Consumer prices fell in January for the third straight month, while inflation over the past 12 months turned negative for the first time since 2009, largely because of cheaper gasoline. In January, the Consumer Price Index sank by a seasonally-adjusted 0.7%, the biggest one-month drop since the end of 2008, the Labor Department reported Thursday.
The pace of inflation over the past 12 months, as measured by the CPI, fell to negative 0.1%, and it’s down sharply from 2.1% last summer shortly before crude prices collapsed. That’s the lowest annual rate since late 2009/early 2010. If this trend continues, we will fall into deflation.
Deflation, not to be confused with disinflation, or a slowing rate of inflation, is dangerous because it reduces the supply of money and credit flowing through the economy, and it can create less demand for big-ticket items from cars to washing machines. At its worst, dwindling demand can lead to global depression.
Many investors are celebrating the widely-held belief that lower inflation is good for stocks and higher inflation is bad. But, as is often the case, this conventional wisdom is misleading, if not plain wrong. A study by the by the National Bureau of Economic Research found that corporate earnings and inflation tend to move up and down together, generally speaking. So the idea that lower inflation is good for stocks may be dead wrong.
But before we get into that discussion, let’s take a look at last Friday’s report on 4Q Gross Domestic Product, which was a disappointment. At the end of today’s E-Letter, I will comment on Fed Chair Janet Yellen’s testimony before the Senate last week. And we will end with some thoughts on President Obama’s quest to reach a nuclear deal with Iran.