Published on May 14, 2018
Investors cheered the lower-than-expected Consumer Price Index (CPI) numbers last week, but the lesser known Underlying Inflation Gauge (UIG) told a different story.
Most of the headlines surrounding last week’s release of April’s Consumer Price Index (CPI) data focused on the fact that the numbers came in slightly below analyst expectations, suggesting inflationary pressures are softening. Equities rallied and Treasury yields fell as investors breathed a sigh of relief.
However, very little attention was paid to another inflation indicator put out the same day by the New York Fed – the Underlying Inflation Gauge (UIG). The Fed uses UIG as a forecasting tool, so in my view it is a better indicator of future inflation than the CPI, which is really a spot measure.
Last week’s UIG data showed no signs of a slowdown in inflation. On the contrary, it increased 5 basis points (0.05%) in April, from 3.15% to 3.20%, rising for the 12th consecutive month. UIG is now at its highest level in 12 years and approaching its all-time high for its 23-year history.
As you can see from the above chart, there are two varieties of the UIG: The Full Data Set and the Prices-Only Index. The Full Data set is the forecasting measure, whereas the Prices-Only Index is a spot measure analogous to the well-known CPI. The full data set incorporates the current conditions from the Prices-Only Index plus a series of economic data that has proven to be predictive of future inflation. These data include Institute of Supply Management (ISM) Indices, labor statistics, money supply, and selected financial indices – in all, there are an additional 113 measures that complement the 254 price indices that comprise the Prices Only index. Both indices demonstrate rising inflation, with the forward-looking index rising more quickly than the current observation.
In a prior post on March 26, I opined that interest rates would likely rise following February’s UIG data, which was the second consecutive month the index checked in above 3%. Since that date, 2-year yields have risen 26 basis points, while 10-year yields have risen 11 basis points.
The TIPS (Treasury Inflation Protected Securities) market has also revealed an increase in inflation expectations, with breakeven yields on the 10-year TIPS rising 10 basis points in this period, from 2.08% to 2.18%. It’s important to be aware the TIPS often trade in sympathy with oil prices, which themselves have risen about 9% in the period. While there are many factors involved in oil prices, it remains an important contributor to inflation expectations and currently sits at a 3-year high.
Taken together, a slight miss in the April CPI data provides little reason to think inflation is slowing just yet. We remain cautious on interest rates, with a preference for TIPS over nominals, and for short/negative duration assets in general.
Vice President & Portfolio Manager
Eddy VataruView Bio
Vice President & Portfolio Manager
Eddy Vataru graduated from California Institute of Technology (B.S. Chemistry & Economics) and from Olin Business School at Washington University in St. Louis (M.B.A.). Mr. Vataru holds the Chartered Financial Analyst designation.
Prior to joining Osterweis Capital Management in 2016, Mr. Vataru worked in senior management positions at Incapture, LLC and Citadel, LLC. Before that he spent over 11 years at BlackRock (formerly Barclays Global Investors), where his last position was as Managing Director and Head of U.S. Rates and Mortgages. While in this role, BGI worked with the U.S. Treasury in implementing its Agency MBS Purchase Program, buying mortgages for the U.S. government from 2008-2009.
Mr. Vataru is a principal of the firm and the lead Portfolio Manager for the total return fixed income strategy. He is also a Portfolio Manager for the flexible balanced strategy.
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Opinions expressed are those of the author, are subject to change at any time, are not guaranteed and should not be considered investment advice.
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Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care.
Duration measures the sensitivity of a fixed income security’s price (or the aggregate market value of a portfolio of fixed income securities) to changes in interest rates. Fixed income securities with longer durations generally have more volatile prices than those of comparable quality with shorter durations.
The UIG captures sustained movements in inflation from information contained in a broad set of price, real activity, and financial data.
The Federal Funds Rate is the rate at which depository institutions (banks) lend reserve balances to other banks on an overnight basis.
A basis point is a unit that is equal to 1/100th of 1%.
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