The Coming CPI Inflation Report Will Be Sketchy

The December 13 CPI report (8:30 AM ET) for November 2022 should show a further inflation decline. That’s the good news. The problem is that the one number reading will set atop a mixed bag of movements. Therefore, putting together a coherent explanation will take thought and time. Nevertheless, the media and markets will charge out of the gate, riding presumptive simplicity.

There are two primary moving parts that make understanding the November report challenging…

First, price drops

Certain areas of the economy had unusually large price run-ups based on special circumstances. Some have now entered reversal periods, with declines moving trends back to “normal.”

The primary areas are:

• Energy, with its 8% weighting
• New cars, 4%
• Used cars, 4%
• Non-energy commodities, scattered throughout
• Shipping, also scattered about

There is a serious problem with those price reversals. Just as the abnormal price gains skewed past inflation calculations higher (remember 9%?), the compensating price declines will push them “abnormally” lower.

As an example, consider the difference between these two movements:

1. A 6% price rise declining to a 4% rise
2. A 10% price rise followed by a -5% drop

Forgetting compounding, both patterns average a 5% rise. However, the large, total 15% downshift in #2 produces an exaggerated decline in overall inflation. The fallout from that occurrence could be a false sense of Federal Reserve success that causes a premature, congratulatory loosening of sorts.

Second, seasonal adjustments

For November 2021, seasonal-adjustment increases occurred in key areas (energy, in particular). That means the beneficial effect of this November’s drop in oil/gas prices will likely be diminished. Here were the main seasonal adjustments for November 2021:

• Overall CPI (100% weight): Nominal (actual) = 0.5%; Seasonally adjusted (the official number) = 0.8%
• Food (14% weight): Nominal = 0.5%; Seasonally adjusted = 0.7%
• Energy (7.5% weight): Nominal = 1.5%; Seasonally adjusted = 3.5%
• Overall CPI less food and energy (78.5% weight): Nominal = 0.4%; Seasonally adjusted = 0.5%

Note #1: All the numbers shown are as originally reported. However, as with most economic and financial reports, revisions of the first reports often happen as more information becomes available. For the November 2021 Overall CPI, the revision was to the seasonally-adjusted number: From 0.8% to 0.7%.

Note #2: To our eyes, the small monthly rates can have a ho-hum appearance. To better view the import of those readings and adjustments, the rates need to be annualized – in other words, compounded over twelve months to put them in perspective of the trailing 12-month changes we keep reading about. Here are the annualized monthly numbers from above:

• 0.4% monthly = 4.9% annualized
• 0.5% monthly = 6.2% annualized
• 0.7% monthly = 8.7% annualized
• 0.8% monthly = 10.0% annualized
• 1.5% monthly = 19.6% annualized
• 3.5% monthly = 51.1% annualized

Note #3: When the December 2022 report is released, there will be another upwards seasonal adjustment. In the chart below, circled are the November and December bars for both 2020 and 2021. The first bar (orange) is the nominal calculation, and the second bar (green) is the seasonally-adjusted one. The 2020 and 2021 seasonal adjustments were:

• November 2020, from (0.1)% to 0.1%
• December 2020, from 0.1% to 0.3%
• November 2021, from 0.5% to 0.7%
• December 2021, from 0.3% to 0.6%

So, what are economists forecasting for November 2022?

According to Econoday.com, the range of seasonally-adjusted forecasts is 0.2% to 0.5%, with a consensus of 0.3%. (October’s monthly rate was 0.4%, both nominal and seasonally-adjusted). The Wall Street Journal, in a CPI outlook article, chose Bank of America economists’ 0.2% forecast.

Those seasonally-adjusted 0.2% (2.4% annualized) and 0.3% (3.7% annualized) forecasts imply a nominal CPI calculation of near zero.

The conclusion of all of this…

The bottom line: Who knows?

Clearly, to understand the November report, we need to spend time and effort. Mixing price drops with seasonal adjustment increases alters the range of possibilities. Any surprises will of course need to be factored into December 2022 estimates as well as those for 2023.

So, to repeat: Look upon the immediate media reports and market movements with skepticism. It will take time and reflection to understand the results. Moreover, better understanding won’t necessarily produce better forecasting. It may be that November is just another rung on the ladder.