The Basket is Getting Heavier

By TJ Kim

September 17, 2012

Last Friday, Bureau of Labor Statistics released the Consumer Price Index. In August, the headline CPI increased 0.6 percent on a month-to-month basis at par with the consensus. This growth surprised many because the CPI stayed below 0.4% for the past 6 months.

Due to the rising price in energy, the gasoline index accounted for around 80% of the headline CPI increase. Moreover, increasing energy prices and the recent drought in the Midwest regions are expected to push up the core CPI as well. Economics analyst from Barclays wrote in Instant Insights.

“As was the case in yesterday’s PPI report, clear evidence of the effect of the drought in the Midwest over the summer has yet to show clearly – for example, the price index for cereals and baked goods was flat in August. As we wrote in US food price inflation: An upside risk, but not a huge one, 9 August 2012, we expect the drought-driven gains in grain prices to feed through to the CPI food component to some extent later in the year, although the lag is likely to be fairly long.”

In the core CPI which marked at tepid 0.1% below the consensus, there were both declines and mild gains. Yet, it appears likely that the upward trend in commodity and energy price index will permeate into the core index.

“First, within core services, there were further declines in airline fares (down 1.3% following a 2.7% drop in July) and lodging away from home (a 0.6% drop following the 2.3% decline in July). Such declines are unlikely to persist, in our view, especially for the former, which tends to track jet fuel costs with a few months’ lag. Elsewhere within core services, there were gains in rent (0.2%), owners’ equivalent rent (0.3%), and medical care services (0.2%). Looking ahead, we expect gradual gains in these components to continue. The second theme was evidence of a broader easing of core goods inflation. This fell 0.2%, with declines in apparel (-0.5%), used vehicles (-0.9%), appliances (-1.0%), and furniture (-0.5%). Here, the easing of inflationary pressure may prove more persistent, especially in the more import-intensive components.”

As evident and impacted by the recent rise in the PPI index, the core CPI may grow at a higher rate in the near future. However, in our current state of economy, consumers are highly price sensitive and easy to retract their spending, due to the high unemployment rate that threatens the security of households’ finance. Therefore companies will be cautious to reflect increased costs of production onto the price tags.

The report was a good news for the bond market as the inflationary pressure remains tame. However, last week’s FOMC announcement on the QE3 gave a rise to the equity market, which caused an upward pressure in the 10-yr U.S. Treasury Yield back to 1.8%.

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