Headline inflation turned to deflation in May

‘Headline’ inflation – the measure that determines the inflation adjustment to principal for TIPS – took a dive in May, falling 0.3%, pulled down by a plunge in gas prices. It was the biggest drop since December 2008 – the dark days of the global financial crisis.

Gas prices sank 6.8 percent, also the most since December 2008. Food costs were unchanged.

But ‘core’ prices, which exclude food and energy and are closely watched by the Fed, rose 0.2 percent for the third straight month. From the Washington Post report:

Over the past 12 months ending in May, consumer prices rose 1.7 percent, much less than the pace for the 12 months that ended in April. Core prices have risen 2.3 percent in the past year, the same as for the 12 months ending in March and April. That’s close to the Fed’s 2 percent target for inflation.

In the Fed’s view, inflation is just about on target. Blogger Michael  Ashton points out that  ‘core inflation didn’t show any signs of rolling over. ‘ Although ‘deflation’ would seem to open the door to new Federal Reserve stimulus, Ashton says:

We’re unlikely to see core CPI dipping any time soon, so if the Fed wants to do QE, they’ll need to suddenly grow interested in headline inflation.

But weakening headline inflation means lower returns for holders of TIPS, which are currently carrying negative base interest rates far up the maturity ladder. When you combine a negative base rate with a weak inflation rate, TIPS holders get double dose of weak returns.

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