A dive into the inflation numbers with bonds, oil & trade (09 Oct 2022)

A dive into the inflation numbers

The most important news in the coming week should be the Consumer Price Index (CPI) update on 13 Oct 2022.  CPI represents inflation in the economy.  Inflation is the "invisible" tax on all (affecting especially the lower income demographics as prices are rising, leading to a lesser disposable income and thus, reduced spending power.  With the "favourable" unemployment number of 3.5% announced on 7th Oct 2022, this will be a key reference for the Federal Reserve's coming interest rate hike.  It is expected that the inflation to remain elevated and the market seems to be factoring in a 75 basis points rate hike.

Monthly 12-month inflation rate in the United States from January 2020 to August 2022

From the chart above, inflation may have peaked.  However, it is to note that this is based on a "12-month rate".  This meant that the inflationary impact prior to the periods before the 12 months was removed from the calculation.  I do not think that there is any fraudulent intent as we need a duration to "express its magnitude within a defined period of time".  To better understand the inflationary impact and changes, we should also look at the cumulative inflationary impact as per the chart below:

US cumulative inflation chart (1913 - July 2022)

(Source: https://inflationdata.com/articles/2022/08/10/u-s-cumulative-inflation-since-1913/)

It can be a tad far-fetched to appreciate how the cumulative inflation reached 2,923.22% between 1913 to July 2022.  However, if we are to narrow this down between December 2009 to July 2022, we get a cumulative inflation rate of approximately 820% (using 2,923.23 less 2,103.56).  To appreciate the inflationary impact of the aggressive money printing since Covid in 2020, let us look at the increase in cumulative inflation between December 2019 (2,522.18%) and July 2022 (2,923.22%).  Between this period (Dec 2019 to July 2022), the US has experienced cumulative inflation of 400+% in over 2+ years (32 months to be exact).  This works out to be over 12% average inflation every month using Dec 2019 as the base month.

Without getting into the technicality of the "basket of goods and services and their respective weightage", different sources have claimed that the inflation (CPI) figure may not always represent what is experienced on the ground.  In fact, the US Bureau of Labor Statistics published an article in Aug 2012 titled " Consumer Price Index data quality: how accurate is the U.S. CPI?"  In this article, they addressed concerns about the basket, the sampling and the methodology.  The article can be found in the link below: https://www.bls.gov/opub/btn/volume-1/consumer-price-index-data-quality-how-accurate-is-the-us-cpi.htm

My investing muse

Looking at 8.3% as a year-on-year inflation rate may disconnect us from the bigger picture as we have experienced inflation of over 400% since December 2019 (pre Covid19).

The US Dollar is really strong and it is not good for US exports as they will become more expensive.  Looking at the UK whose pound has fallen to a record low against the USD, this will imply that their energy costs will be more expensive.  The UK needs to purchase oil in USD (as the world's reserve currency) which is needed for fuel and some of this is converted into electricity.  This places inflationary pressures as the fuel becomes more expensive.  It would require more GBP (English pounds) to purchase even if the oil price remains the same.

With the Fed increasing the interest rates, there will be more international funds coming in to "purchase" USD bonds with "better returns".  This is a double-edged sword and needs to be managed properly if the countries are priced out and forced to turn to more affordable (non-US) options.

However, inflation has 2 components of demand and supply.  The increases in interest rates should slow down the demand.  However, interest rate adjustments may not always help to address issues of supplies and delays of such supplies due to supply chain challenges.  The US is short of 80,000 drivers and the ports of Los Angeles & Long Beach are in need of infrastructural improvements, interest rate changes may not help directly.  With rate hikes, it could be even more costly for the ports to take up loans for such improvements.

The Fed has a difficult job of balancing both inflation and unemployment.  Both work in opposite directions and thus, it is a tough balancing act.  From the recent interviews, the Fed seems bent to bring down the inflation beast which should lead to an increase in unemployment.  

Let us spend within our means, do not leverage.  This can be painful but it is needful for the economy before inflation spins out of control.