Last June, inflation hit a 40-year high of 9.1%.
Since then, it’s been falling monthly, hitting 3.2% in July of this year.
The Fed’s aggressive rate hikes seemed to be doing their job, and their 2% inflation target appeared to be in sight.
But then, the August CPI report came out a few weeks ago…
…and we saw inflation spike, jumping up to 3.7%.
What happened? Where does inflation go from here? And should we be worried about this recent uptick?
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- Bureau of Labor Statistics CPI Report
- Historical Inflation Rates
- The Effects of Rounding on the Consumer Price Index
- Inflation: Don’t Pop the Champagne Yet
- United States Month Over Month Inflation Rate Average
What the Media Won't Tell You About Inflation
Taylor Schulte: Last June, inflation hit a 40-year high of 9.1%. Since then, it’s been falling month over month, with headline annual inflation hitting 3.2% in July of this year.
The Fed’s aggressive rate hikes seemed to be doing their job, and their 2% inflation target appeared to be in sight.
But then, the August CPI report came out a few weeks ago and we saw inflation spike, jumping up to 3.7%.
Where does inflation go from here?
And should we be worried about a double bump in inflation like we saw in the 70s?
Welcome to the Stay Wealthy podcast, I’m your host Taylor Schulte, and today I’m diving into the details of the recent CPI reports to help provide some perspective on inflation and where we might be headed.
To grab the links and resources mentioned, just head over to youstaywealthy.com/200.
As a refresher, inflation refers to the rise in prices for goods and services. And it’s important to monitor because the higher prices rise, the more our purchasing power declines. In other words, it takes more of our dollars to buy that same gallon of milk or take that same vacation. As a result, us consumers have to either earn more money or find a way to spend less.
Some inflation year over year is healthy and expected. But unexpected, skyrocketing inflation OR high, prolonged inflation can cause some serious economic harm. And that is precisely why the spike in inflation in recent years has been making headlines.
Everyone, including the Fed, has been nervous about higher-than-average inflation and the damage it can do if it’s not contained. Hence why they’ve rapidly raised interest rates in an attempt to inject some pain into the economy and slow things down.
I’ve covered inflation extensively on the podcast in recent years, but as a reminder, inflation reports (also known as CPI reports) come out monthly. CPI stands for Consumer Price Index and this index measures the MONTHLY change in prices for things that everyday consumers are purchasing. Food, energy, vehicles, shelter, etc.
If all of these things become more expensive month over month, headlines will conclude that inflation is on the rise. To be extra clear, when we see a spike in prices, it doesn’t mean that those prices will remain high or continue to increase at that rate forever, it just means they were higher this month than the last.
While CPI reports come out monthly and highlight the month-over-month change in prices, inflation is typically talked about as an annual number, like the 3.7% number I shared when referencing the August CPI report. As I’ve shared before, that 3.7% is backward-looking – it’s measuring the rate of inflation over the past 12 months, from August of 2022 to August 2023.
As mentioned at the top of the show, the July CPI report indicated an annual inflation rate of 3.2%. Compared to 3.7% figure reported in August, the conclusion is that, year over year, prices are increasing at a higher rate again.
These annual figures provide a good reference point but don’t necessarily tell the whole story, and don’t help us make educated assumptions about the future. And while nobody has a crystal ball, looking at the month-over-month change in prices sheds a little more light on where we’re at and where we could be headed.
So, let’s open up the hood and take a deeper look.
In August of 2023, last month, prices rose 0.6% as measured by the Consumer Price Index (or CPI). To get to the 3.7% annual figure I’ve been referencing, we simply add the monthly percent change from September of 2022 to August of 2023.
In other words, the August 2022 monthly inflation figure is removed from the annual calculation and replaced with the newly reported August 2023 figure. And this is important because in August of 2022, month over month, inflation only rose 0.2%.
So, fast forward to August of 2023, anything reported that’s higher than 0.2% would have caused the backward-looking annual inflation number to spike.
Said another way, that nice low 0.2% number from last August was replaced with 0.6% this August, taking us from 3.2% year-over-year inflation reported in July to 3.7% here in August.
The August 2023 monthly reported change in prices could have been closer to the long-term historical average of 0.3%, and the media would have still run headlines telling us that year-over-year inflation jumped. And while that would be true, the annual figure doesn’t tell the whole story. It eliminates the fact that a historically low monthly reading from last August was dropped from the annual calculation and replaced with something higher.
By the way, quick side note. If you’ve been following me closely and trying to replicate the math, you might conclude that it doesn’t perfectly add up, and that’s because the Bureau of Labor Statistics rounds the Consumer Price Index to a single decimal place before releasing it, and the published CPI inflation series is calculated from those rounded index values.
