The last time we flirted with deflation was in 2003 (when the Fed cut rates to 1%), but back then, it was led by the “goods” sector as the core goods CPI deflated to historical lows of -2.6% YoY. At that time, the much larger share of the economy, “core services”, was still seeing positive pricing power, at +2.6%. The low in core CPI inflation was +1.1% back then —- we have been below that pace now for five consecutive months (and the housing and credit boom ensured that we took off shortly after hitting that prior low).
Fast forward to today and the deceleration in core CPI has been more broadly based across both goods and services. The core goods CPI was running at +3% at the turn of the year — amazingly, even with a soft U.S. dollar and firm commodity prices (not to mention horror stories out of pricing in China!) — and is now at +1.3%....the aftershocks of the Great Recession have left disinflationary scars in other previously “cyclically insensitive” areas, like education and health care. Delivery services and recreation are also currently disinflating at a pretty fast clip.
The year-over-year trend in core services has slowed to a record low +0.7% as of August after ending last year at +1.4%. It’s not clear from the chart pattern or base-effects from last year that it has bottomed yet, either.
The bottom line is that if the core goods CPI were to ever revert to its historic lows of 2003 and bump against the current historic low in the core services CPI, then we would indeed slip into a mild deflation of -0.2%. Food for thought because that prospect is not remotely priced into nominal bond yields, even with the 10-year note sitting around 2.7% and the long bond yield just under the 4% mark