US Perspectives: Good News and Bad News on Inflation

Inflation data was mixed this week, but signs indicate consumers are balking at higher prices.

Robert Johnson, CFA 20.09.2011
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While on balance the economic news was negative last week, markets rallied on yet another potential resolution to the Greek debt issue and a new funding mechanism for European banks utilizing U.S. dollars. I still don't think we have come close to hearing the end of this issue, but after weeks of poor stock market performance, the market was ready for some good news.

 

On the economic front, retail sales were basically flat at least partially due to Hurricane Irene and continuing supply chain issues with Japanese auto suppliers. The Consumer Price Index jumped more than expected, potentially putting consumers in the hole for at least a couple of more months. As I discuss below, consumers continue to rebel against most price increases. I believe that the news on inflation will be better in the months ahead.

 

Manufacturing news was at least a little brighter as the manufacturing portion of the industrial production report showed a healthy 0.5% gain (6% annualized).

 

Inflation: Good News and Bad News

The news on the inflation front was decidedly mixed as the forward-looking Producer Price Index was basically unchanged from the prior month while the Consumer Price Index jumped a much heftier than expected 0.4% (that annualizes to about 4.8%).  Lower producer prices will take some time to wend their way through to consumer wallets.

 

Even on the producer front all of the news wasn't entirely positive, as the zero inflation was a product of a hefty gain in food prices being offset by a decline in energy prices. A very hot August has caused the Agriculture Department to reduce its crop estimates at least twice already. At the same time, demand has continued to increase for ethanol at a time when inventories are already a little thin. Consequently, we will probably have to wait at least another month or two to see some moderation in food prices.  

 

Gasoline Prices Drive the CPI Higher Despite Lower Prices at the Pump

The 1.9% monthly increase in gasoline prices as reported in the CPI came as a surprise to me given that the price at the pump had fallen during the month of August. However, in the Alice in Wonderland world of government statisticians, a 0.5% decrease in gasoline prices was converted to a whopping 1.9 increase after seasonal adjustment factors were applied. Those adjustments were developed over many years and reflect refinery shutdowns / conversions and summer driving habits.

 

However, as driver habits change and oil prices are increasingly influenced by factors outside the U.S., those seasonal adjustment factors begin to skew. Price increases this spring, when gasoline prices are normally placid, were probably understated and now this summer gas price increases are overstated.

 

Month-to-Month Change Gasoline Prices

 

Actual Price Change (%)

Seasonal Adjustment (%)

Reported Price Change (%)

January

3.8

+

-0.2

=

3.5

February

2.2

+

2.4

=

4.7

March

11.7

+

-6.2

=

5.6

April

7.5

+

-4.2

=

3.3

May

3.6

+

-5.6

=

-2.0

June

-5.8

+

-1.0

=

-6.8

July

-1.5

+

6.2

=

4.7

August

-0.5

+

2.4

=

1.9

Source: Bureau of Labor Statistics

 

Turning Price Decreases Into Gains

I usually refrain from making an inflation forecast because a lot of the underlying variables such as weather and wars are impossible to predict, especially on a short-term basis. That said, slightly slower growth in the world economy, lower prices in the first half of September, and potential resolution of the Libyan oil situation all point to a continued fall in oil prices, which should help move inflation down in the months ahead. As crops are harvested and Russian exports build, I suspect food prices will come down, too, but that will take a little longer than I had hoped.

 

Consumers Pummel Price Gougers

I think it is also interesting to watch how often and consistently consumers punish categories and companies that raise prices too fast. I have talked in many columns that gasoline demand in the U.S. is down for three quarters in a row, which corresponds closely with the acceleration in gas prices. Now some other categories are showing the same phenomena: autos and apparel.

 

As auto prices accelerated this spring (at least partially a result of Japanese supply chain issues) auto sales collapsed. As prices stabilized, sales rebounded. The news in apparel is the same. As prices fell this winter, apparel sales boomed. Then following months of price hikes (many related to the price of cotton), apparel sales not only slowed but actually fell.  Even on a company basis, consumers clobbered Netflix when their new pricing scheme was implemented.

 

Even our consumer team is blaming some of August's dismal restaurant sales on recently announced price increases (Hurricane Irene certainly didn't help any, either).

 

Auto / Retail Sales

 

Auto Price Change (%)

Auto Sales Units*

Apparel Price Change (%)

Apparel Sales Change (%)

January

-0.1

12.6

1.0

0.8

February

1.0

13.2

-0.9

1.9

March

0.7

13.0

-0.5

1.0

April

0.7

13.1

0.2

0.1

May

1.1

11.7

1.2

0.2

June

0.6

11.5

1.4

1.2

July

0.0

12.2

1.2

-0.3

August

0.0

12.1

1.1

-0.7

* Millions (Seasonally Adjusted Annual Rate)

Source: Morningstar Calculations, BLS, Census Bureau, BEA

 

I believe that these consumer "vigilantes" will help keep a lid on prices in the months ahead. However, I am concerned about commodities where there is a world market. Poor U.S. demand has done little to contain oil prices as demand continues to accelerate in Asian markets.

 

Manufacturing Pokes Its Head Up

The industrial production report provided some welcome relief from the drumbeat of negative news flowing out of this sector since late this spring. On the surface, August's overall industrial production number was nothing to get excited about, registering meager 0.2% growth compared with the previous month's more robust 0.9% increase. However, warm weather and a booming utility sector aided July's results, then hurt the August number. Looking at just the manufacturing sector (excluding utilities and mining) recent results just don't look as bad as some of the purchasing managers' reports have been suggesting.

