The Dollar – Best House on a Bad Block
I’m here to draw your attention to something alarming happening in currencies at the moment. Here is a picture of the US Dollar, which has lost a huge amount of value in the past year.
Now, before certain ones of you get all excited and say that this proves Trump is ruining the dollar and forcing foreigners to vamoose out of the United States, take a look at the Euro.
I’m not going to tease you too much with this. The first chart is just the dollar in terms of ounces of gold; the second is the Euro in terms of ounces of silver. Don’t worry, longtime readers: I’m not about to go all gold-bug on you. I could have done those charts with almost any currency against a wide variety of commodities: the Bloomberg Commodity Index is up 23% since mid-August, and +12% since the end of the year. So this isn’t just a precious metals story, and it isn’t just a dollar story. It’s a fiat currency vs ‘stuff’ story.
The recent breathless coverage of the melt-up in precious metals seemed to me to miss the bigger point of what it means. It’s awesome if you’re long precious metals. But the abrupt turn vertical is – or should be – alarming. But nothing looks alarming when it’s pointed higher.
Treasury Secretary Bessent, as I write this, just came out and stated that the United States has a strong dollar policy and has not intervened (at least not yet) to push the dollar lower against the yen. That’s all very nice but I don’t worry a lot about the level of the dollar against other currencies in the medium term and here’s why.
Let’s look at the monetary pipes, which to me imply an increase in the dollar and/or a sharp increase in long-term interest rates regardless of what happens to overnight policy rates. (Many people are concerned about long-term rates because of some vague sense that we are borrowing too much or because everyone is going to sell their US bonds – to buy what with the dollars they receive, no one seems to mention – but there is a mechanical/accounting relationship could cause that outcome).
To this end, the illustration below (Source: Enduring Investments[1]) is a helpful visual guide. For this analysis we are interested in the flows of the dollar system, more than its stock. And the important flows are – or have been – pretty stable. The US has for a long time run a substantial budget deficit, which means the government needs to source dollars by borrowing them. The three sources of those dollars have historically been foreign investors, the Fed, and domestic savers. Foreign investors have extra dollars because the trade deficit means that Americans send more dollars to foreign producers than foreign consumers send to US producers, and those extra dollars are invested in the US into government bonds (spigot on the lower left) or otherwise invested in markets or direct investment (spigot on the lower right). The Fed balance sheet, over the last decade or so, has often been a supplier of dollars to the system when it has been expanding more often than not. Finally, there are domestic savers who buy Treasury bonds among other things (but consider that when they’re buying US stocks, for example, the dollars are just sloshing from one domestic saver to another – that’s why there’s no flow shown for domestic savers buying US stocks). Those three ‘suppliers of dollars’ are the top hoses filling up the barrel of dollars in the illustration below.
Those flows tend to reach stasis via automatic stabilizers. For example, if the government is draining more money (with a big budget deficit) than is being supplied elsewhere, then either interest rates rise to induce domestic savers to provide more money, or the trade deficit expands. My concern is that automatic stabilizers tend to take time to stabilize, and currently there are some big changes. See the next illustration and focus on the differences compared with the prior one.
The cessation of the expansion of the Fed’s balance sheet has been happening for a while, and the balance sheet has even been shrinking a little. But the Trump Administration’s trade policies have caused two major changes: first, the trade deficit has been shrinking sharply (see charts below, source Bloomberg; the first shows the net trade balance monthly and the second shows the recent trends of declining imports and rising exports).
Some of this may be ‘payback’ for the surge in imports at the beginning of the year by importers trying to beat the imposition of tariffs, but there seems little question now that the trade deficit really is closing substantially. At the same time, foreign companies have been tripping all over each other to start making substantial investments into the US. In the second ‘barrel of money’ chart above, note the spigot at the lower right is really gushing, and two of the hoses supplying dollars have slowed to a trickle or stopped.
