There's a fundamental disconnect between the way Wall Street (and the financial media) interpret inflation and the way normal people experience it.
Yesterday's announcement that the year-over-year CPI (Consumer Price Index) inflation rate had fallen to +3.2% in October was better than expected, as most economists had predicted +3.3%.
The context for this number is crucial. After spending most of the last decade below 2%, CPI started climbing rapidly in 2021, peaked at over 9.0% in June 2022, then declined to a low of 3.0% in June 2023. But in recent months, that number had ticked higher again: 3.2% in July, 3.7% in August and 3.7% again in September. So October's drop back down to 3.2% was significant.
Further crucial context: while 3.2% is better than we've seen lately, it's still quite a bit higher than the Fed's stated goal of 2%.
Reading all those numbers, and living through the monthly releases with their accompanying breathless reporting and corresponding market reactions (yesterday's gains were pretty extreme), one gets the feeling of sitting in the stands at a football game. Inflation is up (groan)! It's back down (yay)!
This is not real life
In contrast, real people experience inflation cumulatively. So it's less about the fact that inflation has round-tripped from 3% to 9% and back to 3% over the last 30 months. That's the Wall Street story. It implies that prices are getting "back to normal." Nothing could be further from the truth.
The Main Street story is that the cumulative cost of this inflation adventure since COVID broke out in February 2020 is running somewhere between 19.3% and 23.5%, depending on whose data you use. The official Consumer Price Index shows a +19.3% increase since the beginning of February 2020, while the Truflation website says +23.5%.
I'd argue the precise figure isn't what's important, because it's more the general psychology that matters. We all roughly remember what things cost 3-4 years ago, before all this blew up, and we're painfully aware that everything we buy now costs so much more.
The dirty secret of inflation is the prices never go back down. The inflation rate may come back down, but that's just the rate of future additional price increases. We're left with the ~20% permanent increase in the cost of everything.
This persisting accumulated inflation is a big part of the psychology of inflation expectations becoming embedded, and that happens largely independent of fluctuations in the rate of inflation. It's why longer-term inflation expectations are increasing, even as the CPI rate is declining. As people come to understand these price increases are permanent, they factor the expectation of future higher prices into their thinking, even as the marginal rate of increase is slowing down.
"Transitory" was always an illusion
All of this helps explain why the whole "transitory" story we were told when inflation first started to bubble was so problematic. In the financial vernacular, transitory referred to the inflation rate: it would go up and come back down again. But normal people don't care about that, they care about the level of prices. Those weren't ever likely to go up and come back down — at best, they were going to go up and then plateau at some higher level.
It's obvious in hindsight that even the Fed's understanding of "transitory" was way off, as their early communications made clear they never expected the inflation rate to stay elevated so long.
Future implications
The regime shift in inflation — and the changing nature of interest rates that has followed as a direct result — has significant implications for us as investors. I'll be delving into these implications in more detail in upcoming SMI articles.
