CPI : Rotten to the Core

While CPI has ticked up of late, rekindling inflation fears, global long-term interest rates, a better indication for the market's expectation of inflation, remain benign.

Story Highlights:

  • The consumer price index (CPI) has ticked up of late, rekindling inflation fears.
  • But CPI is a flawed and frequently misinterpreted index.
  • Global long-term interest rates are a better measure of inflation expectations.


Inflation concerns once again dominate headlines, partly due to increases in the consumer price index, the popular inflation indicator known as CPI. And the latest news is CPI took quite a jump in June.

U.S. Consumer Prices Climb by the Most Since 2005
By Shobhana Chandra, Bloomberg

Note: CPI is measured two basic ways—headline and core. And it's true, headline CPI was up more than forecast for June. However, less commented on was the "core" number (which strips out food and energy prices) has remained benign. Core CPI has stayed generally between 2% and 2.5% over the last several years (far from the 10% to 13% stagflationary days of the 1970s).

Inflation-spooked folks may wonder why on earth stripping out food and energy makes any sense. After all, gas and energy prices seem like they're skyrocketing lately—as we're reminded every time we drive past a gas station.

But food and energy prices are stripped out of the core number precisely because they can be extremely volatile. Let's not forget, Tuesday and Wednesday featured record downward volatility for oil.

Oil's 2-Day Decline: $11 a Barrel
By Kenneth Musante,

Such volatility tends to make the headline number bounce around from month to month. Folks tend to accept this when inflation is further down their list of market concerns, and both measurements are considered valid. However, when certain headline prices spike—as energy and to some degree food have—suddenly the core reading is index non grata. But that's not right—investors shouldn't only accept indicators when they corroborate their conclusions.

As we said in our 07/16/2008 cover story "Demand or Speculate," investors like to have it both ways. This may suit our present psyches, but it's not very instructive in figuring out what's impactful looking forward.

The more important point is—when it comes to CPI—it might be better to have it neither way. That's because CPI, core or otherwise, is your typical government indicator prone to inconsistencies, biases and revisions—and perhaps better if viewed with a highly skeptical eye.

Fortunately there's a better, market-driven way to gauge whether inflation is a legitimate concern looking forward: global long-term interest rates. They are very sensitive to inflation expectations. Why? If you are going to lend someone money for 10 years (basically, this is what you do when you buy a long-term bond), and you expect inflation to move higher, you will demand a higher rate from your money renter. This makes long-term rates one of the best indications of where the market expects inflation to go. (See our recent cover story, "Global Inflation Conflagration" 06/16/08, for more.)

And with global bond yields remaining very benign (currently under 4% for US Treasury bonds), though headlines fret, the market seems more disinterested. When looking for guidance on inflation, don't trust CPI—it may be a bit rotten to the core.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.