Is this a conspiracy to make inflation look tamer? No. It’s a routine but important update.

By David Enna, Tipswatch.com

Over the last few weeks, I’ve gotten questions about “surprise” price-index reweightings coming in the January inflation report about to be issued by the Bureau of Labor Statistics.

Uh-oh. Sounds like a conspiracy, right? The BLS is going to find a way to make inflation look tamer than it really is, right? All of our inflation-linked investments are going to suffer, right?

Wrong.

This reweighting of the CPI price indexes is a rather routine affair. Until 2002, the reweighting was done every 10 years, but the BLS realized that was no longer practical. So the schedule was increased to every two years. Now, with this January inflation report, the schedule is being changed to every year, taking effect with the January report each year. The BLS explains:

“Beginning with the January 2023 index, scheduled for publication on February 14, 2023, BLS plans to update the spending weights in the calculation of the CPI every year instead of every 2 years. Spending weights indicate what share of total expenditures each item represents. This change will improve the relevance of CPI spending weights by using the most recent consumer spending information. By improving the relevance of spending weights, BLS can improve the accuracy of the CPI.”

These reweightings are created through surveys by the BLS of consumer spending information. For the 2023 weightings, the BLS will use consumer data collected in 2021.

When I learned about these reweightings, I sent out a plea to Michael Ashton of Enduring Investments for an explanation, minus the conspiracy theories. I guess I wasn’t the only person asking. Ashton, who is known as @inflation_guy on Twitter, created a podcast explaining the logic behind the change in the weighting schedule. Here it is:

In explaining the reasoning behind these reweightings, Ashton talks about the balance between “core goods inflation” and “core services inflation.” In 2022, the BLS was giving a higher weight to core goods inflation, based on its consumer surveys in 2020, during the depths of the pandemic. Supply issues caused the cost of goods to soar in 2020, so goods got a higher weight in 2022. But in 2022, core goods inflation shrank to nearly 2%.

On the flip side, consider the cost of “core services” in 2020: How many times did you eat in a restaurant? Travel by airplane? Get a big raise for working at home? So based on its 2020 surveys, the BLS reduced the weight of core services for 2022. But in 2022 the cost of core services began escalating. So the CPI was missing the real inflation picture, at least slightly.

The BLS is switching to annual reweightings to try to get a more accurate snapshot of U.S. inflation. If the BLS continued to use the 2020 survey weightings, inflation in 2023 would be underestimated because of the skew toward goods over services. Consider this from the Wall Street Journal in its preview of the December inflation report:

The root problem for investors is that inflation itself has become more complicated. Core goods inflation has turned negative in recent months, thanks to increased supply of many products and reduced demand. But services inflation has remained elevated—the result, many argue, of a stubbornly hot jobs market and escalating labor costs.

Ashton notes: “In 2020 we had this thing called Covid and consumption patterns changed dramatically and the BLS very carefully considered if they should use intervention analysis. … but they ultimately decided hands off.

“People are always saying that the BLS monkeys with the CPI to keep inflation reported lower than it really is. There is no conspiracy, but there are factors that … do have that result. And those things happen in both directions, obviously.”

We won’t know exactly what the new weights will be until the BLS issues the January inflation report. Ashton expects core services to get a higher weighting, and core goods to get a lesser weighting.

Why does it matter?

“If you believe that inflation is going to fall back to 2% … you have to believe that something is going to happen in core services,” Ashton says. “It’s going to have to happen from the services side,” because core goods is already down to about 2% inflation.

“It’s easy to exaggerate overall how important this is. … Normally the reweighing is a snoozer, it doesn’t matter at all. Nobody cares. It doesn’t really change very much.”

In 2023 we will get bigger-than-normal weighting changes, but they are still what Ashton calls a “rounding error.”

“If you have a 1% change in the weight of a category that is inflating 2% faster than the average, then that adds 2 basis points to the annual inflation. … So it’s not a big deal. Now you know if you should care about it. Probably not.”

For a positive spin, we will let the BLS have the final word: “Transitioning from biennial spending weights to annual spending weights is another milestone towards our goal to improve the accuracy and timeliness of the CPI.”

Who is Michael Ashton?

His audiences know him as the “Inflation Guy.” He is a pioneer in the U.S. inflation derivatives market. Before founding his company, Enduring Investments, Ashton worked in research, sales and trading for several large investment banks including Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003, when he traded the first interbank U.S. CPI swaps, and 2004 when he was the lead market maker for the CME’s CPI Futures contract, he has played an integral role in developing new instruments and methods for accessing and hedging various inflation exposures. In 2016, Ashton published What’s Wrong With Money? The Biggest Bubble of All. He is a graduate of Trinity University and lives in Morristown, New Jersey.

Have a question? Get the Inflation Guy app in the Apple App Store or Google Play, or email InflationGuy@enduringinvestments.com.

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David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. I Bonds and TIPS are not “get rich” investments; they are best used for capital preservation and inflation protection. They can be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.