If that’s a fair representation, then what are the implications? If those trends persist, then the demand for dollars is going to outweigh the supply of dollars, leading to two outcomes. One of those is that in order to induce more dollars to fund the federal deficit, interest rates will have to rise. The Fed can control the policy rate, but in order to keep long-term rates down the Committee may eventually be forced to start up their hose again – intervening to buy Treasuries in the market to prevent long rates from rising, and expanding the balance sheet. The market stabilizer here would be for interest rates to rise and induce more domestic savings; if for policy reasons the Fed doesn’t want that then they’ll have to add more money themselves, with inflationary consequences. (It’s inflationary either way, but if interest rates rise it’s only indirectly inflationary in that higher interest rates also increase money velocity).
The other implication is that the dollar would strengthen on foreign exchange markets, since if foreigners are going to invest in the US in financial markets (or with direct investment, building new plants and so forth) they will need dollars to do so and the trade deficit is no longer providing a surplus of those dollars. It’s likely also that, with fewer dollars being sent abroad, domestic stock and bond markets would struggle more than they have been. A stronger dollar would be disinflationary at the margin, helping to hold down core goods prices, but this effect is fairly small…especially in the broader context I’ve mentioned, which is that all fiat currencies right now are getting smashed versus real stuff.
These are the implications of the recent large changes in financial flows. There are potential offsets available. If the trade deficit declines and the federal budget deficit declines also, it diminishes upward pressure on interest rates since domestic savers do not have to be incentivized to provide as much of the dollars in deficit. You can infer this from the barrel illustrations as well: if the federal budget moves towards balance, it lessens the net change in the system.
And there had been some positive signs on that score. The tariff revenue has been large, and some of the spending priorities of the prior Administration have been de-emphasized. These are positive developments which could lessen the pressure on the dollar and interest rates…except that the Trump Administration has been mooting the idea of ‘tariff dividend checks,’ increased defense spending, buying Greenland, and other significant spending initiatives.
It is also possible, even probable, that the Fed or Congress could change banking liquidity regulations in such a way that banks are forced to hold more Treasuries, which would add an additional hose to the top of the barrel. However, the more assets that banks are required to hold, worsening the return on assets of traditional banks, the more banking functions will start to move to non-bank entities or into crypto, increasing the money supply while decreasing the Fed’s control of it.
The upshot of all of these changes is that – based on the flows as we see them now, which could change – I believe we are going to see a significantly steeper yield curve and a significantly stronger dollar over the next few years.
Having said all of that, let me circle back to the start of this note – while the USD is not likely to collapse against other currencies, the movement against commodities (not to mention equities) and other real assets is disturbing. The US money supply has been accelerating recently; M2 is only +4.6% in the last 12 months, but that’s near (or may even be above) the maximum rate that is sustainable without causing inflation in a country that is deglobalizing and in demographic reverse. I am not bullish on gold and silver at these levels, and am more cautious on commodities than I have been in a while. But while I am a dollar bull against other currencies, I am a bear of fiat currencies against real assets generally…and I am concerned that the recent waterfall-like behavior of fiat presages a re-acceleration of CPI-style inflation. Commodities feed broadly into prices, but so do wages and lots of other things that are measured in terms of dollars. If the problem is fiat, and not gold and silver themselves, then it’s a bullish signal for inflation.
[1] These images were generated using AI image generation tools to create an illustrative representation for explanatory purposes.
They’re Starting to Come Around on Rent Inflation
For a couple of years, I have been relentlessly defending my forward inflation forecasts against a sizeable group of people who looked at various high-frequency rent indicators and concluded that rents were going to be imminently in deflation. (For most of the last year many of those same people thought tariffs would be a large and immediate effect increasing inflation. Fortunately for them, being wrong on both counts, at least the errors offset somewhat.)
