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The U.S. Federal Reserve Interest Rate Decisions and Inflation Drivers - Consumer Price Index Analysis - 2017 - ONYX RESEARCH, INC.®

United States Federal Reserve Interest Rate Decisions
Inflation Drivers - Consumer Price Index Analysis - 2017


The United States Federal Reserve makes interest rate decisions based, in part, on inflation data. The headline number is an aggregate value. What are the key drivers that influence that headline inflation number?

The following executive summary graphic quantifies each major driver.

Executive Summary
Key Inflation Drivers

United States inflation drivers by category (1) Housing, (2) Transportation, (3) Food, (4) Medical Care, (5) Recreation

The top five drivers are (1) Housing 43%, (2) Transportation 15%, (3) Food 14%, (4) Medical Care 8%, and (5) Recreation 6%.

Generating a single number that captures consumer prices is, on average, accurate. However, digging one level deeper, it is clear that both inflation and deflation occur, but that inflation can wash out when averaged over the United States population (~323 million people). For example, rising wages in silicon valley have increased home prices and rental rates significantly incentivizing many people to move due to rising prices and constrained construction and housing supply.

Top Five Inflation Drivers

(1) Housing. The largest category that drives inflation is housing at 43%. This category includes property sale prices, leveraged home purchases, rents, leasing, utilities, and maintenance. The current trend is towards renting. Segmenting into renters and buyers, it is likely that there is little growth here given that wages are flat. There are also many ways that people can contain spending on housing (e.g., renting, rental and temporary co-use, and living longer with parents/relatives). Areas with high paying jobs are inflating (San Francisco, Seattle, Denver, shale regions) while other areas are flat or declining.

United States One Hundred Dollar Bill - Benjamin Franklin

(2) Transportation.  Transportation is the second largest expenditure for a household at 15%. Again this sector has a great deal of flexibility (used cars, ride shares, bus, train, plane). Advanced phones and networks allow users to more efficiently use physical assets (e.g., AirBnb, Uber, Lyft, Via, Zipcar).

(3) Food. The third expenditure category is food at 14%. Like housing and transportation, spending on food can vary widely based on discretionary budgets. Meals out and food quality can be adjusted relatively easily based on wages. With energy prices low, inputs that would drive commodity prices upwards are currently restrained.

(4) Medical Care. The fourth expenditure category is medical care at 8%. U.S. medical costs have risen substantially. Depending on your financial situation there may be inflation, or these costs may be diffused into a broader public commitment and debt. This diffusion likely obscures inflation in this area.

(5) Recreation. Recreation is the fifth largest price category. Again, highly discretionary and easily tunable. With stable wages the population consumes at a steady rate or consumes recreation that is less costly as budgets run thin.

Combined, the top five categories represent 86% of the prices in the consumer price index (CPI-U). The remaining 14% includes communications (internet service, cellular phones), education, apparel, personal care, beverages, and smoking products (including tobacco).

With this analysis it is no surprise that inflation is contained. Wages are, on average, flat, population growth is steady, and advanced telecommunications and moblie devices contain supply limitations by improving information flows, pricing transparency, and more efficient market making.

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