For example, in August of 2023, the monthly change in prices wasn’t 0.6%, it was actually 0.63%. In July of 2023, it wasn’t 0.2%, it was 0.17%. I’ll provide a link in the show notes if you want to dig deeper into the methodology, rationale, and implications of this rounding, which can again be found by going to youstaywealthy.com/200.
Ok, so to quickly summarize where we are at, year-over-year inflation jumped from 3.2% in July of 2023 to 3.7% in August, and that’s because the nice low 0.2% uptick from last August dropped out of the backward-looking annual calculation – and it was replaced with a monthly increase of 0.6% here in August of 2023.
So, how does this help us make some educated guesses about where we might be headed? Well, to start, as I just mentioned, the long-term historical average for month-over-month changes in the consumer price index is about 0.3%.
In other words, if monthly CPI was in line with our long-term average and rose by exactly 0.3% every month for an entire calendar year, the annual rate of inflation for this hypothetical year would be 3.6%, the often-referenced long-term historical average for inflation.
But it’s likely safe to say that, right now, we aren’t in a long-term historical average environment. Inflation has been a problem, and it’s been well above the long-term average in recent years.
So, with four months of inflation reports left for the year, perhaps we assume that the monthly percent change in prices from now until the end of the year is closer to the trailing 3-year average, which is about 0.45%.
In other words, let’s say that the upcoming September CPI report comes in at 0.45%, October at 0.45%, November at 0.45%, and December at 0.45%. If that were to happen, annual headline inflation would end the year at 4.3%. That’s adding up the month-over-month change from January to December, inclusive of our assumed rate of inflation for the last four months of the year.
And that 4.3% number that isn’t too far out of the realm of possibility is significantly higher than the 3.2% figure reported two months ago in July. If this happens, the media would no doubt have a field day and likely inject a lot of fear into consumers and investors. But in reality, it’s not that far-fetched and doesn’t necessarily indicate a reversal in the long-term downward trend.
Again, if ignore the headlines for a minute and zoom in on the monthly historical inflation numbers, we’ll find that in November of 2022, inflation was 0.2%, and December was 0.1%. Those are some nice, historically low inflation figures that will be dropped from the annual inflation calculation and potentially be replaced with something higher.
In order to maintain our current rate of inflation, which sits at 3.7% as of August, we would need to see the remaining four monthly CPI reports match our long-term historical average of 0.3%.
And while that could certainly happen, it doesn’t really change the narrative too much. We would still end the year with a higher annual inflation number than the low of 3.2% that we saw in July. Which again would likely lead media outlets to send the wrong message to retirement savers.
Instead of reporting that we had four straight months of inflation readings in line with our long-term historical average to finish off the year, the message will likely be that inflation is heating up and continues to be a threat.
Now, I’m not saying that we’re out of the woods and that we should ignore the recent uptick in the annual inflation reports. I’m just saying that it wouldn’t be crazy to see annual inflation remain at this 3.7% number through year-end or even creep up into the 4% range.
And not necessarily because inflation is rearing its ugly head again… it could just be that some of the ultra-low monthly inflation numbers from the last quarter of 2022 are dropping off and being replaced with slightly higher numbers that are more in line with recent averages to finish off 2023.
As Rob Arnott put it in his recent paper on inflation that I’ll link to in the show notes,
“We find it a bit amusing that, if inflation finishes the year at half its peak levels of mid-2022, it will be an adverse shock to many investors. If we finish the year at 4½% inflation, we will be pleased by it following a dangerous inflationary surge, but most of the investment community, media, and political elite will likely be alarmed (fear sells!).”
My attempt to analyze and make educated guesses about the future has nothing to do with pretending I have a working crystal ball that allows me to put myself (or my clients) in a better financial position…and has everything to do with eliminating surprises. Eliminating surprises so we don’t react or respond irrationally and put our retirement plans in jeopardy.
It’s not all that different than our intentions behind understanding and evaluating the financial markets in an effort to make smart investing decisions. If we know that the stock market is in negative territory 1 out of every 4 years, then we shouldn’t be surprised when it happens.
If we know that the stock market suffers losses of 30% or more every 10 years, then we shouldn’t be surprised when it happens. And if we know that inflation could jump up into the 4% range by year-end, even with some fairly conservative monthly reports to finish off the year, then we shouldn’t be surprised by it.
And we shouldn’t let the headlines that may come as a result cause fear and panic and uncertainty. I think most of us would prefer to plan for the worst – or at least have a plan for less ideal outcomes – and hope for the best.
Once again, to grab the links and resources mentioned in today's episode, just head over to youstaywealthy.com/200.
Thank you, as always, for listening and I will see you back here next week.
Episode Disclaimer: This podcast is for informational and entertainment purposes only and should not be relied upon as a basis for investment decisions. This podcast is not engaged in rendering legal, financial, or other professional services.