This battle began in early 2023, shortly after the publication of new indices by the Federal Reserve Bank of Cleveland, supported by a paper entitled “Disentangling Rent Index Differences: Data, Methods, and Scope” by Adams, Lowenstein, and Verbrugge. Those authors parsed the BLS rent microdata to separate out the new tenants, and created a “New Tenant Repeat Rent” (NTRR) Index that supposedly served as a leading indicator of what all rents were going to do. Naturally, NTRR had peaked early and was heading down sharply, which reinforced the observation from things like Zillow, Apartment list, etc that new rents in the aftermath of the post-eviction-moratorium catch-up were declining.[1]
The San Francisco Fed also published a piece in mid-2023, entitled “Where is Shelter Inflation Headed,” by Kmetz, Louis, and Mondragon. Don’t get me wrong, I love it when people try to create better models of inflation processes. But this was another one that made just terrible forecasts, because (as in the former case) it was put together by econometricians who didn’t understand the actual underlying process and thought they could just torture the truth out of the data. They included this wonderful (and subsequently damning, because the Internet remembers everything) chart.
Accompanying that chart was the helpful clarifying statement, in case you didn’t get the import: “Our baseline forecast suggests that year-over-year shelter inflation will continue to slow through late 2024 and may even turn negative by mid-2024.”
In case you were curious, it didn’t turn negative; in mid-2024 it was a bit above 5%.
So back then is when I had to start defending a fairly simple premise: the behavior of landlords when they offer rents to new renters does not necessarily mirror what they offer to renewing renters. In fact, I could be even more strident – landlords could not offer lower rents to everyone, even if they offered them to new renters. That’s because a landlord needs to cover his costs or he won’t be a landlord for long. And in 2023, the costs for a landlord were still rising very rapidly – labor, energy, insurance, taxes, maintenance, and so on. My model – first presented in Enduring Investments’ Quarterly Inflation Outlook in August 2023 – suggested that rents were going to decelerate, but much more slowly than others were forecasting. I had them as low as 3% by mid-2024 before flattening out, and even that turned out to be too aggressive on the disinflation side.
By now, regular readers are familiar with this model and familiar with the fact that it still is calling for Rent of Primary Residence to hang around the current 3% level for quite a while yet. Want ‘em lower? Lower landlord costs.
But this article isn’t meant (only) to pat myself on the back. I also want to recognize when someone gets it right and the great inflation analysts at Barclays recently published an article entitled “Apples and oranges in the CPI basket: Why market rent gauges mislead on shelter,” by Millar, Sriram, Giannoni, and Johanson. It is marvelous article, and you have access to Barclays Live and care about this topic you should read it. While they don’t build a cost-plus model like I did, they got to many of the core reasons why looking at new-renter indices is bound to be misleading. My favorite charts from the piece are below (I also had these in my recent CPI report).
What my model does is tell you why that had to be the case: landlords can’t just lower rents on their whole renter base if their costs are increasing. The only exception to that would be if there had been significant overbuilding such that there was a surplus of apartments over the demand from renters. In some places, especially those currently experiencing a negative immigration shock, that may be the case (although those places happen to also be the ones experiencing large increases in insurance costs, so it’s not quite that easy). But nationwide, there is not a surfeit of apartments for rent. Ergo, no rent deflation. And it’s going to stay that way for a while.
One final note here, about the recent Trump announcement that the Administration desires less institutional ownership of single family homes and apartments. I say ‘desires,’ even though that isn’t how it was phrased, since there appears to be no obvious way that the Administration can force this. They are reportedly looking into whether antitrust regulations can be used to keep institutions from accumulating very large portfolios of shelter units, but this looks like (at best) a task for the legislature, not the executive. But let’s consider quickly what the effect would be if Trump got his way in this regard.[2] Institutions which own homes and apartments don’t hold them off the market. That would be terrible carry. They rent them, just as landlords do. If you forced institutions to divest single-family homes, it would simply move supply from the rental market to the owned-home market. That would probably drive home prices a little lower, relative to the prior baseline, but increase rent growth at the margin. This doesn’t seem productive!
