We have focused on the theme of the misplaced fear of deflation at Variant Perception frequently over the past 18 months.  At several points, markets and commentators seem to have become preoccupied with a belief that growth-destroying deflation was imminent. Using our indicators we have kept pointing out that – while inflation is not about to move significantly higher – there is certainly no justification for believing inflation is going to remain chronically low, or even begin falling.

Our latest discussion on US inflation was from our Tactical of last Tuesday (Housing: the dog that hasn’t barked, 23rd February 2016). We discussed how core PCE, the Fed’s favoured measure of inflation, was looking like an outlier. On Friday, it came out and surprised to the upside, at 1.67% YoY.

img1Source: Macrobond and Variant Perception

From our Tactical piece of 23/02/2016:

Housing affordability and tighter credit conditions for mortgages have helped conspire to push the rental vacancy rate in the US to its lowest in over 20 years.  This should keep the shelter component of CPI well supported (top chart), which accounts for almost a third of the headline CPI.  Our LEI for US inflation has long pointed to an upward bias for core CPI.  This has been the case, with January’s YoY core CPI the highest since mid-2012.  Even headline CPI has turned up sharply in recent months as the effects from falling energy prices recede (bottom chart).

However, the Fed’s favoured inflation measure, core PCE, remains subdued (although this too has shown a modest increase recently).  PCE contains a lower weighting for shelter and a higher waiting for healthcare.  Shelter inflation, as we have seen, has been rising and healthcare inflation has been falling, explaining most of the difference for the two measures.  PCE looks like the outlier.  It is apparent inflation is alive and well in the US, if not yet at overly concerning levels.


img3Source: Macrobond, Bloomberg and Variant Perception