Can You Believe How Good October CPI Data Was?

I read through the whole CPI print. Here’s what I found:

🚗 Used car prices decreased by 2.4% during October.

👨‍⚕️ Insurance prices decreased by 4% during the month.

These two data points are the largest reason CPI came in lower than expected (7.7% realized vs 7.9% expected).

I checked out used car sales, and nothing was odd. But insurance… Oh, but insurance.

In this latest CPI print, the BLS (Bureau of Labor Statistics - government stats people) began including Medicare part D in the CPI calculation. Why’s that a big deal? Because the BLS uses a retained earnings method to compute inflation. They say that retained earnings = premiums - benefits. Then they create a retention benefit ratio which is retained earnings / benefits; this is effectively a net profit margin. They take the current year retention benefit ratio / previous period retention benefit ratio - 1 to compute inflation.

Here’s the issue: 85% of Medicare Part D is funded by state and local taxes. Thus, their earnings are negative (for example: 0.15 - 1 = -0.85). This creates a negative retention benefit ratio, which, compared to a retention benefit ratio without Medicare Part D, will show that inflation is artificially lower due to the net loss Medicare Part D is operating at.

And?

I did the math (ask me for the spreadsheet if you want) and, assuming that last month's reading is a reasonable proxy for insurance inflation without Medicare Part D, inflation would have been 7.8%. Oops, I guess that accounts for about half of the “outperformance” of inflation. I’d be surprised if papa Powell didn’t see this, as I suspect this is why some Fed officials are saying “oh, yeah, inflation print was good, but we still have a ways to go.”

The CPI print is good news, but be careful of irrational exuberance; the market is looking for opportunities to rally, and the BLS certainly gave them a good reason to.