[1] I talked about NTRR in a July 2023 episode of my podcast: Ep.74: Inflation Folk Remedies
[2] Honestly, I don’t think he really means to do this. Some amount of what the President says – especially the impossible things – are intended for consumption by voters. I could be wrong on this. Mr. Trump does have a way of making things happen that didn’t seem possible initially, but in this case there’s probably not much he can do and anyway it wouldn’t have a big impact anyway.
Inflation Guy’s CPI Summary (December 2025)
Let’s start this month by remembering the absolute dumpster-fire that was last month’s CPI. The number for November was patently ridiculous on its face, and it took mere minutes to realize that the BLS was showing 2-month changes for what were essentially one-month changes:
“Because what it looks like is that for many series the BLS didn’t calculate a two-month change based on the current price level – it looks like, especially for housing, they assumed October’s change was zero so that the two-month change reported for this month was actually a one-month change spread over two months. For example, even with the low Owners’ Equivalent Rent print in September, the y/y figure was 3.76%, so about 0.31% per month. The BLS tells us that the two-month change in OER was +0.27%. That looks more than a little suspicious to me.”
That in fact was what had happened. The BLS has clearly spelled-out procedures for what happens when they cannot collect a price. If they can collect the price for other similar items, they impute the data for the uncollected price by ‘adjacent cell imputation.’ Happens all the time, and has happened more since there have been fewer data collectors, and that has upset a lot of people…but it’s no big deal. What happens less often is that the BLS can collect no similar price, or they don’t have a statistically-significant sample; in that case the BLS procedures call for the prior price to be carried forward and then the price gets naturally corrected the next time it can be gathered. I’ll talk more about this in a week or two, but if the item was generally rising in price that unchanged estimate for monthly price change will be a little low in the first month and a little high in the second month. If the item was generally getting cheaper, you’ll be a little high and then a little low when you catch up. But that’s better than taking a wild unscientific guess.
But normally, that happens for tiny categories. In this case, since no prices were collected, the BLS realized that its procedures called for carryforward pricing. After the data were released, they were very transparent about the fact that this caused understatement in the CPI, and that while most categories will be corrected by normal sampling in a month or two, the rent and OER samples will take about six months to correct because of the way those samples use overlapping six-month survey panels. You don’t need to worry about the fine details here, but to realize that the October number is missing, the November number is garbage, and the year/year numbers won’t be “right” for a while.
Ergo, take everything in today’s number, and all the charts, with a grain of salt.
A little side note is that the BLS was able to collect some data for November, when there was historical data available, so some of the series are complete. And some series have a dash (“-“) for November. Bloomberg simply omits October for those series. The practical consequence is that this is a massive mess for anyone who has built spreadsheets based on fairly normal assumptions about data structure! And it will be for a while. Anyway, on to today’s number.
Over the last month, inflation markets have been little changed.
They’re actually even more unchanged than that looks like, because the apparent rise in short-term inflation expectations is a quirk of the fact that every day, the window covered by a 1-year swap rolls forward one day, and as it turns out the day that it loses on the front end is a day when the NSA CPI was declining sharply thanks to the garbage report we just mentioned. So, the new 1-year swap has less of that garbage dragging the y/y rate down, and so it rises slightly. The net result is that inflation expectations at the front end are not really rising.
The expectations for the December CPI were for +0.31% on the seasonally-adjusted headline, with +0.32% on Core. These are even more guessy guesses than normal, since economists had to figure which categories might jump back and by how much. The actual CPI came in at +0.307% (SA) on headline CPI, and +0.239% on Core CPI. We will ignore the y/y rates for now. If we take those numbers at face value, it would annualize to 2.9% on Core CPI and 3.75% on headline CPI. That doesn’t seem wildly off, with the obvious caveat that annualizing a one-month change is stupid. Sorry.
