WE MISS DEFLATION FEARS

The key metrics that investors should be watching on inflation

Despite having their worst week in two years, US stocks took a further sharp turn downwards yesterday, falling more than 1,000 points and erasing all of 2018’s gains. And the VIX—a key measure of stocks volatility—has doubled since the start of the year.

One of the key concerns? Inflation.

We already believe that the Federal Reserve will add a surprise fourth interest-rate hike this year to curb inflation. But how will the US central bank know when inflation—that is, the cost of goods and services—is rising and they should be worried?

The most-cited inflation indicators remain relatively stable and within desired bounds. But there are a few key indicators are suggesting that there could be more going on. We’re focused on prices and wages.

Prices

While every measure of retail pricing is trending upwards, one in particular is above its typical range and trending higher: median CPI. The median-price change is the price change that’s right in the middle of the long list of price changes that are used to calculate CPI and, according to new research done by the Cleveland Fed, is one of the better predictors of near- and longer-term price rises.

The Underlying Inflation Gauge (UIG) is also on the rise. The UIG is important because it represents the most robust measure of trend inflation. It is derived from a large dataset, not just price variables. It is based on the premise that if there are trends in other economic and financial indicators then it’s likely that there are trends in underlying inflation.

Producer-price indexes for commodities and materials are generally falling. However, the ISM Manufacturing Index, a survey-based index that sources information directly from the front lines of company supply chains, is rising. When it’s rising, it means that employment, production, inventories, new orders, and supplier deliveries are also rising, which is good news—but is also a potential indicator of imbalances forming. This index has been steadily rising for a couple of years, from a low in January 2016 of 34, to a recent peak of 69, as of November 2017. We are watching closely for any departure from its typical upper limit of around 75.

Wages

Wage stagnation has been an ongoing problem. But wages seem poised to move, and they could move faster than expected. It’s a complex picture in the US but we have narrowed our focus down to a couple of measures.

The National Federation of Independent Businesses surveys small businesses on a variety of labor-market indicators. The NFIB worker compensation survey is an important insight into the pressure on small business to raise pay. According to the survey, the shortage of qualified workers reached a record high in December, suggesting that wage pressure could build at a rate higher than anticipated.

(While comparable data for January hasn’t been released, the top-line wage growth figure for January supports this trend. Average hourly earnings for all private employees increased to $26.74 in January, from $26.65 in December.)

We are also watching wage-growth statistics, focusing on four particular groups:

  • Part-time workers, because they have seen some of the least recovery;
  • Young people, because they are a proxy for the ability to switch jobs for a higher wage;
  • Lower-skilled workers, because we think the ability to automate low-skill jobs is overstated;
  • Metro areas, as a rise may indicate a limit on rural-to-urban migration.

All of this together is not perfect. But it goes some way to answering the question about whether inflation is coming back. Nevermind the fact that everything we know about inflation may actually be wrong.


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