Today we got the US inflation (CPI) data for January.
Both headline inflation and core inflation (excluding food and energy prices) came in higher than expected. Headline inflation was 3.0% year-over-year, while core inflation rose to 3.3% year-over-year.
This is hardly good news.
However, we should be very careful about drawing too many conclusions from month-to-month changes.
This is why I’ve taken a broader view. I’ve looked at the 1-, 3-, 6-, and 12-month growth rates in both CPI and core CPI (annualized) and combined all of these into a single number. This approach should help filter out the noise in the data and capture the underlying trend.
You can see this in the graph above, where I show the Deep CPI Trend against the Fed’s 2% target, along with the range of 3-month moving average inflation rates.
What we observe is that what I call the “Deep CPI Trend” was falling after the inflation shock of 2021-22, but we never quite managed to return to 2%. Just as we were almost there about six months ago, the Deep CPI started moving upward again.
Now we’re almost at 4% – far above the Federal Reserve’s official inflation target. We’re seeing something similar in consumer inflation expectations – which have become stuck above 2% and have recently increased sharply.
If we look at Google searches for the word “inflation” in the US, we see the same pattern. We’ve never returned to pre-2020 levels. In fact, the data shows search interest running at about twice the pre-pandemic levels.
I find it hard to interpret this as anything other than an erosion of Federal Reserve credibility.
Some thoughts on Truflation – when the truth isn’t so truthful
Many of my readers have been asking me about the Truflation index, which, despite its name’s implications, might not be telling us the whole truth about inflation dynamics.
Truflation is a digital platform that calculates inflation in real time by gathering data from a wide range of sources. It uses blockchain technology to ensure transparency and accessibility for everyone. The goal is to provide a more dynamic and up-to-date picture of price developments in the economy.
The index is showing a rather different picture with inflation dropping sharply, but there are good reasons to be skeptical.
I’ve long been an advocate of using high-frequency indicators in monetary and economic analysis, and I was initially quite excited about Truflation and have often used the data. However, I’m becoming increasingly skeptical about its methodology.
The main problem is that Truflation adjusts the weights for different commodity groups monthly. This creates significant jumps in the data, particularly visible at the start of each month, when these weight adjustments take effect.
The UK data provides a particularly clear illustration of this problem. Since Truflation launched its UK series, we have seen large jumps at the beginning of multiple months throughout the year. While official UK inflation is trending down through 2024, Truflation shows the opposite pattern. These systematic jumps at the start of each month are clearly methodological artifacts rather than actual inflation dynamics – a problem that becomes very apparent when analyzing the UK data series in detail.
While I appreciate what the Truflation team is trying to do, and I think it’s still a potentially useful tool, I suspect the developers might not fully grasp all the economics aspects of what they’re measuring.
The broader picture
The broader point here is that the Federal Reserve’s credibility is being eroded.
When the US public loses faith in the central bank’s commitment or ability to maintain price stability, we risk inflation expectations becoming unanchored. As Milton Friedman taught us, expectations matter greatly for inflation dynamics.
The evidence for this erosion of credibility is mounting.
The latest University of Michigan Consumer Sentiment Survey shows short-term inflation expectations jumping to 4.3%, while long-term expectations continue drifting upward – a particularly worrying development that occurred even as actual inflation moderated through 2023-24. See also here.
This isn’t just survey data speaking – if we look at the Google Trends data shown below, we can see that public concern about inflation remains quite elevated.
The search interest in “inflation” is still running at about twice the pre-2020 levels, clearly indicating that inflation remains top of mind for the American public – and it likely was the key reason Donald Trump won the presidential election.
What’s particularly concerning is that this elevated level of inflation awareness has persisted long after the initial 2021-22 inflation shock. In a situation where monetary policy was credible, we would expect to see these indicators returning to their pre-pandemic levels. The fact that they haven’t suggests that the public isn’t fully convinced by the Fed’s commitment to price stability.
This is exactly what we’re seeing reflected in our Deep CPI Trend measure – inflation expectations becoming entrenched above target, making the Fed’s job increasingly difficult.
The combination of actual inflation readings, consumer expectations, and public interest in inflation all point in the same direction – a persistent credibility problem for the Fed. While we’re not yet in a 1970s situation, the warning signs are clear.