Now, the Median CPI is going to be a snap-back sort of month. I think. The median category appears to me to be one of the regional OERs, so the actual number will depend on the seasonal adjustment the Cleveland Fed applies to that subindex. And I don’t know what the Cleveland Fed did for their last data point so they may be jumping off differently than I did. But any way you slice it, we’re going to be around 0.30-0.35% for median.
This is right about where the trend was prior to September. A word on September: while it is convenient to think that September was the ‘last good data point’ we had before the shutdown, remember that month had an outlier Owners’ Equivalent Rent number (0.14%, vs a series of 0.28%-0.40% that happened in the year prior to that) that we expected to rebound in the next month. We never saw the rebound. Median CPI was also affected by that, and so the last truly normal number was August. The upshot of it is that there may be some continued deceleration in median CPI, but it isn’t clear at all.
Core goods as of this month were +1.42% y/y. They look to be leveling off a bit, and it may be that the bump from tariffs (which, contrary to economic theory but in keeping with the way it really works, got bled into prices over a period of time rather than all at once) is petering out. Too early to tell, and part of this leveling out is due to soft Used Cars data in this month’s release. Core Services, mostly housing, continues to decelerate but see all of the caveats about rents.
And yes, rents went back to doing what they had been doing. Primary Rents were +0.26% m/m, and Owners’ Equivalent Rent was +0.31% m/m. So, yeah: that dip in OER in September was a mirage, and we’re still running at 3-4% in rents although the one-month BLS blip makes it appear that we’re still decelerating. I am not sure that’s really true.
Speaking of rents, Barclays put out a great piece earlier this week. It’s called “Apples and oranges in the CPI basket: Why market rent gauges mislead on shelter,” and if you have access to it you should read it. If you do not have access to it, you can just read my articles from the last few years. Seriously, though – it’s a very good piece and I’ll talk about it more in a week or so. But here are two of my favorite exhibits from their writeup.
Since 90% or so of rents are continuing rents, and all of the high-frequency rent indicators are recording new rents…can you see why there’s a problem?
That’s why a few years ago I migrated my model for rents to be based on a bottom-up estimate of what landlord costs were doing. Here is that model with the updated Primary Rents.
Normally, the Enduring Model has more lead time, but since part of it relies on PPI data that haven’t been released since September (and which is coming out tomorrow), the look forward is shorter than normal. Still, it says the same thing I’m saying above and approximately what Barclays is now saying – 3% on rents is about where it should be. It is not likely to decline sharply from here. And that means that getting CPI to 2% is going to depend on a collapse in goods prices or core services ex-rents, neither of which I see happening soon.
Although I should point out that core services ex-rents, aka Supercore, has been looking better of late.
As with everything else, we need to wait and see how this evolves once we get a few more months of decent data. I expect core services ex-rents to continue to decelerate a little, but that’s mainly because of Health Insurance (which fell -1.1% last month, and because of the way the Health Insurance estimate changes only once per year and gets smeared over 12 months this should work out to a drag of about 1bp/month on Core CPI). Outside of Health Insurance, the downward pressure on core services ex-rents is lessening.
And really, that’s the summary of the number: some of the effects from bad stuff (e.g. tariffs, which were never as big a deal as people treated them) are wearing off but some of the positive trends (e.g. the deceleration in rents) have also mostly run their course. The Enduring Investments Inflation Diffusion Index shows that there’s a bit of an upward trend in the distribution of accelerations/decelerations.
All of which points to the same thing I’ve been saying for a while, and that’s that once the spike was over we knew inflation would drop but it was likely to settle in the high 3s/low 4s (since amended to mid-to-high 3s). The tailwinds on inflation have turned into headwinds, so monetary policy overall needs to be tighter than it otherwise would be. The Fed doesn’t see it that way yet, and new additions to the Board of Governors are definitely more likely to be dovish than hawkish. Not only that, the federal government is also adding liquidity…or will be, if the President convinces Fannie Mae and Freddie Mac to buy $200bln in mortgages. A Federal Reserve which appreciated the inflation risks would be preparing to drain away that liquidity, no matter what it was going to do on interest rates. There’s no sign of that.
