CPI for August Down 0.1% As Oil Drops To $91, YOY Up 5.4%, Credit Crisis Overshadows Inflation

The US Consumer Price Index was down 0.1% in August and up 5.4% year over year through August versus being up 0.8% in July and up 5.6% year-over-year through July. Like last month, this was the largest YOY spike since 1991, and is due mostly to the oil price spike we had during early summer. Normally rate markets would spike on this inflationary news, but the negative monthly figure is all the more important this month because it proves that as oil dips below $100/barrel versus the $140+/barrel levels of early summer, it has an immediate downward impact on rates.

If you exclude oil and food prices from the report, Core CPI was up 0.2% for August and up 2.5% year over year through August, versus being up 0.3% in July and up 2.5% year-over-year through July. These numbers are still above the Fed’s comfort zone of 1-2%, but with the giant flare up in the credit crisis in the past two weeks, we don’t expect the Fed to hike rates on this inflation data. The monthly inflation data is moderating as measured by this CPI report and last week’s PPI report. They must continue to walk the tightrope, and will likely use tactical lending and cash infusion policies more so than rate policies.

Since last Monday: Fannie and Freddie, the two largest mortgage companies in the country, were taken over; two of the world’s largest investment banks disappeared: Lehman Brothers declared bankruptcy and Merrill Lynch was taken over by Bank of America; and AIG, the world’s largest insurer, and the firm with an untold amount of exposure to credit unregulated derivatives that affect the entire global financial system is on life support. Many think all of this means the Fed will cut rates to calm markets, but we’re way beyond rate cuts given this dire state of affairs and we think the Fed will hold the line and then work on some way to try to help AIG either directly or indirectly.

Back to inflation to conclude … as for the debate about Core versus Overall inflation: It seems difficult to look at the Core number if food and gas account for 33% of inflation. But this summer’s spike then drop in oil prices is the reason there are Core versus Overall readings. Food and Energy are considered to be volatile enough to leave off, or at least look at separately. As we see the oil price volatility’s effect on PPI, CPI and PCE, it becomes a relevant argument to look at the two figures separately. But the spread between core and overall should speak for itself—it’s a wide spread that cannot be ignored, especially when everyone has to eat and drive.