Articles

Three More Months until the Intermission Ends

May 26, 2015

Two of the key statistical series that analysts count on to help them understand what is going on in the economy have been almost unintelligible for the past nine months.

2015 05 26 US and Canada Inflation Graphic

World oil prices began their steep descent in July of last year, producing effects that first showed up in other data in August 2014. Since that time, the measures of both inflation and retail sales have been knocked way out of kilter. (Retail sales are traditionally reported in ‘current’ or not-adjusted-for-inflation dollars.)

‘All-items’ inflation has been reduced to near-zero in both the U.S. and Canada and retail sales have been anemic, due to one special circumstance.

The headline Consumer Price Index (CPI) in the U.S. in April was -0.2%, while in Canada it was +0.8%. A huge retreat in energy prices was the major explanation, with year over year gasoline being -31.7% in America and -21.0% in Canada.

A sub-plot has featured currency values. A strong greenback has lowered the price of imports in the U.S.; a weak ‘loonie’ (i.e., Canada’s currency) has driven up the price of imports north of the border.

Leaving out food and energy items – because their prices tend to be extra volatile – in the calculations of inflation for both countries yields ‘core’ rates of +1.8% in the U.S. and +2.3% in Canada.

Those levels aren’t far off the +2.0% target considered desirable by the Federal Reserve and the Bank of Canada. As a result, there isn’t a great deal of fuss being made about a deadline that is fast approaching.

I’ll have more to say on that pivotal date in a moment, but first consider what’s been happening with retail sales.

In April, total retail sales in the U.S. were a nearly comatose +0.9% year over year. Dig into the detail, however, and you’ll quickly discover that, on account of petrol’s price plunge, sales wrung up at the gas pump fell 22.0%.

Omitting gasoline stations from the mix yields a year-over-year change in U.S. total retail sales of +3.6%. Although that’s still below the +5.0% benchmark figure that indicates a healthy level of buying activity by the public at large, an improving jobs market and steadily increasing salaries are guiding U.S. shoppers in the right direction.

In Canada, the latest year-over-year retail spending gain of +3.1% is elevated to a pleasingly robust +6.2% if the 17.4% drop at the cash registers of gasoline stations is ignored.

Think of the past nine months as being an intermission in the world economy’s latest Cinema Scope production.

On account of simple mathematics, having to do with the year-over-year percentage-change calculation, the interlude will end in three months. 

From August of this year on, gasoline and other energy prices will no longer be compared with figures that were much higher. Latest-period values will be versus numbers that rapidly declined through the second half of 2014.   

As long as global energy markets don’t deteriorate further from their current state, we’ll soon stop seeing annualized price pull-backs of -20% to -30%.

If the scenario unfolds as expected, without major surprises – although that can hardly be counted on these days − there will be a fairly rapid return to energy pricing stability.

Hence, ‘all-items’ inflation rates, no longer burdened with fossil fuel drops, will pick up speed again.

Central bankers must be worried that a media focus on ‘all-items’ inflation will then lead to an elevation in ‘core’ rates as well – through wage bargaining and opportunistic pricing decisions by managers in many services and goods sectors.

This is probably why Janet Yellen, Chairman of the Fed, recently re-stated, during a speech at her alma mater − Brown University in Providence, Rhode Island − that she would like to proceed, after seven years of inaction, with a (supposedly price-restraining) first rate hike before the end of 2015. 

As for retail sales, gasoline prices staying at their current low level will continue to present drivers with a bargain, relative to earlier times.

The fact gasoline prices will be ‘flat’ year over year, rather than ‘falling’, will also provide a lift for total retail sales.

As a positive side effect, analysts will become more optimistic about the economic outlook.

(Consumer spending as a share of gross domestic product or GDP is 70% in the U.S. and 55% in Canada. Foreign trade plays a bigger role in Canada than in the U.S., driving down the share dependent on domestic purchasers.)

The commotion surrounding energy prices is obscuring some significant price movements in other areas of the economy.

On account of U.S. exchange rate strength, year-over-year prices for television sets (-16.2%) and personal computers (-10.0%) in America have been in marked decline.

And the drop in energy prices, including jet fuel, has helped lower airline fares to the point where they are now -7.5% year over year.

But for many other notable items, there have been year-over-year price increases of +5.0% or more. Included are such categories as: admission to sporting events, +6.4%; college textbooks, also +6.4%; hotel and motel lodging, +5.6%; gardening and lawn care services, also +5.6%; tax return preparation and other accounting fees, +5.5%; and motor vehicle insurance, +5.4%.

In Canada, a major price hike has occurred in traveler accommodation, +6.7%; but what people are commenting on most is the trajectory of the price for meat, +11.2%.

The foregoing scenario, in which year-over-year energy prices ease back into stability from August on, and ‘all-items’ inflation gradually rises again, is the best case model. 

There is another outcome that warrants consideration.

What will be the inflationary ramifications if, by any wild chance – for example, brought on by a ratcheting up of military action in some conflict zone (e.g., the Middle East, Ukraine, West Africa, etc.) − there is a spike in energy prices over the next 12 months?

The only and rather-lame response that immediately comes to my mind is, “Well then, Houston, we have a problem.”

Click here to view Alex Carrick's AEC Café 2015 AIA Convention Video.

Canada inflation – all items CPI vs CORE*
(not seasonally adjusted)
Canada inflation – all items CPI vs CORE
In Canada, the April 2015 year-over-year change in the energy sub-component index was -13.5%. Gasoline was -21%.

The Canada figure (CPI) is the All Items Consumer Price Index. *Core inflation has been defined by the Bank of Canada. It is the Consumer Price Index (CPI) excluding the eight most volatile components: fruit, vegetables, gasoline, fuel oil, natural gas, intercity transportation, tobacco and mortgage interest costs. It also excludes the effect of changes in indirect taxes on remaining items. The core inflation rate in Canada is monitored with respect to setting interest rate policy. The target range is 1% to 3%.
Data source: Statistics Canada.
Chart: CMD.
U.S. inflation: all items (CPI-U) vs all items less food and energy
(not seasonally adjusted)
U.S. inflation: all items (CPI-U) vs all items less food and energy
In the U.S., the April 2015 year-over-year change in the energy sub-component index was -19.4%. Gasoline was -31.7%.

The U.S. figure (CPI-U) is the All Items Consumer Price Index for All Urban Consumers.
Data source: U.S. Bureau of Labor Statistics (Department of Labor).
Chart: CMD.
Canada vs U.S. retail sales – Total
Canada vs U.S. retail sales – Total
*"Year over year" is each month versus the same month of the previous year.
Based on latest three-month averages of current dollar adjusted data (and placed in latest month).
Data source: Statistics Canada and U.S. Census Bureau (Department of Commerce).
Chart: CMD.


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