Is U.S. Inflation Falling?

After today's PPI report, which showed sharp declines in both the all-items and "core" price indexes, some analysts, including the usually perceptive Nouriel Roubini have concluded that inflation is falling and falling rapidly.

The problem is that the decline in the October PPI can be traced to two temporary items: first the decline in energy prices, which have halted now as oil have stabilized at slightly below $60 per barrel. Secondly, the entire decline in core PPI and more can be attributed to a one-time hedonic adjustment of the perceived quality of new cars. Excluding this adjustment, core PPI rose 0.1%. I am not against hedonic adjustment in principle, but I have little faith in the government's estimates of it. And at any rate, even assuming it is done correctly, attributing the entire month to this month and thus misleading. And it will not be repeated in the coming months.

If you look at the underlying cost picture for the items consumer buy, you see a strong upward pressue. Unit labor costs is soaring, rents are rising due to a shift in preferences from owned to rented housing, the dollar is falling and non-energy commodity prices is soaring.

Weakness in consumer demand will however mean that consumer prices will rise a lot less than what you would expect given the trends in above mentioned underlying costs. Instead, corporate profits will be squeezed. But, I still expect core inflation to be above 2.5%, greatly limiting the scope for Fed rate cuts during the coming recession.