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December CPI preview: expecting a big fall in YoY inflation & a below consensus print
As we move through the second week of January, the time has arrived for my latest US CPI preview.
In December, I expect a major drop in the YoY CPI growth rate, and one which is larger than the consensus forecast. Let’s delve in, beginning with a recap of where things currently stand.
Where are we now?
After peaking at 9.1% in June 2022, the YoY CPI growth rate has fallen to 7.1% in November.
Underlying this reduction in inflation has been a MAJOR downshift in MoM CPI growth rates. From January to June 2022, the average MoM change in the CPI was 1.0%. From July to November? Just 0.1%!
The higher MoM growth rates from earlier in 2022 are an INTEGRAL part of the disinflation picture for 1H23, as most months from January to June 2023 will see very high prior comparables rolled off.
The recent decline in MoM growth rates has seen the 3-month annualised CPI growth rate fall to 2.1%, and the 6-month annualised growth rate fall to 3.7%.
As I explain below, I expect the 3-month annualised growth rate to turn NEGATIVE in December, and to 0.2% on a 6-month annualised basis.
Let’s now unpack some of the key factors and elements that underpin my CPI forecast.
YoY M2 growth turns negative for the first time in 60+ years
Underpinning the major turnaround to lower MoM CPI growth rates has been one of the sharpest decelerations EVER seen in the US’ M2 money supply. The deceleration has indeed been so sharp, that the YoY rate of change in the M2 money supply is now NEGATIVE.
This hasn’t happened in at least 60+ years. What does this mean in a nutshell? Continued declines in the YoY growth rate of inflation are on the way. Indeed, should the Fed continue with its aggressive tightening for a prolonged period, then outright deflation cannot be ruled out in 2023.
Durables expected to see another MoM fall — may turn YoY negative
After leading inflation on the way up as people spent stimulus checks whilst cooped up at home during COVID lockdowns and restrictions, durables prices are now leading inflation on the way down.
In a warning to those who think that inflation is generally a “sticky” phenomenon, after peaking at a YoY growth rate of 18.7% in February 2022, I forecast that YoY durables prices will be only modestly positive in December, with the potential existing for outright YoY durables price deflation — just 10 months after peaking at nearly 19%. While inflation can take some time to move to a higher or lower gear after major changes in the M2 money supply, once it does, it generally moves quickly.
This sharp drop-off in YoY durables prices comes alongside outright MoM price declines in each of the past three months, and declines which have been well in excess of their historical monthly average price change. Given this trend, and ongoing falls in M2, I anticipate that a larger than usual decline will again be seen in December.
Looking for continued deceleration in CPI food prices as food commodities fall for the 9th straight month
I have previously spoken about the strong directional correlation between the UN FAO Food Price Index, and CPI food at home prices, with the latter being highly correlated with a 6-month lag.
In December, the UN FAO Food Price Index recorded its 9th consecutive month of price declines, falling by 1.9% MoM. YoY the UN FAO Food Price Index is now down 1.0%.
Given these persistent movements in underlying food commodities, I expect the CPI’s food at home index to continue to show signs of price growth deceleration. Indeed, we can see in the figure below that the YoY growth rate of CPI food at home prices has begun to turn lower. Once higher comparables begin to be cycled from January, I expect the YoY decline to accelerate.
While November saw a negative MoM change in CPI food at home prices, much of this was due to seasonal factors. While I thus anticipate the rate of growth versus prior historical averages to moderate in December, I do expect a return to MoM growth in CPI food at home prices.
Energy commodities to provide major downward pressure in December
The CPI’s energy commodities component is highly correlated to the EIA’s monthly average change in gasoline prices. With the latter falling by 12.9% in December, CPI energy commodities are set to provide a MAJOR downward driver to December’s inflation numbers. Indeed, I expect this to drive a significant overall MoM decline in the CPI.
Looking for moderating shelter costs, but not penciling it in
While both declining market rents, and a lower proportion of new leases during the winter months both suggest that the CPI’s rent based components should begin to exhibit more moderate growth rates, this is yet to show up in the data, with the gap between the CPI’s lagging rent based indexes and spot market rents, so far remaining too vast.
Nevertheless, some spot market based measures, such as Apartment List’s, have shown a major convergence to the CPI’s rental based measures over recent months.
While the convergence between the CPI’s rental indexes and spot market measures like Apartment List’s suggests that a significant moderation in the CPI’s rental based measures shouldn’t be too far away, given the lack of any clear moderation in the CPI’s rental based indexes — both owners’ equivalent rent (OER) and rent of primary residence indexes rose MoM in November — I continue to forecast high growth rates for both of the CPI’s rental based indexes in December.
Health insurance to keep dragging CPI down
Since the BLS’ annual revision of health insurance prices in October, it has been an important contributor to lower CPI inflation.
Given that the annual revision is applied fairly evenly over the 12-month period, we can expect to see another MoM decline in CPI health insurance prices of ~4%. We can also expect this significant downward pressure on the CPI to continue until September 2023.
While many may claim that such a system of recording price changes is technical and not an accurate depiction of underlying market changes, it is the system that the BLS uses. It’s what goes into the official CPI, and thus contributes to the overall number that the Fed watches, and which it will use in its decision making. For such reasons, we must be aware of the mechanism that the BLS uses, and how it will impact the CPI — which until September 2023 will provide a significant contribution to lowering the rate of growth in the CPI.
Watch telephone services after unusual November jump
One of the more peculiar items in November’s CPI report was the jump in telephone services prices, which rose 2.1% MoM vs an average change between 2010-19 of -0.1% in November.
Given the odd November price movement, it will be worth watching whether or not this is repeated again in December, or whether price changes return to be more aligned with historical norms.
Expecting a MoM change of -0.36%
Putting it all together, I am forecasting a MoM CPI change of -0.36% (non-seasonally adjusted). This would mark the largest MoM decline since April 2020.
Expecting a YoY change of 6.4% — below consensus of 6.5%
In terms of the YoY number, I am forecasting December to come in at 6.4%. This is slightly below consensus forecasts of 6.5%. This would mark a major decline from the 7.1% growth rate recorded in November, and the 6th consecutive month of lower YoY CPI growth.
3- and 6-month price changes to show a MAJOR shift
My forecast suggests that the 3- and 6-month annualised CPI price changes for December will further highlight the MAJOR shift that has occurred in price growth since June’s CPI peak.
My forecast suggests that the 3-month annualised CPI growth rate will turn NEGATIVE, whilst the 6-month annualised price change will fall to just 0.2% — well below the Fed’s 2% target.
Given the numerous examples that point to lower inflation ahead, as well as the clear moderation that has already been observed in the CPI over recent months, it should be increasingly clear to Fed officials that they are massively overtightening, and are set to plunge the US economy into a severe recession should they stubbornly refuse to change course (just as they stubbornly refused to alter their policy stance as inflation first began to rise).
Though instead of actively changing course as the data changes, time and time again, the Fed instead horribly lags the underlying reality of the economic situation.
Plan and act accordingly.
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