U.S. inflation drops a sharp 0.4% in April

Is this what deflation looks like? At least for spring 2013, yes.

The Bureau of Labor Statistics announced today that ‘headline’ inflation – known technically as the Consumer Price Index for All Urban Consumers (CPI-U) – decreased 0.4% in April on a seasonally adjusted basis. This was a much sharper fall than the 0.1% drop that experts were expecting.

The non-seasonally adjusted number for April was -0.1%, and has been running at 1.1% over the last 12 months.

This non-seasonally adjusted inflation number is especially important to holders of TIPS and I Bonds, because it is used to adjust the principal balance of TIPS and set the future inflation-adjustment interest rates for I Bonds.

Therefore, TIPS holders will see their principal balances adjusted down 0.1%. Not nice, and this trend seems very likely to force TIPS yields higher, even versus traditional Treasurys. When inflation fear is out of the pictures, TIPS are not in high demand.

(Meaning … possible buying opportunity.)

Read the full CPI report.

As in March, the big deflationary factor was the price of gasoline, which fell 7.9% in April and resulted in a whopping 4.3% one-month decrease in the energy index. The food index, unchanged in March, rose 0.2% in April. The only category showing any real inflation was ‘used cars and trucks,’ which rose 0.6% in the month.

Over the last six months, seasonally-adjusted inflation has netted out to -0.1%, creating a half year of deflation, as shown in this chart:

12 months of inflation

Core inflation? The Federal Reserve tends to ignore headline inflation and watches ‘all items less food and energy.’ Core inflation rose 0.1% in April and has increased 1.7% for the last 12 months. This is well below the Fed’s ‘implied’ inflation top of 2.5%, and seems to open the door for continued bond buying in 2013.

Commentary from the Associated Press report:

Unusually low inflation means consumers can stretch their paychecks and buy more goods and services. But if it were to fall further, it could stoke fears of deflation.

“Subdued demand means that core inflation is likely to edge lower, as retailers will be forced to pass previous falls in raw material costs onto customers,” Paul Dales, an economist at Capital Economics, said in a note to clients. “The Fed may soon put more emphasis on fading inflation trends.”

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