Earlier this week, we saw the Consumer Price Index (CPI) report was down from last month and generally well below expectations—in this case, a good thing. Today, we got the Producer Price Index (PPI) report, which was also down from last month and less than expected. Inflation appears to have peaked and is potentially on track to decline.
This is good news. But I don’t want to get into the details of the numbers here. Instead, I’d like to think about how to interpret economic news in general, especially with respect to the headlines and what this data means for the future. Headlines tend to scream that inflation is at 40-year highs, which is certainly important in one sense. But as an economist and investor, that information is useless, as it is already in the markets.
The Real Question
For any data release, record or not, the real question is not where it is, but where it is going. To think about that, we can’t just look at the current number. We also have to look at last month and last year. The real question is whether things are getting better or worse. Beyond that, are they getting better or worse at a faster or slower rate? The actual number doesn’t mean that much when we look at the future—and that is how we have to look at this month’s data.
To put this in context, if you are driving 30 mph, will you get a ticket? Maybe, but it depends on whether you’re in a school zone or on the interstate. Context matters. Apart from getting a ticket, are you happy to be driving at that speed? Again, it depends. If you were doing 60 mph and had to slow for traffic, probably not. On the other hand, if you were in stop-and-go traffic and doing 10 mph when the traffic opened, you probably would feel a lot better about 30 mph. It’s not the number; it’s what it means in context.
Big Change, Not a Big Surprise?
This brings us back to inflation. Yes, inflation is down, but it is still quite high. Is that good or bad? Probably good, despite the fact that it remains high. The difference is that now it seems to be moving down rather than up. That matters more than the fact that it is still high. That change in trend is what markets are responding to. We have gone from things getting worse to things getting better. Regardless of the current numbers, that is a big change.
It isn’t that big of a surprise, either. The underlying inflation data was slowing in prior months, still increasing but at a slower rate, suggesting that reasonably soon we would see the overall trend change. You have to decelerate to a stop before you go into reverse, to go back to the driving metaphor. So when you see that deceleration, you know to look for a reversal. This is the real basis for all of the forecasting we as investors have to do: not what the number is, but where it is going—and how quickly.
That suggests more good news for inflation. It is still too high, but now the trend has changed from up to down. While it will likely take time for it to fully cool—and inflation will likely never return to the pandemic lows—the worst cases are moving off the table.
A Look Ahead
So, don’t look in the rearview mirror at the headlines, but to where we are now and where we are going. The headlines are still scary, but the future now looks a lot better.
Authored by Brad McMillan, CFA®, CAIA, MAI, managing principal, chief investment officer, and Sam Millette, manager, fixed income, at Commonwealth Financial Network®.
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