The Big Idea

A sticky situation

| July 29, 2022

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Inflation has accelerated and broadened this year to a much wider set of goods and services. The Dallas Fed Trimmed-Mean PCE index gets lots of attention as a window on the breadth and persistence of inflation. But another measure with a unique view is the Atlanta Fed’s Sticky-Price CPI. The Atlanta Fed’s take on inflation suggests it is putting down deeper roots in the economy and will require significant additional Fed tightening to trim it back.

Sticky-Price CPI

Economists define a price of a given good or service as sticky if it does not change frequently. For some businesses, there are significant costs to changing prices, so they tend to only change prices on occasion. Coin-operated laundromats would be one example.  Other prices are more flexible and move around all of the time. The most familiar example of flexible pricing would be gasoline.

To the extent that some firms face significant costs to change their prices, the theory is that a price hike or cut will only be made if the company expects the shifting forces pushing it toward a price change to persist for a substantial period of time.

A pair of economists published an academic paper in 2004 where they scoured through all of the categories of the CPI and determined how frequently prices changed in each component.  Building on this research, economists at the Atlanta Fed divided the 45 major categories of the CPI into those that change prices frequently—“flexible-price” goods and services—and those that change less often—“sticky-price” goods and services.

The Atlanta Fed researchers drew the line at 4.3 months.  Categories that change prices more frequently were considered flexible and those that shifted less frequently were considered sticky.  By that definition, about 70% of the CPI by weight reflects sticky price categories, while the rest falls in the flexible bucket.  Roughly half of flexible-price categories by weight were in food and energy.  Within the core, flexible categories were mainly autos, apparel and hotel rates, categories roughly corresponding to the Fearsome Five that I often refer to in CPI write-ups.  The sticky-price aggregate is heavily weighted toward services, including shelter costs, medical services, education, and personal care services.

The Atlanta Fed researchers then examined the flexible-price and sticky-price CPI measures relative to economic performance.  They found, not surprisingly, that the flexible-price CPI tended to be more closely correlated to the degree of economic slack. They also found that the sticky-price CPI did a better job of predicting future inflation than the headline CPI.  Moreover, the longer the time horizon of the inflation forecast, the larger the improvement of the sticky-price gauge over the traditional headline CPI.  They determined that this reflected the fact that sticky-price CPI movements tell us a great deal about firms’ inflation expectations.  Since they face high costs to making a change to prices, a “sticky-price” business would only do so if it expected the need for higher prices to persist for some time. The Atlanta Fed’s Sticky-Price CPI gauge consequently offers insight into how persistent inflation might be.

What does sticky-price CPI say about the current situation?

A look at the Flexible-Price and Sticky-Price CPI measures on a 12-month change basis over the past 10 years shows clearly that the surge in inflation in 2021 occurred almost exclusively in flexible-price categories. As of June 2021, which encompasses the first big spike in headline and core inflation, the 12-month change in the Sticky-Price CPI measure had only accelerated to 2.7%, while the Flexible-Price gauge had surged to 13.8% (Exhibit 1)

Exhibit 1: Sticky-Price vs. Flexible-Price CPI

Gray bars indicate periods of recession.
Source: Federal Reserve Bank of Atlanta

Moving forward to this year, the Flexible-Price CPI gauge has remained extremely high (18.7% as of June), due to a significant degree to the surge in gasoline prices.  However, the more troubling development is that the Sticky-Price CPI measure began to take off late last year and has accelerated sharply in the first half of 2022, reaching 5.6% in June.

The steady acceleration in the Sticky-Price CPI corroborates the evolving inflation picture that we see daily in the press and everyday life.  Each day that the public sees high inflation raises the perceived likelihood that prices will continue to move up rapidly because people are growing accustomed to high inflation. Businesses that might ignore short-term swings in their costs in a stable price environment have begun to raise their prices more because they perceive that inflation may continue to be elevated.

The prevailing view currently in the financial markets is that the economy is turning down and that inflation will cool quickly in response. This may be true for many flexible prices. We are already seeing a moderation, for example, in gasoline prices.  However, the rapid acceleration in the Sticky-Price CPI gauge, which covers 70% of the overall CPI and an even higher proportion of the core CPI, over the last six to 12 months suggests that inflation will prove more persistent, forcing the FOMC to work harder to bring price increases back to its 2% target than current market pricing implies.

Stephen Stanley
stephen.stanley@santander.us
1 (203) 428-2556

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2023 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.

The Library

Search Articles