While annual inflation dipped slightly, inflation continues to run hot — too hot for complacency by the Federal Reserve.
By David Enna, Tipswatch.com
When is a surprise not a surprise? When it comes to economists trying to predict U.S. inflation.
All-items U.S. inflation rose 0.3% in April, exceeding economist predictions of 0.2% for the month and continuing a string of monthly upside surprises. The year-over-year number was 8.3%, also exceeding expectations of 8.1%. Core inflation looked even worse, coming in at 0.6% for the month (beating expectations of 0.4%) and 6.2% for the year (versus 6.0%).
The stock market’s instant reaction was negative. Just minutes before the Bureau of Labor Statistics released the report at 8:30 a.m., S&P 500 stock market futures were trading at 3996. Minutes after the report, futures were down to 3969.
In April, U.S. inflation rose 0.3% even though the price of gasoline — a major factor in the monthly all-items report — actually declined 6.1%, but remained 43.6% higher year over year. Already, this trend has reversed, with gas prices rising to record highs in May.
The BLS noted that increases in the indexes for shelter, food, airline fares, and new vehicles were the largest contributors to the seasonally adjusted all-items increase. Some highlights:
- The food at home index rose 1.0% in April, the fourth month in a row with price increases higher than 1%. Year over year, food at home prices were up a painful 10.8%.
- Food prices have increased 17 months in a row. The BLS noted that the index for dairy and related products rose 2.5%, its largest monthly increase since July 2007. The index for eggs increased 10.3% in April.
- Shelter costs increased 0.5% for the month and are now up 5.1% year over year. Shelter costs are a lagging indicator and should be a factor in higher inflation in coming months.
- The cost of used cars and trucks fell 0.4% in April, but are still 22.7% higher year over year. The index for new vehicles was up 1.1% for the month.
- Apparel prices also fell 0.8% in the month.
- The index for airline fares increased a mammoth 18.6% in April, the largest one-month increase since the inception of the CPI-U series in 1963.
- Costs of medical care increased 0.5% in April and are up 3.5% year over year.
Here is the trend in all-items and core inflation over the last year, showing that annual inflation did peak in March, but remained at a very high level in April:
A side note: The separate inflation index — CPI-W — used to determine Social Security’s annual cost of living increase has increased 8.9% over the last 12 months, a bit higher than overall U.S. inflation. But the Social Security increase for 2023 will be determined by the average of inflation from July to September. It’s too early to draw any conclusions.
What this means for TIPS and I Bonds
Investors in Treasury Inflation-Protected Securities and U.S. Series I Savings Bonds are also interested in non-seasonally adjusted inflation, which is used to adjust principal balances for TIPS and set future interest rates for I Bonds. For April, the BLS set the inflation index at 289.109, an increase of 0.56% over the March number.
Keep in mind that since non-seasonally adjusted inflation was running higher than the seasonally adjusted number in April, this will eventually reverse in coming months. The two numbers merge after 12 months.
For TIPS. The April inflation number means that principal balances for all TIPS will rise 0.56% in June, after rising 0.91% in April and 1.34% in May. Here are the new June Inflation Indexes for all TIPS.
For I Bonds. The April inflation index is the first of a six-months string — from April to September — that will determine the I Bond’s new inflation-adjusted variable rate, which will be reset on November 1. So far, that 0.56% number would translate to a variable rate of 1.12%, but it’s way too early to draw any conclusions from just one month. Inflation can be highly volatile in summer months.
Here are the data I’m tracking:
What this means for future interest rates
While annual inflation slipped slightly lower in April, the upside surprises for both all-items and core inflation indicate that the Federal Reserve has to stay the course with balance-sheet reductions and routine increases of 50 basis points in short-term interest rates.
I think the bond market has already priced in this trend, with the 5-year nominal Treasury rising above 3% earlier this week. The real yield of a 5-year TIPS is inching ever closer to zero and should quickly rise to positive, if the Fed stays the course and attempts to hold down inflation expectations.
I don’t expect annual U.S. inflation to continue above 8% for long. It should begin gradually slipping lower in coming months, possibly ending the year in the 4% to 5% range. This is what the market expects, but a lot will depend on if the U.S. economy can remain reasonably strong at a time of soaring energy prices and rising interest rates.