 

Manufacturing Sector Growth

 

Monthly Change (%)

March

0.7

April

-0.5

May

0.1

June

0.0

July

0.6

August

0.5

Source: Federal Reserve

 

The good news in August wasn't driven entirely by a rebounding auto industry, either. Even excluding automakers, the manufacturing sector was up 0.4%. This halfway decent result came despite a lot of summer shutdowns and vacation-related slowness.

 

Toyota Back to Normal at Last

In a press release, Toyota announced that U.S. auto production levels were officially back to pre-earthquake levels. Industry-wide production levels seem to support this claim as well.

 

Total US Production, Cars and Light Trucks

 

Millions of Cars*

January

7.82

February

8.29

March

8.60

April

7.64

May

7.65

June

7.59

July

8.35

August

8.53

* Seasonally Adjusted Annual Rates

Source: Federal Reserve

 

The strong rebound in auto production is why I am highly confident that GDP growth in the third quarter will far exceed second-quarter levels. Production increases of 15% or so combined with an approximate 0.2% weight in the GDP calculation could translate into a GDP contribution of close to 1% when annualized.

 

Regional Purchasing Managers' Reports Still Soft

I hate to throw cold water on all this good news, but the regional purchasing manager reports out of New York and Philadelphia for September were nothing to write home about. The Philly Fed, while still in negative territory, rebounded from August's recession-like reading of negative 33.7 to a less disastrous negative 17.6. The Empire State Survey, which uses a similar scale, moved the wrong way, from negative 7.7 to negative 8.7. That's not catastrophic, but I was hopeful that both indexes would show improvement especially in light of continued good news on durable goods orders and now a favorable industrial production report. Lately these two reports have been volatile and not particularly predictive of the national report. The Chicago report due on Sept. 30 is much more predictive of the national results, which come the next day.

 

Retail Sales Disappoint

Retail sales were virtually unchanged in August as slipping auto sales (down 0.3%) and hurricane-induced weakness in the restaurant sector (down 0.3%) held back overall sales increases. These are two categories not included in the same-store results that showed much more positive news previously.

 

Hurricane Irene, which hit the East Coast at the end of the month, didn't help the August results, either (weekly reports showed a sharp rebound a week later). The mysterious, very volatile, and most revised category in the report (miscellaneous retailers) tanked a remarkable 2.2%, weighing heavily on the overall report. Eight of the 13 categories in the report showed growth, with sporting goods stores and electronics stores leading the way.

 

One overall trend noted by retailers was strong sales of hard goods like computers and bikes and poor sales of soft goods like clothing (down 0.7%). Hot weather probably didn't help the sales of fall clothing. And as I've mentioned, consumers are reacting strongly to price increases. Higher prices and bad weather were probably major factors in the decline in restaurant sales, too.

 

Revisions to July Retail Data Mean July Consumption Data Was Too High

The retail sales report also contained a reduction in July's sales growth rate to 0.3% from 0.5%. Unfortunately, that means that we will probably lose 0.1% or 0.2% from July's stunningly good consumption report (inflation-adjusted sales jumped 0.5% in July, one of the best numbers of the recovery).

 

Weekly Shopping Data Still OK

Weekly chain stores continue to show a consumer that hasn't given up, at least according to the same-store sales report for the International Council of Shopping Centers. Year-over-year sales grew at a 3.3% rate for the latest week, a nice rebound from the slower but still acceptable 2.7% rate when Hurricane Irene-related closings were at their peak. The five-week moving average is now 3.1% year-over-year growth, pretty much in the middle of the 2.5%-4.0% range carved out over the last 18 months. This growth moved briefly into the 4% range this summer, helped along by particularly favorable weather conditions. The Council expects total September sales to be about 4% higher than a year ago, roughly in line with June and July results.

 

Housing Data in Focus this Week

This week we will receive data on housing starts, builder sentiment, existing home sales, and house pricing data. I am not expecting anything too exciting on any of these fronts. The great uncertainty relating to the debt crisis and the debt ceiling debacle certainly doesn't provide a good backdrop for consumers laying down big bucks for a long-term asset, no matter how attractive the price.

 

The consensus expects housing starts to fall from 604,000 in July to a more anemic 590,000 in August. Existing home sales are expected to remain basically flat at 4.7 million units on a seasonally adjusted annual rate basis. Poor appraisals and tight lending standards continue to weigh on closings despite positive news on initial contract signings.

 

On the positive side of the ledger, the FHFA housing price index is likely to eke out at least one more month of gains before seasonal weakness begins to set in. Nevertheless, a positive report will be a welcome relief to all the Chicken Littles that thought prices were going down big, in a straight line fashion, starting this spring. A positive number this month would mark the third straight month of increases.

 

A Special Note to Readers

This will be my last column before my six-week sabbatical. My column (and videos) will return in early November. Remember, watch the consumer and don't get distracted by all the extraneous noise. Just as I was taught as young wrestler, focusing on the right body part (the stomach) and ignoring wild flailing elsewhere, I could avoid being faked out and taken down by my opponent.

 

 

This is an edited version. The article originated from Robert Johnson’s column at Morningstar.com.


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Robert Johnson, CFA  Robert Johnson, CFA, is Director of Economic Analysis with Morningstar.

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