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Forget Core CPI, Market Pros Are Searching for Supercore Inflation

Dow Jones2023-01-11

Prices of services are rising quickly. Prices of goods are falling. Energy is all over the map. Policy makers and market watchers already strip out volatile components of price indexes to understand "core" inflation. These days, many are on the hunt for an even narrower measure: a supercore.

When the Labor Department releases its latest inflation reading on Thursday, most investors will still look first at the monthly change in the so-called core consumer-price index, which excludes food and energy categories to provide a better sense of inflation's longer-term trajectory.

Some, though, will quickly look past that number to metrics such as core services excluding housing -- or even core services excluding housing and medical care. And even that won't be entirely satisfying.

The root problem for investors is that inflation itself has become more complicated. Core goods inflation has turned negative in recent months, thanks to increased supply of many products and reduced demand. But services inflation has remained elevated -- the result, many argue, of a stubbornly hot jobs market and escalating labor costs.

"Last year I think it was pretty clear that CPI was the major focus for markets because we continued to get such shocking numbers to the upside, " said Roger Hallam, global head of rates at Vanguard.

Now, he said, when the CPI report is released, "the goods and the shelter print will get less relative focus compared to what's happening on the services side of things" -- and, as the year goes on, "the market will transition towards a greater focus on the labor-market numbers."

In recent months, Federal Reserve Chairman Jerome Powell himself has emphasized the importance of core services excluding housing, though he has focused on that category as it is measured by the Fed's preferred inflation gauge, the personal-consumption expenditures price index. That index isn't released until the end of each month and has diverged more than usual from CPI since early 2021.

Adding an extra dose of complexity, Mr. Powell has helped convince many investors that the labor market is the key to understanding the direction of inflation, making inflation data itself arguably less important.

Yet that has opened its own can of worms -- with investors looking beyond traditional metrics like the unemployment rate to myriad other gauges, each with their own drawbacks.

For all the caution that investors express, recent market moves suggest that they broadly believe that the inflation threat has narrowed over the past few months.

Yields on U.S. government bonds, which largely reflect investors' expectations for short-term interest rates set by the Fed, reached their peak last October. Back then, data had yet to show a drop in core goods prices, even as it was showing an acceleration in services inflation.

Yields have since come well off their highs, with PCE core goods inflation over the past three recorded months running at an annualized rate of minus 1.9%.

Adding to investors' optimism, last Friday's jobs report included a double dose of good news -- from Wall Street's perspective at least -- about the pace of wage gains in recent months. The report not only showed that average hourly earnings rose less than expected in December, but also included significant downward revisions to the gains from previous months.

The yield on the benchmark 10-year U.S. Treasury note, which falls when its price rises, settled Tuesday at 3.618%, down from its 2022 peak of 4.231%, set in the fall.

For investors, a big question now is how much to worry about the persistence of high services inflation. There is also a question about how much stock to put into the monthly wage data, given its large swings in recent months. Overall, core PCE prices climbed at a 3.6% annualized rate over the three months ended in November, still well above the Fed's 2% target.

Fed officials, for their part, have mostly expressed continued concern about the inflation outlook.

Minutes from the Fed's December meeting, released last week, again emphasized the importance of core services excluding housing, which was noted to be the largest component of core PCE inflation. The minutes also revealed that officials were worried that investors might underestimate their resolve to hold interest rates at higher levels, leading to "an unwarranted easing in financial conditions."

Notably, one measure of labor-market tightness that Fed officials have highlighted showed little sign of cooling in a report last week, with the number of job openings holding near historically high levels.

As for wages, some amount of confusion could be resolved later this month. That is when the Labor Department will release its quarterly employment-cost index, widely seen as the most reliable gauge of worker pay.

Investors remain highly attuned to what the Fed is saying about inflation and the labor market. Otherwise, bonds might have rallied even more than they have, analysts noted.

"Today, you're probably focusing more of your attention on the service sector" in large part because "the Fed is telling you that their policy-reaction function is highly skewed right now towards that," said Jim Caron, a fixed-income portfolio manager at Morgan Stanley Investment Management.

Still, some investors and analysts question the Fed's basic argument that a tight labor market will inevitably keep services inflation elevated and therefore overall inflation at unacceptably high levels.

One factor behind high services inflation last year was a surge in airline fares, partly due to increased fuel costs, said Omair Sharif, president of research firm Inflation Insights LLC.

Mr. Sharif's own preferred measure of services inflation strips out not only energy and housing categories but also medical care and transportation. That gauge has shown a less alarming trend in the rate of price increases.

The Fed's "focus on this core PCE housing stuff is obviously driven by their belief that wage pressures are closely linked with core services," he said. "And the question is to what degree that is actually true."

Disclaimer: Investing carries risk. This is not financial advice. The above content should not be regarded as an offer, recommendation, or solicitation on acquiring or disposing of any financial products, any associated discussions, comments, or posts by author or other users should not be considered as such either. It is solely for general information purpose only, which does not consider your own investment objectives, financial situations or needs. TTM assumes no responsibility or warranty for the accuracy and completeness of the information, investors should do their own research and may seek professional advice before investing.

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  • 来人
    ·2023-01-11
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    ·2023-01-11
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