridge.

But will it? It is evident that since January 2009 there have been significant diversions between the two time series that could be explained by an aggressive reduction in inventories, especially in 2009, leading to downward pressure on prices.

In my opinion the oil price and especially the absolute change from a year ago is by far the superior indicator of the underlying CPI inflation rate.

Sources: Plexus Asset Management; I-Net Bridge.

Yes, but what about the divergence that has been evident since October 2009? Initially it also puzzled me but I found that the main reason for the divergence is the housing CPI. The answer probably lies in the extremely weak housing sector and shelter in particular. The former’s weight in the CPI is 42% (rounded off), while that of shelter is 32.3%.

Sources: Bureau of Labor; Plexus Asset Management; I-Net Bridge.

To get a rough guide of US CPI inflation excluding shelter I merely subtracted the weighted shelter PMI and reweighted the residual by dividing by (100% minus shelter’s weight of 32.3%). The year-on-year change in the oil price explains the US inflation rate excluding shelter perfectly!

Sources: Bureau of Labor; Plexus Asset Management; I-Net Bridge.

What does this mean? It tells me that given the current oil price (light Louisiana Sweet) I can expect an ex-shelter CPI inflation rate of approximately 3.5% in March if the current oil price holds through end February. Furthermore, it is evident that the numbers for January and February could be approximately 2.5% and 3% respectively compared to my calculated 2.0% for December last year.

Although shelter’s CPI change on a year-ago basis turned positive in December (+0.44%), I expect it to remain at that level for the time being. January’s CPI (to be published on around 18 February) can therefore be expected to be approximately 1.8% – significantly higher than December’s 1.39%. The numbers for February and March could come in at 2.2% and 2.5% respectively. Much in line with what is expected in the bond market as measured by the yield gap between 10-year government bonds and 10-year inflation-indexed bonds.

Sources: ISM; FRED; Plexus Asset Management.

Sources: FRED; Plexus; I-Net Bridge.

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