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FUNNY HOW THAT WORKS OUT!

I made a resolution to myself that I was going to try and focus on things other than inflation in this column! That is proving difficult. Inflation is such a giant focus in the market and the Fed is acutely watching changes in inflation to help them devise their strategy to begin a rate reduction cycle. The Consumer Price Index was released this morning (May 15th), and the core index (ex-food and energy) came in slightly below expectations. This has caused equities to rise by about 1% on the news.

I was discussing inflation with Nick Gentile, our Co-Head of Fixed Income, and he mentioned an analysis he recently saw discussing the composition of the CPI index. I am not playing amateur conspiracy theorist, however, there are some curious changes to the index that have occurred over the years. Someday, when I have the time and we can have a GIANT blog post, I will discuss “owners’ equivalent rent;” the real estate component of the CPI.

Briefly, as per Investopedia, “Owners’ equivalent rent (OER) is a statistic that is followed by homeowners and tracked by the Bureau of Labor Statistics. The data used for calculating owners' equivalent rent is obtained through surveys, which ask members of a household (called a consumer unit) the following question: ‘If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished, and without utilities?’1 OER is a commonly cited measure that provides a gauge for changes in real estate market values. If OER is high, it may be more worthwhile to buy a home rather than rent it. On the other hand, if OER is low, renting might be a better prospect. Owners’ equivalent rent typically changes with movements in the Consumer Price Index. OER increases over time and was steadily increasing up until 2022 when the economy was hit with high inflation, which saw OER increase at higher rates than before 2022.” My view…there must be a less convoluted way to do this! But I digress.

With respect to recent changes, coffee, vegetable shortening, and canned tomatoes were eliminated from the “basket” used to compile the CPI index. As Nick and I discussed these index changes, we sarcastically noted that the removal of a beverage consumed by a significant portion of Americans seems like an obvious choice to be removed from the index. The fact that coffee is up over 7% since year-end 2023 cannot possibly have anything to do with its removal from the benchmark2. Keep in mind that coffee reached a near-term high of 240.35 cents per pound on April 17th and that represented a price increase of 29% from year end2.

I am not suggesting that the CPI index is being manipulated. I am suggesting that inflation is a key statistic in the economy and has a major impact on interest rates, credit spreads, expected return, and other factors. A clear, understandable definition of inflation and its drivers should not be too much to ask for. Now, where is that next cup of non-inflation-adjusted coffee?!

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