As a result: I think it’s reasonable to expect dovish outcomes from the Fed from here, although Chairman Powell will doubtless try to stick it in the eye of the President (and the American people get caught in the crossfire) before his term is up. That differs from the Fed of the last 30 years only in degree. They are going to be too loose, and there’s a good risk that inflation heads higher from here (not to 9%, mind you, but getting the sign right will matter).
Which Rates Are Converging?
In early 2020, global nominal interest rates converged around zero, with the US (at the 10-year maturity point) under 1% and the EU slightly negative. The monetary spigots were on, and central banks coordinated to squirt liquidity everywhere they could. Since that time, as monetary policy has diverged somewhat, nominal interest rates have diverged. Notably, Japanese rates remained lower than other developed country rates, but in general the picture spread out a bit.
What is interesting, though, is that this behavior of nominal rates obscures what is really happening ‘under the hood’ so to speak. Recall that nominal rates are (approximately) the sum of real rates – the cost of money – and compensation for expected inflation. Thanks to the CPI swaps market and/or the inflation-indexed bond market, we can break nominal rates into these two components. The evolution of those two components tells very different stories depending on the country or region. For the purposes of this article, I’m considering the US, EU, Japan, and the UK. Obviously the UK is the smallest economic unit there but they have the oldest inflation-linked bond market so they’re a crowd favorite.
In 2020, the UK had the highest implied inflation of this set, and the lowest real rates. In the UK, long-term real rates have been persistently very much lower than in the rest of the developed world, mainly because pension fund demand caused long-term linkers to be outrageously expensive.[1] On the other end of the curve, investors in Japanese inflation have persistently priced near-deflation so that in 2020 Japan had the lowest implied inflation and the highest real rates. So, even though Japan and the UK had very similar 10-year nominal rates, the composition of those real rates was wildly different. Note that in the second chart below, I am representing real rates as the spread between LIBOR/SOFR rates and the CPI swap rates, rather than looking at the inflation bond yields.[2]
Collectively, what these charts say is that inflation expectations across many disparate economies are converging, and right now that convergence looks like it’s headed to roughly where the US is at 2.5% (adjusting for differences in index composition). On the other hand, the cost of money is not noticeably converging, although real rates are gradually rising across many economies. Real interest rates are supposed to roughly reflect equilibrium economic growth, so the picture seems to be of gradually strengthening long-term equilibrium growth expectations across the US, EU, Japan, and UK, with the US having the strongest expected growth and Japan the weakest. Notably, the UK real rate has moved above the EU’s rate, which seems to make sense to me given the hot mess Europe is right now.
I don’t think this has any hot money trading implications. But I do think it’s useful to understand that while nominal rates remain different across economies, that’s becoming more and more due to differences in real rates and less and less due to differences in expected inflation rates. Of course, you can also see that the average cost of money globally is rising. Eventually, that could cause issues for other asset classes.
[1] Naturally, there are also some differences in the inflation definitions from one country to the next, and differences in what index is used for inflation swaps, which can account for some of these differences and explain why they never will, nor should, fully converge. I am abstracting from these differences; just look at the overall trend rather than try to read too much into the absolute differences, which may have good economic reasons.
[2] One reason I am doing so is that the JGBi bonds, unlike the inflation bonds in the US, UK, and Europe, do not have a deflation floor so that when inflation is very low, the real yields on those bonds naturally diverge because of the value of the embedded deflation floor. Which isn’t what we’re trying to look at. [ADDENDUM – A reader pointed out that I am very old. What I call the “new JGBis” do in fact have the deflation floor. The “new ones” have been issued since…2013. So this turns out to not be a very good reason supporting the way I’m doing this. Man, time flies.]
Inflation Guy’s CPI Summary (November 2025)
What better way to end this crazy year than with an economic data point that we don’t know how to really interpret? Happy New Year!
