US inflation/CPI


The December inflation print looked hotter than expected. It isn’t. But to unpack that, you’ve got to dive into the inflation categories (e.g. goods, services, services ex shelter, shelter) and see what’s moving and why.

Next, you’ve got to translate CPI to PCE, which is the measure that the Fed actually uses to set policy.

So in the below note, we go into some of the detail. It matters, because at the moment, the rates and inflation story is driving everything (market narratives, cross asset class performance) so please do slog through the below.


Headline print

The December headline inflation print might have disappointed, at first glance.

Note actuals at or above expectations. Below is the Bloomerg print.

Yields initially rose on the release, and fell back quickly once the detail was parsed. No doubt about it, good progress on inflation continues. You can see the big spike below, followed by retracement.

Helicopter view

Let your eyeballs drift to the below, and consider it without the category labels (the values) for a moment, to take a holistic, high-level snapshot, that’ll help you get a sense of how things are trending.

All measures (core inflation (middle row far right), headline inflation (bottom left), PCE price (bottom row middle) and even the Cleveland median measure (top left)) continue to trend lower. That’s the progress being made.

Getting into the componentry

So, how did the numbers themselves initially disappoint? It’s shelter costs again. Below is from Mike Konczal (Roosevelt Institute). Goods are behaving (left), core services (right) is broadly behaving, shelter costs (middle) are rising.

Isolating shelter costs

Which takes us to this CEA graph on direct housing inflation (OER, owners’ equivalent rent). The graph has the same “actual” blue line as the shelter graph above (e.g. in pink, the middle graph above) and uses a “new rent” measure to get a sense of where the actual will go. It’s lower.

Why is it doing that? Well, housing, in the CPI report, uses a measure of lagged rents. New rents (i.e., what you’d pay if you signed up today) are much lower, and hence if you use that new rent measure you wind up with a much lower forward-looking series.

In our client event decks, we’d often break out these various inflation measures using the below table (which was for November, we stopped using it, switching to other methods of showcasing the table). That table is a useful reminder of how the different categories look and why we bother to look.

Pausing for a second to remember why we are doing this

Hopefully readers are still following along. It absolutely matters, even as it feels a bit tedious or muddy, because the outcomes determine macroeconomic policy, and those expectations about the Fed and the market set yields which determine, well, everything, at the moment, across the asset classes (rates, FX, equities, property etc).

Mapping CPI to PCE

The next important thing to note is that CPI is a closely watched measure, but the one that really matters is PCE, personal consumption expenditure inflation. Core PCE tends to run lower than CPI, and in turn that is due to weighting differences in how shelter is treated.

On a range of measures, the spread between CPI and PCE tends to be 40-70 basis points, i.e. reasonably large. Note of course that since we don’t have the December PCE, the above table is also only to November. The point is to show the relationship of CPI to PCE.

So, not only should we expect the PCE print to be lower, we should also expect that since shelter is weighted differently, it won’t have the same factors that caused CPI to “look a little hot” in this most recent December print.


The bond market appears to have digested all of this quite quickly. Yields surged initially, but then fell back as the result was analyzed.

In the wisdom of the market, progress continues, and there’s no reason to doubt the degree of near term cuts that are priced into the market.

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