This is what demand destruction looks like. The 0.8% decline in the Consumer Price Index in April, announced on Tuesday, should serve as a cautionary tale to those espousing dead dogma around risks to the outlook linked to inflation.
The U.S. economy is absorbing a significant demand shock, and April’s decline in consumer prices is a preview of things to come. While it will take some time before the decline in oil and gasoline prices work their way through to the year-over-year core metric, risks to the economy and household consumption are going to be skewed toward deflation for the foreseeable future.
This pricing data, and that to arrive in the coming months, should underscore efforts at the Federal Reserve to put a floor under the financial sector and the real economy to mitigate the shocks that are still cascading through the domestic economy.
The data should underscore efforts at the Federal Reserve to put a floor under the financial sector and the real economy.
Inflation will not, and should not, be the primary aim of policy. Deflation, defending price stability around the zero lower boundary, market-derived nominal negative interest rates, rising unemployment and dollar appreciation — all of which will push prices down — will be.
The data strongly reflects the demand shock affecting the economy. Energy prices declined 10.1%, gasoline fell 20.6%, while apparel and transportation prices dropped 4.7%, all on a month-over-month basis. Public transportation was down 8.1% while airline fares dropped 14.8%.
On a year-ago basis, energy prices declined 17.7%, apparel 5.7% and transportation 9.5%. Food prices increased 1.5%. Commodity prices declined 1.6%, with commodity prices excluding food and beverages down 3.5%.
Core CPI was down 0.4% month over month and was up 1.4% on a year-ago basis.
Our core preferred year-over-year CPI metrics, CPI excluding food and energy, declined from 2.1% in March to 1.4% in April, while CPI services excluding rent and energy dropped from 2.53% to 1.79% in April.
Given the likely move in the U.S. unemployment rate above 20% and the total number of unemployed surpassing 40 million in the near term, it is difficult to square calls for inflation or any near-term rebound in the Consumer Price Index or the policy-sensitive Personal Consumption Expenditures Price Index.
Deflation is going to be part of the economic narrative and policy picture over the next two to three years at a minimum.
In our estimation, the pricing on the two-year Treasury is signaling that investors expect negative nominal rates soon, which would imply that the bond market is acutely sensitive to risks to the economic outlook linked to deflation. My sense is that the bond market is not pricing in negative interest rate policy by the Fed. Rather, rising risks of negative nominal interest rates derived by market pricing are linked to an economic outlook that is defined by demand destruction, elevated unemployment and an elongated economic recovery that will look far more like a Nike swoosh than a V envisioned by some policymakers.
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