Perception vs Reality – Is There Really an Inflation Worry?
This week’s release of CPI and PPI confirmed our worst fears that inflation would persist despite a weak economy. A full 45% of people surveyed by Kathleen Hays’ show, The Hays Advantage, said that stagflation was the most likely economic outcome. Another 40% said inflation was most likely and only 10% thought disinflation would prevail. Another poll by Absolute Return Research (Exhibit 2) suggested that inflation, and not fears over future tax increases are the major drag on confidence. We note that neither TIPs nor the forward market indicate that inflation is a major worry, but that doesn’t mean it isn’t a fear that is impacting consumer behavior.
Exhibit 1: U.S. CPI Figures (YoY)
Sources: BLS/Haver Analytics
Consumers have cut back on gasoline use since prices started rising in the spring of this year. But this has only moderated prices slightly. If we look at Brent crude oil prices, they have fluctuated between $97/bl and $127/bl over the past 35 weeks. At these levels, gasoline purchases comprise greater than 12% of retail sales. We can see from Exhibit 1 that energy prices are still rising in the double digits. August data also reveals that higher cotton prices are being passed on to consumers with apparel prices rising slightly over 100b basis points in August. Food prices continue to move higher rising 30 basis points to 4.5%. The combination of these factors pushed up both headline and core CPI.
Exhibit 2: Which one of the following worries you the most at this time?
|Jun ‘10||Jan ‘11||Jul ‘11|
|Drop in income*||14%||12%||14%|
|A rise in the cost of living
|Having insufficient savings||22%||18%||16%|
|None of these||5%||6%||6%|
* Lower wages, investment income or benefits
Sources: ASR Consumer Survey
If one looks at the Dallas Fed Trimmed Mean PCE which (profiled in our April 21st edition of The Week Ahead) one can see a lower rate of price increases when one takes into account substitution; it comes in at a mere 1.6% y/y. So why all the worry? We believe the answer lies with the oil price. During the 2001 recession CPI was higher than it is now, the Core CPI was higher than it is now and the Dallas Fed Trimmed Mean PCE was higher than it is now, but oil prices were below $30/bl. At this time gasoline station sales as a percent of total retail sales was below 9%. That 3% makes a significant difference in how people feel about inflation and the level of consumer confidence. Thus, all the backlash towards the Fed. The magnitude of easier money on the price of oil is up for debate, that easier money has helped push up the oil price is not. A jobs policy that helped get more natural gas running cars on the road or that gets more West Texas crude to refineries would do much to help not just jobs but consumer confidence as well.
This begs the question what if oil prices level off? No what if they fall, I am not even suggesting we be that optimistic, merely what if they level off? In exhibit 4 we show the Brent oil price with forecasts in a random walk between a price of $109-$120/bl and the corresponding y/y% change in price. By February of next year we start to see a flattening out in the y/y price change. This will begin to help consumer confidence if it happens but will it be too late?
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