The Trouble with CPI: How We Adapt to Imperfect Information
The Consumer Price Index, or CPI, is “a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services,” according to the U.S. Bureau of Labor Statistics (BLS), which calculates CPI.
Issued monthly, CPI is a standard measure of inflation and is widely quoted in the media and used heavily by the financial markets. Lately, however, staffing shortages have led the federal government to scale back the number of people conducting the price surveys used to calculate CPI.
In June, the U.S. Department of Labor (which oversees the BLS) announced it had cut back on these price checks across the country, and in some cities suspended data collection entirely.
CPI is known to be somewhat imprecise, as the BLS readily acknowledges. But this latest staffing problem has naturally led to concerns by economists over the accuracy of the CPI report.
For portfolio managers who must incorporate economic data such as inflation into their research and decision-making process, this raises a very good question: How else can inflation be measured and monitored if traditional inflation reports are becoming less accurate?
At Tableaux Wealth, we’ve always used many indicators to monitor our inflation outlook, in addition to the CPI.
We believe this approach helps us not only to better understand the current state and outlook of inflation but also to rely less on the traditional government-produced inflation indexes.
Truing up with Truflation
One such indicator we’ve referenced more often in recent months is the Truflation US Inflation Index.
Rather than relying on people to manually collect price information, Truflation, a decentralized platform designed to track inflation, collects over 18 million data points on goods and services to provide a daily-updated measure of inflation.
Truflation’s more frequent measurements can provide an arguably more accurate indicator of inflation as compared with the government’s monthly CPI reports.
For example, at the time of this writing, the most recent CPI report indicates a 2.7% year-over-year rate of inflation rate based on data collected in June, while today’s Truflation report shows a lower year-over-year rate of 1.65%, as shown here:
Forecasting with Commodity and Oil Prices
Investment in commodities is often considered useful as a hedge against inflation. But the price of commodities (including oil) can also serve as a leading indicator of inflation.
That is because commodity prices tend to react quickly to supply-and-demand changes, which reflect broader inflationary pressures.
Of course, commodity and oil prices also affect the costs of producing goods and services. When commodity and oil prices rise, so does the cost of producing and delivering those goods and services, which has a second-order effect of increasing prices.
Monitoring commodities and oil prices therefore offers a slightly more extended outlook for inflation. It can help us anticipate inflation.
Looking at the last five years (see the line chart, below), we can see that commodity and oil prices started to increase steeply just before the run-up in inflation starting in 2021.
By the time CPI peaked in 2022, commodities and oil prices had already started a sharp descent.
Breaking the Code
For a longer-term inflation outlook, we look to the U.S. Treasury markets.
Breakeven rates provide a measure of the market’s expectations of inflation over a given period.
For example, by comparing the yields of five-year Treasury bonds and five-year Treasury Inflation-Protected Security (TIPS), we can interpret the resulting difference in yields—the five-year breakeven rate—as what the bond market expects the average annual inflation rate to be over the next five years.
These days, since the leveling off of inflation in 2023 after its peak in 2022, long-term inflation expectations for the next five to ten years have remained between 2% to about 2.5%:
Putting it all together
None of this is to say that we no longer use the government’s CPI traditional monthly inflation reports. We do.
But the growing professional skepticism about the reliability data in the CPI reports gives us an opportunity to highlight our careful practice of using data and other market and economic information.
By combining a multitude of data from a variety of sources, we can construct a more thorough and complete picture that enables us to make what we believe are better-informed decisions.