PIMCO: US CPI Commentary

by | Nov 10, 2022

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By Tiffany Wilding, PIMCO North American Economist 

Bottom Line: Finally a softer inflation report. We had flagged October downside inflation risks, but this report was softer than we and consensus were expecting. The core price index only gained 0.3% month-over-month (m/m) (vs 0.5% month-over-month consensus). The details were also more favorable than expected. Pre-holiday discounting and a decline in used cars moderated the headline index; however, rental inflation also took a much needed breather after shockingly strong gains over recent quarters. While we still expect inflation to re-accelerate somewhat over the next few months, this report also increases our confidence in our 4.5%-5% expected range where the Fed pauses. We also lowered our Dec 2023 forecast 0.3ppts to 3.7% vs 4% previously.  

On the details of today’s report, softer-than-expected inflation readings were broad based across categories. Core goods prices dropped 0.4% m/m, while services inflation slowed to 0.5% m/m vs 0.8% m/m last month. Furthermore, sub-categories within core goods, that should be more interest rate sensitive (autos and furniture) recorded price declines in October. 

  • Core goods prices were dragged down by price slashing across used car dealerships, after retail prices of used cars has previously been holding up despite the price declines witnessed across wholesale used car auctions. Higher inventories and lack of rental car company buying had contributed to whole sale price declines; however, it wasn’t until October that dealers more fully passed on the price declines to consumers. Nevertheless, while this is good news for overall inflation, we think used car prices may reaccelerate in the months ahead, as elevated recorded auto damages from Hurricane Ian will likely temporarily support prices in the months ahead. 
  • Meanwhile, early holiday discounting from Amazon and other retailers contributed to flat retail goods prices over all, and notable declines across the household goods – and the interest rate sensitive furniture category – and appeal categories. We have been expecting discounting since inventory to sales ratios recovered earlier this year. However, this is the first month that it is actually showing up in the BLS data.  
  • Turning to core services, importantly rents and OER cooled after a string of shockingly strong reports.Alternative data on rental listing prices and rents recorded in new leases have shown a notable cooling over recent months, as has the broader housing market. However, given the usual lags, we don’t expect this cooling to be reflected in CPI reported OER/rentals until late 1Q or early 2Q next year. Net/net OER looks like it will maintain a roughly 0.7% pace until then. 
  • Of note healthcare insurance prices dropped, and this new pace will contribute to more moderate inflation in the broader healthcare category over the next year.  Recall that the BLS uses a retained earnings methodology using data that is only published once per year and with a lag. CPI has been benefitting from strength in health insurance margins due to the lack of procedures that occurred in 2020 during the pandemic, but this will fall out starting with this report.

Overall today’s softer than expected reading did lower our year ahead forecasts a little bit to 3.7% vs 4.0% previously. Due to the BLS’s health insurance methodology, the price drop will continue throughout the year, putting down pressure on the monthly sequential pace of inflation. However, it’s important to keep in mind that these categories are not included in the PCE, and as a result this would help to reduce the wedge between the two series. 

Another possible implication of this report is that consumer spending is softening further. Retail margins (as implied by the government data) have held up surprisingly well in recent quarters; however, we expect falling real consumption will moderate retailers ability to maintain those margins. The retail sales data for October will be released next week, and we will triangulate our forecast with the big bank credit card data, nevertheless, this inflation report suggests there are downside risks.

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