They call it the “headline CPI” for a reason.
Today all the headlines I’ve seen tout the drop in headline inflation, the all-items Consumer Price Index, in May to an annual inflation rate of 4.0%. In April the annual inflation rate was 4.9%. The month-to-month rate dropped to an increase of 0.1% from April from 0.4% in April.
This is undoubtedly good news on inflation. Good for consumers–the price of eggs finally plunged, for example, with egg prices falling by 13.8% in May from April. (That’s the largest month-to-month drop in egg price in 72 years.) And good for a Federal Reserve battling to get inflation down to its 2% target rate.
The stock market read the headlines and cheered. The Standard & Poor’s 500 closed up 0.69% on the day. The Dow Jones Industrial Average gained 0.43%. The NASDAQ Composite climbed 0.83% and the NASDAQ 100 added 0.69$. The small-cap Russell 2000 rose 1.23%.
But, beyond the headline number, the inflation picture wasn’t nearly as rosy. The core CPI, which doesn’t include changes in the prices of food and energy, rose 0.4% in May from April. The annual core inflation rate was 5.3% in May. Economists had expected a 5.2% annual core inflation rate.
Unfortunately, for the financial markets, the Fed watches the core rate much more closely than the all-items rates on the theory that subtracting more volatile food and energy prices gives a truer picture of structural inflation in the economy.
If you pay attention to the core rate rather than the headline inflation rate, the Fed’s inflation fight doesn’t look like it’s anything like over.
But most news sources and most consumers pay more attention to the headline inflation rate than to the core rate.
And that’s the source of the Federal Reserve’s big current political problem. (Yes, Virginia, there is a Santa Claus and the Fed pays attention to politics.)
Raising interest rates by 25 basis points tomorrow–when everyone knows inflation is falling quickly because the headlines say so–would open the central bank up to intense criticism from everyone who is worried that the Fed will send the U.S. economy into a recession.
Much better to play to those headlines by announcing a skip in rate hikes for June–thus showing the Fed’s sensitivity to Recession fears–and keep the next interest rate increase, which the core inflation rate says is necessary, to the July 26 meeting.
But do watch for the Fed to signal its dissatisfaction with the current inflation rate in tomorrow’s update of its DotPlot forecasts for the year ahead.
