Happy Halloween!

Today I have a collection of items concerning inflation (one of the boogeymen for retirees).

This article examines CPI across the world. It discusses the differences in the basket of goods used in different countries and how consumers in developing nations change their purchasing behaviors much more dramatically than developed countries.

Here is a great article by Scott Burns introducing the Personal Consumption Expenditures (PCE) which the Fed uses instead of CPI for tracking inflation. He also talks about a recent innovation out of the Dallas Fed to move away from core inflation (i.e., excluding food and energy) and instead using Trimmed PCE (a technique that excludes the extreme data points.

I’m generally not a fan of market commentary, but sometimes it is just too much fun.

From Bloomberg, on October 31st

  • The 5-Year Treasury was yielding 4.57%
  • The 5-Year TIPs was yielding 2.52%

Which means the market is projecting an inflation rate of 2.05% (or less if you think TIPs have an insurance premium component) over the next five years. Consider the following.

  • The lowest 5 year annualized inflation rate in the last forty years (since the switch to fiat money) is 2.16% (Feb 1997 – Feb 2002).
  • An inverted yield curve implies economic difficulties are ahead which should ease pricing pressures (i.e., keep inflation low).
  • Inflation as measured by trimmed PCE is rising
  • High deficit spending exerts pressure to devalue the dollar and thereby increase the price of imports.
  • The Fed has said they will not tolerate deflation and will fight inflation above 2%.
  • The CPI uses rent prices to track housing costs which is why the run up in housing prices did not effect the CPI dramatically. Depending on how much housing prices stabilize I would expect rents to start catching up over the next 5 years.
  • Hedonic adjustments implemented in ’97 reduce the CPI by 0.5% to 1.1% a year (see Bill Gross’s commentary on the subject)
  • Labor pool and productivity trends indicate that future real economic growth in the US will likely drop by a half percent.

What does all that mean? I don’t know. But if I look at all the various asset classes out there TIPs seem one of the few that are not overpriced and should perform reasonably well under most scenarios in the next 5 years.