Inflation: Not Done Yet?

The big story for the remainder of 2023 will likely be inflation. Fed Chairman Powell intentionally avoided the implications underlying words like “pause” or “skip” when he said the Fed would “make our decisions meeting by meeting, based on the totality of incoming data.” Let’s look at a structural element that will influence the upcoming inflation data.

June’s Consumer Price Index (CPI) likely will continue this year’s underlying trend of lower inflation… hurrah! But, mid-year is likely to be the inflection point toward higher inflation reports into year-end. Those calls are far from certain, yet recent history significantly drives the future.

CPI inflation is reported on a year-over-year basis as a percentage increase (or decrease). The percentage change is based on the CPI Index, which is a cumulative measure of price inflation expressed as a number with three decimal places.

For example, May’s CPI Index of 304.127 is divided by May 2022’s CPI Index of 292.296 to calculate an annual inflation percentage rate presented with one decimal place (i.e., 4.0%).

Thus, the “annual inflation rate” for each month is the percentage increase of this year’s CPI Index over last year’s CPI Index for each respective month of the year. As a result, the value last year significantly influences this year’s percentage!

The blue line in this graph reflects the index value for each month of 2022. The solid red line reflects the five reports thus far in 2023 (through May 2023). As the gap between the lines narrowed over the past five months, the rate of increase narrowed (i.e., decreased), providing the declining annual inflation rate reflected by the solid green line (i.e., from 6.4% to 4.0%).

However, the second half of 2022 experienced a stall for the CPI Index. Nonetheless, inflation remained high across 2022 because of the relatively low CPI Index for each respective month of 2021. The STALL in 2022 set the stage for this year’s increase.

If each month’s inflation rate through year-end 2023 proceeds at an annualized 3% rate (as reflected by the dashed red line), the resulting increase in each month’s index will drive an increasing annual inflation rate over last year’s stalled level (i.e., the green dashed line). Note the widening of the expected gap for the next six months between this year’s and last year’s CPI Index.

A constant 0.247% monthly inflation rate (i.e., a 3% annualized rate) for the rest of 2023 is very unlikely. Instead, this analysis aims to identify and communicate key factors that will impact the reported inflation measures through year-end.

The progression of inflation has major implications for the likely press reports (and the corresponding pressure on the Fed)… and the compounding effects that both could have on the financial markets.