Image Source: Pixabay

By: Steve Sosnick Chief Strategist at Interactive Brokers

Statistics can be confusing. Depending upon your viewpoint, Wednesday’s CPI report was either a continuation of hot inflation, though at a lower level of heat than before, or a welcome relief from rising prices.  Inflation could be reported as 8.5% or 0%. They sound like conflicting narratives, but they can actually both be correct. That sounds implausible, but it’s not.

A key problem is that CPI is well-known by the general public, but thanks to a combination of sloppy usage of terminology and a poor understanding of statistics it is frequently misunderstood. Many of us think of CPI as the rate of inflation, but it is actually an index. It’s not dissimilar to the S&P 500 (SPX) in that sense. Imagine if instead of reporting that SPX rose by 2.13% on Wednesday to close at 4210.24, people simply used the shorthand that SPX was 2.13%. They would rightfully get confused.CPI is an index, CPI inflation is the percentage change in that index. The Bureau of Labor Statistics (BLS) reports the percentage rates of change in that index on a one-month and one-year basis, though the year-over-year basis is more commonly reported in the press. Among other things, escalators tied to CPI inflation are baked into various labor contracts and governmental payments, thus more relevant to the general populace.

On Wednesday, President Biden said, “Today we received news that our economy had 0% inflation in the month of July”.Politics aside, this was a factual comment. The level of the Consumer Price Index, as reported by the BLS, was 296.276 in July. In June it was 296.311. That means that the monthly change in consumer prices was -0.16%, or effectively zero. This was clearly noted in the report as a zero change month-over-month. It was a factual statement but appeared to those on the opposite side of the aisle to be cherry-picked data, or worse. 

By that same measure, prices did indeed rise by 8.5% since July of last year. The level of the CPI Index in July of 2021 was 273.003, and it was 271.696 in June of 2021. The year-over-year rise from 296.276 to 273.003 was 8.5%, whereas last month the year-over-year rise from 271.696 to 296.311 was 9.1%.In a sense, we can say that the year-over-year change in prices occurred almost exclusively in the 11 months from July 2021 to June 2022 since prices didn’t change in July 2022. 

Let’s put this in a format which should be familiar to most investors – charts. Here is the change in the level of CPI since 2017:

(Click on image to enlarge)

Source: Bureau of Labor Statistics

If you think of the CPI Index like SPX, we see it rising gently until late 2020, at which point it took off sharply. It’s obvious that the annual rate of change, or annual inflation rate, was accelerating as well, which is something we see in the following chart:

(Click on image to enlarge)

Source: Bureau of Labor Statistics

We can see July’s decline in the inflation rate at the right of the graph. But it’s not even the first time this year that the rate of CPI inflation fell this year. It fell in April to 8.3% from 8.5% in March, only to continue its advance for the next two months.

Naturally, the month-over-month changes are smaller and more volatile. We see Covid-related declines in 2020, but you will notice in the chart above that annual inflation even in May 2020 never turned negative. We can clearly assert that there was deflation in the monthly measures in early 2020, but we never actually saw year-over-year CPI deflation even during the worst of that short recession.

(Click on image to enlarge)

Source: Bureau of Labor Statistics

The 8.5% jump in prices is indeed highly uncomfortable and well above the Federal Reserve’s 2% target.Whether 9.1% or 8.5%, this is a problem that our central bank must address with alacrity and resolve.But the urgency becomes more of a subject for debate if one can reasonably assert that inflation is slowing.Last month’s CPI change was definitely encouraging.While it’s understandable why politicians would want to extol it, it is less clear that central bankers with a longer-term focus would be wise to read too much from a single month.

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