Takeaway: Core CPI inflation came in at 2.6% year over year, much lower than consensus expectations of 3.0%. That’s the largest difference between expectations and reported CPI in recent memory. Rates will fall ever so slightly, but not nearly as much as they normally would given the seismic miss because the data are heavily distorted by assumptions the Bureau of Labor Statistics (BLS) made to smooth over the missing October data.
Up to a third of the goods and services that factor into core CPI may have distorted prices due to missing data collection and assumptions necessitated by the government shutdown. Most of these distortions should resolve in December, but some will take longer, including rent.
- The government shutdown that ended November 12 meant that (1) October inflation data could not be collected and (2) November data collection was delayed. With October data missing, the BLS could only release year over year metrics or two month average metrics, not the usual month over month metric.
- Economists expected core inflation to read 3.0% year over year in November. However, the BLS published a methodological update last night that caused forecasters to update their expectations in favor of a lower reading closer to 2.8%. The actual reading came in at 2.6%, a historically large miss relative to expectations.
- Today’s inflation data is biased downwards because the BLS does not collect new prices every month. For many items, they collect prices every two months or every six months. For the items scheduled for collection in October, the BLS policy is to carry forward the price from the previous month. This assumes that prices stayed flat (implying zero inflation) rather than assuming the same inflation rate from the previous period. This is consistent with their normal procedure and potentially affects up to 30% of the total basket. Those items with price collection every two months should see a reversion in December, but rent is collected every six months, so part of the rent sample will have lower than expected inflation until April.
- It would be like if you wanted to measure how much temperatures rose in the United States between May and July, and you measured temperatures in every state in May, but then only checked half of states in July, and assumed temperatures were flat in every state you didn’t check. You would significantly underestimate temperature increases.
- In addition, the shutdown delayed November data collection deeper into the holiday discounting window, so the BLS collected lower prices than they otherwise would have. This was taken into account by forecasters ahead of time and should revert in December.
- The distortions in the data obscure any underlying real decline in inflation that may be present. The December data will be much less noisy, but still not fully back to normal.
Mortgage rates will not drop nearly as much as they normally would after such a big decline in CPI because the distortions mean the Fed will not use this data to justify a rate cut.
- Fed Chair Powell had sent a clear signal in the last press conference that the noisy post-shutdown data would not be a greenlight for a January rate cut, saying “So we’re going to get data, but we’re going to have to look at it carefully and with a somewhat skeptical eye by the time of the January meeting,…and understand that it may be distorted by very technical factors.”
