Consumer Prices Flat but the Sky is Not Falling
- The July Consumer Price Index was unchanged as energy prices eased for the fourth straight month.
- The June core CPI increased by 0.1 percent as new and used vehicle prices fell.
- Industrial Production increased by 0.6 percent in July, with gains in vehicle assemblies.
- The MBA Mortgage Applications Survey showed declining purchase apps through August 10.
- The National Association of Homebuilders Survey showed improving conditions again in August.
That consumer prices are weak is apparent in the July CPI report. However, it is very important to ask why consumer prices are weak, especially because of the ongoing intrigue about possible Federal Reserve policy actions. The consumer price index was unchanged in July as energy prices fell for the fourth consecutive month. With now four consecutive weak consumer price reports, the headline CPI for July is essentially unchanged from February. This can be interpreted as yet another signal that the economy is weak and heading back into recession, and therefore could be a motivation for another round of quantitative easing by the Fed. However, much of the drag on the CPI is coming from energy. The energy sub-index of the CPI has decreased every month from April through July. Lower petroleum prices this spring and summer have little to do with collapsing demand for transportation. Gasoline prices are in part lower because the U.S. petroleum supply is increasing and U.S. vehicles are increasingly fuel efficient. That is to say that technology changes have shifted both the supply and the demand curves for gasoline. The other big part of gasoline prices involves geopolitical risk for international crude oil supplies, which is unrelated to aggregate demand in the U.S. Technology has also shifted the supply curve for natural gas, giving drillers an incentive to keep drilling at lower prices. If we remove energy from the CPI we see a different picture. CPI less energy (not the familiar core CPI, less energy and food) has increased every month since February 2010, and is now up 2.1 percent on a year-to-year basis. Moreover, food prices are expected to put increasing pressure on headline CPI. That did not happen in the July CPI report as consumer food prices increased by only 0.1 percent. However, in the July producer price report we do see upstream food prices increasing as a result of the Midwest drought. Another side effect of the drought will be higher transportation costs for some commodities normally shipped by barge, which may temporarily need to be shipped by rail. The core CPI for July gained 0.1 percent, held down by weaker prices for new and used vehicles. In vehicle prices is where we may be seeing some drag from weaker demand, as new car sales have plateaued near a 14 million unit annual pace so far in 2012. Technology is also having a broader impact on both consumer and producer prices, as the combination of increasing market penetration of smart systems along with the ongoing decrease in computational costs is shifting both supply and demand curves for a range of products and services. To sum up, current weak consumer prices are not entirely due to a weak economy, in some cases, just the opposite.
U.S. industrial production increased by a solid 0.6 percent in July with gains in manufacturing, mining, and utilities. Manufacturing was in turn boosted by a 3.3 percent increase in motor vehicle and parts production. The gains in vehicle production are consistent with the shorter-than-normal summer shutdowns at auto plants this year. Mortgage applications fell for the week ending August 10, showing the fourth consecutive weekly decline in purchase apps, indicating soft numbers for new and existing homes sales in August. Conversely, the National Association of Home Builders housing market index for August increased for the fourth consecutive month. The biggest gain in the August NAHB survey was in the Midwest.
Market Reaction: Equity markets opened weak, but have since rebounded. Treasury yields are up at the long end of the yield curve. NYMEX crude oil is up to $93.71/barrel. The dollar is up against the yen and the euro.