Hot Numbers & The Misleading Core

A: Hot economic data folks. The headline PPI came in high at 1.1%, while excluding food and energy in the so-called core PPI came in at 0.1%. Retail sales were strong. The question in my mind is how much weight should be given to the CORE #'s overall as the fed targets inflation; Barry Ritholtz's take on the misleading core is well known. Fact is, the US economy is a mature, resilient economy and as such I think the day of the CORE # has passed. Inflation is OUT there and the fed's model of focusing only on the core needs to be updated so we don't get hit by the 'cruelest tax of all'. Lets discuss.

First the data. According to Yahoo Finance:

Retail sales posted a stronger-than-expected gain in September as a big jump in auto sales helped offset weak demand for clothing. The Commerce Department reported Friday that retail sales increased 0.6 percent September, compared to August. That was double the gain that economists had been expecting and was also in contrast to reports Thursday of sluggish demand from the nation's leading retail chains.

In other news, the Labor Department reported that wholesale prices jumped by 1.1 percent in September, pushed higher by gains in food and energy costs. Excluding those volatile categories, wholesale prices were up by a moderate 0.1 percent.

The street interprets the retail sales strength as evidence the slowing housing market is not yet hitting the wallets of consumers. They interpret the headline PPI data as evidence that inflation in the pipeline should be a concern. That is what I want to focus on.

I was listening to Rick Santelli this morning and he made a statement that I thought was dead on regarding the Core data that the fed seems to love so much. Let me first explain how this works.

Headline # ---> shows the total data for the specific report type

Core # ---> excludes food & energy because these items are thought to be volatile #'s (sudden & sharp movements) that skew the headline # and don't give an accurate look into how the overall economy is doing on the specific report type
*the fed has been known to follow the core dataset more heavily for policy actions

The argument is WHY THE HELL SHOULD WE REMOVE THE FOOD & ENERGY ELEMENT OF THESE DATASETS? You eat right? You use energy to heat your homes & fill up your gas tank right? They are a part of everyday living right? So, why exclude them when monitoring if inflation is in-line or out of control? Here is what some of the fed governors say about this (via Real Time Economics: WSJ Blog):

Cleveland Fed President Sandra Pianalto ---> "The reality of rising oil and commodity prices is evident, and my Federal Reserve colleagues and I have been clear that we believe the impact of these influences will dissipate over time. But until our beliefs are validated by the data, there is a risk that the public’s trust could erode and inflation expectations could move higher."

Dallas Fed President Richard Fisher ---> "Both food and energy have had a steep upward tilt for the last three years in a row. Under those circumstances, I’m personally reluctant to put complete faith in the core measures because they may be removing more signal than noise."

Berkeley Professor Brad DeLong says:

If the rise in inflation is thought to be (a) transitory and thus (b) self-limiting, the Fed would prefer to let sleeping dogs lie rather than hit the economy on the head with a brick.

However, when increases in inflation are confined to (i) energy and (ii) food prices, odds are that the increase is transitory and will be self-limiting. Hence the concept of "core inflation." If the Federal Reserve concludes that the current rise in inflation is transitory and self-limiting, it can point to the core inflation number as a principled excuse for not hitting the economy on the head with a brick.

Back to real world Rick Santelli: this morning Rick made a statement to the effect that the Core # is a somewhat old school methodology for a time where a spike in energy and food prices was sudden and temporary. Are higher food & energy prices transitory (not lasting) and self-limiting (limiting its own growth by its actions) as Prof. DeLong says? On the contrary, I would argue that food & energy prices have been high for years now and is part of the new world that we live in as globalization plays a key role and the US economy matures. So shouldn't we put less weight on the core # and NOT exclude these elements that seem NOT to be just a temporary spike?

Look at what is going on in the mind of Axel Weber, a governing council member of the European Central Bank (via Bloomberg):

European Central Bank governing council member Axel Weber yesterday said policy makers might need to increase borrowing costs to keep inflation under control.

"If risks to price stability are threatening to materialize, monetary policy can't lose sight of its primary mandate -- even if that means no longer supporting the robust economy or becoming restrictive," Weber, who also heads Germany's Bundesbank, said in the text of a speech in Munich. There may be an "additional need" to raise interest rates, given the "expected acceleration in euro-region inflation over the coming months."

Wow! A central bank member that actually stands by the stated mandate of the governing body! It's clear that Ben Bernanke & our Fed has chosen economic stability / growth over price stability and inflation; as evidence by the aggressive 1/2 point rate cut at the expense of future inflation in the pipeline and a very weak US dollar.

Ive said it before; read my post "Moderating Inflation? I Don't Think So" where I discuss this in more detail. I think the days of ultra cheap money and deflation are over. I think we are headed for a longer term period of higher rates and inflation as the global boom continues.

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