Next week’s reopening auction of a 10-year TIPS should be interesting. That TIPS is currently trading on the secondary market with a real yield of 0.32% and a price discounted to par. We haven’t seen that in a long time. I will be writing a preview article on that auction this weekend.
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David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he discusses can purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.
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I really don’t get the market/experts predictions 4-5% for 2022. I guess it’s probably answered by your opening sentence:
Here’s my reasoning on why 4-5% is a dream: In the first four months, we’ve seen CPI go from 278.802 to 289.109. That’s 3.7% right there. To keep it to 5.0%, CPI would have to end December at 292.742. That’s a 0.156% month/month average increase from here on out, equal to 1.89% annualized rate. That’s lower than “target” or “normal”, and there’s really no evidence that kind of slowdown will happen given the 0.5% month/month rate we’re seeing on housing, which is slow/lagged and by itself will generate more than the required inflation to top 5% since it’s ~1/3rd of CPI. Honestly, we may hit the 4% number of that 4-5% range in the next couple weeks, especially given recent gas trends! Only things I see getting us into the 4-5% range for the year would be some massive shock like a 50% drop in gasoline price, and something like that would likely stem from an event that has a lot of other negative repercussions.
I know this isn’t an inflation-predicting blog, and normally I don’t try to predict such things either, but sometimes common sense and basic estimations are enough to show that the market’s predictions are highly unlikely, and if so, that’s when I call it out!
As usual, thanks for the well written and easily understandable report. I love your frequent updates on the status of TIPS and their potential benefits to a portfolio.
I certainly agree inflation could run higher than 5% December to December, but there are some factors that can keep it around that level: 1) Congress spurred inflation by racking up huge direct payments to consumers in 2020 and 2021. Those have ended. 2) Interest rates were ultra low for two years, but are now climbing and the days of “free money” and speculation could be over. 3) The economy is going to slow down, but at the same time interest rates will have to remain relatively high.
However, on the other side is the war in Ukraine, which could keep gasoline and energy prices sky high, and affect prices for food and many other products. Ukraine was the reason for the huge surge higher in February and March. Gas prices were up 6.6% in February and 18.3% in March. That’s not sustainable, at that level.
So maybe it would be better to say — I can’t predict inflation — that inflation might start pointing toward an annual rate of 3% to 5% by the end of the year, which might mean monthly increases of 0.3%, same as this month’s increase. The summer inflation numbers are notoriously fickle. I wouldn’t be surprised to see one or two deflationary months.
Thanks Karl. As I noted in March, I’ve been “nibbling” into these recent TIPS auctions, but I think we are getting to yields that make sense as a larger — but not crazy large — investment. A 10-year TIPS with a real yield of 0.31% is going to out-perform I Bonds if held to maturity.
This is the first time since 2019 that the 5 year TIPS might break consistently into positive territory. I’ve been watching the yields flop around over the last week. Athough it appears to be going the wrong way today, it’s getting close.
Back in the 2017 to 2019 period, I dabbled in TIPS (small increments of 10K). Then in the early 2020’s TIPS yields went negative so I sold most all of them at a nice profit. I just got tired of having 5 year CD’s beat my TIPS yields by over two percent (and inflation).
Now that CD’s don’t appear to be anywhere near matching the inflation rate for the next year or so, I’m going to move back into the 5 year TIPS. I’m willing to put up with purchasing them above par once the inflation factor is applied to the bond price.
At this point, I really don’t see much difference between purchasing them on the secondary market as opposed to the upcoming auction in June. Once the bond price declines to under par value, it looks like a buying opportunity to me (when holding to maturity).
It’ll be interesting what your take is on the upcoming 10 year TIPS re-opening auction this month. Unfortunately, at my age the 10 year term is too far out to my liking. Right now, it’s going for 99.07. With accrued inflation applied (1027), that’s 101.74?
Thank you, David for the insight. Your writing style is very easy to digest, timely and greatest of all, it pertains to us that are holding TIPS and I-bonds. On a side note, I bought a lot of the 10-year TIPS at the reopening in March. I wish I would have leaned more into the recent 5-year TIPS which has a better yield but I did purchase some. Either way, I feel it was a good investment outside of I- bonds (my wife and I bought 20k for each other as gift I-bonds right before the end of April).