How Headline Inflation Works
It has been a long time since Americans have dealt with serious inflation. The United States, and the whole world, is working to bring down inflation resulting from the lingering effects of COVID-19 and the prolonged invasion of Ukraine by Russia. I would like to provide a little insight into how the Headline Consumer Price Index (CPI) is calculated and what to expect going forward.
Inflation is comprised of many different components (energy, food, and goods) that build up to one primary number called Headline CPI that is typically reported and discussed in the news.
Below is a chart of annual inflation dating back to 1948. After the high periods of inflation in the 1970’s and early 1980’s, annual inflation has only peaked above 5% twice. The first time was in the early 1990’s and the second in 2008-2009 as a result of the Global Financial Crisis. This was followed by a brief period of deflation (prices going down).
Inflation Calculated over the Last 12 Months
The Consumer Price Index (CPI) is based on monthly readings of inflation from a variety of products meant to represent a basket of purchases for an average, urban American. Since 2004, the United States has experienced lower rates of inflation than historic averages. You can see this visually in the chart above. On average, the inflation rate during this time was ~2.4% per year or 0.21% per month.
The number you see in the news for CPI measures how much prices increased from one year ago. To calculate this, you multiply each monthly inflation rate together during the 12 month period to get the total annual inflation rate for that period.
The table on the right shows the monthly readings for the last 12 months. All of these individual monthly readings make up the August 2022 1-year ago inflation.
A quick look at the table shows 10 of the last 12 months were over this average of .21% … but not the last two! That is at least a little progress.
What to Expect Next?
What is important to note, is that CPI won’t suddenly revert to the old 2.4% average. The CPI calculation is a rolling return meaning the high months of March (1.24%), May (.97%), and June (1.32%) will take some time before they roll off of the headline CPI.
The table to the right illustrates (and it’s just that, an illustration not a forecast) what the future headline CPI numbers would look like if inflation reverted back to the average of 0.21% inflation per month from here on.
Notice that we won’t, mathematically, get below 5% annualized inflation until February 2023 if inflation comes in at just the historic average. It could fall faster if inflation comes in significantly lower or negative.
Why the Recent Headline Inflation Jolted the Market?
If the overall inflation figure was below average, why did the market react so strongly? The answer lies in the components that make up the headline. Specifically what is called “Core CPI” which pulls out Food and Energy which tend to be very volatile.
It is this Core CPI figure that ticked upwards against expectations causing investors to re-evaluate their future assumptions.
No one knows what the future of inflation holds. Hopefully, inflation will subside and return to a more sustainable rate. It is important to have a plan for whatever risks the future holds – whether unexpected inflation, long-term care costs, or an unexpected death. A comprehensive financial plan can give you peace of mind that you and your loved ones will be cared for.
At Gilbert Wealth, I am an independent, fixed fee-only financial planner and wealth advisor providing thorough and researched financial and investment advice. My goal is to make the pieces of your financial life work in balance with each other and help my clients be comfortable and confident about their financial futures. If you’re not a client, book an introductory meeting on my online or give me a call. I’d love to talk to you.