U.S. inflation: Further Significant Declines Expected

Year-on-year growth in U.S. consumer prices fell to 3.6% in October from 3.9% in September. Due to its significant contribution of 32% to the overall CPI, shelter continues to keep the CPI in check with its year-on-year gain of 1.8%. The CPI excluding shelter fell to 4.4% in October from 5% in September on a year-ago basis. I was not surprised, though. More than 90% of the change in the CPI ex shelter with a one-month lag can be attributed to the year-on-year absolute change in the price of crude oil as represented by Light Louisiana Sweet.

Sources: I-Net Bridge; FRED; Plexus Asset Management.

The change in the oil price from a year ago indicates that the CPI ex shelter is likely to fall further to the 3.8–4% region in November. Assuming that growth in the shelter PMI remains unchanged at 1.8%, it means the overall CPI is likely to be in the vicinity of 3.2%, marking the lowest year-on-year growth since April this year. It will mean that in November the CPI will plunge by 0.27% from October – the largest decline since November 2008.

Producer price inflation is also rolling over. The change in the price of crude oil from a year ago indicates a further drop in the year-on-year growth rate of the PPI in November and December to approximately 5.5% is on the cards. That compares with 6.1% in October and 7% in September.

Sources: I-Net Bridge; FRED; Plexus Asset Management.

I expect year-on-year growth in both CPI and PPI to moderate further to 2% and 3% respectively in the first quarter of 2012 should the oil price remain unchanged at current levels. I do not think the FOMC will be concerned about slowing inflation as real disposable income will benefit substantially. An abrupt decline in both these gauges is unlikely unless the oil price falls out of bed. A sharp drop in the oil price will indicate global demand is falling and will in any event result in the FOMC acting aggressively.

Furthermore, I expect the growth rate of the core CPI to accelerate as its honeymoon resulting from a weak shelter CPI (contributing approximately 38% to the core CPI) is over as the latter’s growth on a year-ago basis is catching up with the growth in other components of the index.

Sources: I-Net Bridge; FRED; Plexus Asset Management.

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