It's been a bad year for inflation forecasters: every month this year, economist consensus has expected core CPI to rise by 0.2% and every month since March, that figure has proven to be too high, resulting in 5 consecutive inflation misses and the weakest stretch of core inflation growth since 2010.
Tomorrow's CPI print, however, should finally break the spell: following a stabilization in cell phone plan costs, a rebound in hotel prices, and the ongoing weakness in dollar, should make tomorrow's 0.2% core CPI forecast easier to achieve. And while year-over-year core growth is expected to slow to just 1.6% , the weakest since January 2015, Fed officials - having telegraphed a December rate hike - have indicated they’re looking more closely at the month-to-month trends for hints on what inflation will do next.
“Inflation matters for the December decision, which is still very much up in the air,’’ Jonathan Wright, an economics professor at Johns Hopkins University and former Fed economist told Bloomberg. If core price gains remain low through the end of the year, “it would be too hard to insist that inflation is still on track.’’
Headline inflation is also expected to come in a tad stronger: 0.3% M/M the highest since January, and 1.8% year-over-year due largely to a jump in gasoline prices following hurricane Harvey. “The core inflation numbers are going to be some of the lesser-affected of the key data between now and December,” said Stephen Stanley of Amherst Pierpont.
And yet, while countless algos will react within nanoseconds of tomorrow's CPI print, with a laser focus on whether tomorrow’s US core CPI will come out at 0.1%, 0.2% or 0.3%, it is easy to lose sight of the bigger inflation story. Simply put, inflation has been trending down across the major economies for decades. Take the US, each decade has seen inflation average as follows:
- 1970s: 7.1%
- 1980s: 5.6%
- 1990s: 3.0%
- 2000s: 2.6%
- 2010s: 1.7%
A similar pattern can be seen in Europe and Japan, though the latter seems to have settled around zero for the past two decades. Returning to the US, a big contributor has been a strong decline in goods inflation to around zero since the early 2000s. Meanwhile, services inflation has fallen but at a much slower pace and seems to be settling around 2%
As Nomura's Bilal Hafeez writes, it comes as no surprise that the early 2000s saw a major expansion in US (and world) trade with China. Indeed, President Clinton with the help of Republicans in Congress passed legislation to normalise trade relations with China in 2000. Soon after that, trade with China increased substantially, which helped put downward pressure on goods inflation. While there has been rhetoric from the current administration about reversing some of these measures, nothing has passed. Moreover, US trade is also increasing with other low-cost Asian producers, such as Vietnam, which is now the fifth largest net goods exporter to the US. Vietnam has not so far featured in any anti-trade rhetoric.
Still, tomrrow's numbers matter particularly for what the Fed will do next: with core inflation stubbronly below the Fed's 2.0% core traget, FOMC members have been scrambling to justify they ongoing rate hike in light of persistent price weakness. "Fed policy makers seem to believe that inflation weakness is temporary, and they are probably right on that,” said Roberto Perli of Cornerstone Macro LLC in Washington. “But the more weak data we get, the more uncertain they will be about that interpretation and therefore the higher the likelihood of a postponement.”
One key factor, however, which may spoil the party and keep inflation prints depressed is the deflationary impact of technology in general, something even the Fed has admitted in recent months, and the role of tech giants like Amazon in particular.
Discussing this issue, Nomura writes that while globalisation was the meme of the 2000s, this decade’s has to be the “Amazonisation” of commerce. Hafeez takes the argument further, and while ascribing to Amazon much of the good disinflation in recent years, suggests that one solution would be to weaken the dollar, i.e., go back to square 1 and either cuts rates or engage in QE.... just to offset the effect of Amazon!
Given the bulk of the cost of goods is distribution costs, Amazon’s unique distribution model and widening range of products could impart a new disinflationary impulse on goods prices. There may already be signs of that if we compare the expected growth at Amazon with that of more conventional retail outlets as expressed through their relative share prices (Figure 3).
So what can policymakers do to generate inflation? Services inflation is already around 2% – with the bulk of services accounted for by housing, medical and education costs, further increases may not be politically viable. That leaves raising goods inflation. But the forces of global trade and Amazonisation are unlikely to turn soon, barring some kind of breakthrough for President Trump in accomplishing political goals.
The most obvious step, then, could be to weaken the nation’s currency. It worked for Japan when Abenomics was first launched with a weak yen in 2012 (inflation rose as high as 1.7% by 2014), and recently the weak pound has helped propel UK inflation to close to 3%. For the US, it’s noteworthy that goods inflation appears fairly tied to the dollar cycle – so a weak dollar in the 2000s saw inflation rise, while dollar strength since 2012 has seen goods inflation fall (Figure 4).
But is it really Amazon's fault the Fed can't hit its inflation target?
Conveniently, that is just the question posed recently by Capital Economy in a recent research report. What it found is that, contrary to FOMC members seeking an easy scapegoat, it's not Jeff Bezos' fault why the Fed has failed at one of its two key mandates for nearly a decade. As Capital Eco's Paul Ashworth writes:
The drop back in core inflation to well below the Fed’s 2% target this year has prompted claims that prices are being held down by structural changes linked to the growing importance of online sales. With Amazon also regularly in the news recently thanks to its surging revenues and stratospheric stock price, it is understandable that people have put two and two together. Unfortunately, the data simply don’t support the theory that competition between online sellers and traditional bricks and mortar stores explains the low level of inflation.
A breakdown of his argument:
- The shift to online sales is having a transformative effect on the retail industry, but does not explain the weakness in core inflation, either this year specifically or the Fed’s more general failure to hit the 2% target in recent years.
- Online retailing should be boosting productivity, since it eliminates the cost of running expensive stores in prime locations and reduces staffing needs. Those productivity gains should be reflected in lower prices. But goods prices have been falling since the early 2000s, when production was first outsourced to low-cost developing countries and behemoths like Walmart unleashed their own efficiency revolution in the retail sector.
- Thanks to the rapid growth in non-store retail sales, the proportion of total retail sales accounted for by e-commerce has doubled since 2010. But it still accounts for a relatively minor 8.4%. Looking at Amazon specifically, its recent performance has been undoubtedly impressive. Nevertheless, Amazon’s importance within the overall US retail market still pales in significance to more traditional retailers. Even after years of strong growth, Amazon’s revenues are still only one-fifth of Walmart’s.
- The biggest categories for online sales are clothing, furniture & home furnishings and electronics. Looking at price inflation for those top three categories, a mixed picture emerges. There is little evidence that clothing prices are falling more rapidly now. In contrast, there is perhaps some evidence that prices for household furnishings and sporting goods have been falling at a slightly faster pace over the past five years. Before we conclude that is due to structural shifts in online versus bricks and mortar stores, however, it is worth bearing in mind that the dollar’s strength has also probably played a role.
- In the services sector, e-commerce now accounts for almost a third of revenues in air transportation and travel agencies. But airline fares are still being driven almost entirely by fuel prices. Despite the explosion in private short-term rentals through sites like Airbnb, hotel room rates continue to rise.
In short, CapEco finds that "the drop off in core inflation this year is mainly due to transitory factors", not Amazon, and as a result, "it will rebound next year as those factors fade and the dollar’s weakness begins to feed through."
Or at least it should.
Meanwhile, if tomorrow's CPI is the 6th consecutive miss, the Fed would be better advised to look at its own erroneous decision-making, its faulty models, and the flawed CPI basket construction, the before trying to once again pin the blame on some external force.