Recall that, thanks to the government shutdown, the BLS released September CPI (by recalling workers to calculate the number based on data already collected) but didn’t do any of the normal price-collection procedures for the prices that are normally collected by hand. That’s far less than 100% of the index, but it’s a lot and so the October CPI was not released at all. Which brings us to today, and the November CPI – where the data was mostly collected somewhat normally. However, the calculation procedures had to be adjusted in ways we don’t really know about. You’d think that the way you do this is that you figure out the value that equates to the price level you just measured, and just say ‘hey, that’s a two-month change’ but it isn’t quite that easy. And some very smart people think this could bias the CPI lower for a few months. Whatever they end up doing, the lack of an October number is still going to mess up all the feeds (e.g. from Bloomberg) and all of the scripts and spreadsheets based on those feeds.
The BLS said in a FAQ yesterday that “November 2025 indexes were calculated by comparing November 2025 prices with October 2025 prices…BLS could not collect October 2025 reference period survey data, so survey data were carried forward to October 2025 from September 2025 in accordance with normal procedures.” In other words, November will basically be a 2-month change. (Or so we thought: see below).
Looking back to the last real data we got, in September: recall CPI was weaker than expected, but a big part of that was because of what looked like a one-off in OER. But the breadth of the basket that was accelerating was increasing, which was not a good sign. Normally the OER question would have been answered last month but…oh well.
Coming into the month…we at least have market data!
There was a big drop in short inflation swaps and breakevens this month. A lot of that is due to the steady drop in gasoline prices (see chart below), but some of it may be because sharp-penciled people anticipated that the BLS adjustment for October’s missed data is going to bias the number lower.
And boy, did it. This number is absolute garbage.
There are going to be two eras going forward: pre-shutdown inflation data and post-shutdown inflation data. Much like when there are large one-offs in the data, as in Japan years ago when there was an increase in the national sales tax rate, the year-over-year data for the next year are going to look artificially low. The BLS never adjusts the NSA data ex-post. If it’s wrong, it stays wrong. We can really hope that this doesn’t affect seasonal adjustments when the BLS calculates the new factors for next year, because that would mean next October’s CPI is going to be massively biased upwards.
Because what it looks like is that for many series the BLS didn’t calculate a two-month change based on the current price level – it looks like, especially for housing, they assumed October’s change was zero so that the two-month change reported for this month was actually a one-month change spread over two months. For example, even with the low Owners’ Equivalent Rent print in September, the y/y figure was 3.76%, so about 0.31% per month. The BLS tells us that the two-month change in OER was +0.27%. That looks more than a little suspicious to me.
Largely from that effect, core services inflation dropped from 3.5% y/y to 3.0% y/y in just two months. Riiiiight.
If in fact these two-month changes are all (or mostly) one-month changes, then the data makes a lot more sense. Either way, it’s hard to believe that the y/y change in Health Insurance dropped from 4.2% y/y to 0.57% y/y, thanks to a -2.86% decline in November from September. Yes, the Health Insurance category does not directly measure the cost of health insurance policies, and October is often when the new estimation from the BLS goes into effect, but a monthly -1.43% pre month decline for the next 12 months in Health Insurance is implausible.
Ergo, I’m not going to show most of my usual charts. This is garbage all the way down. Now, in my database instead of having a blank for October as the BLS does (for many but not all series. Seriously this is going to completely mess up any spreadsheet based on pulling data from Bloomberg), I am going to assume the price level adjusted smoothly over those two months – that is, I interpolated between September and November. That’s naïve, but it’s necessary to assume something and that’s better than assuming no change for October!
I have no idea what this will do to Median. If the Cleveland Fed follows the BLS lead, they’ll report a blank for October and a Median of something like 0.24% for the two-month period (that’s what I calculate), but it’s also garbage because garbage-in, garbage-out.
Really, this is a low point for inflation people and a low point honestly for Inflation Guy. I expected more from the BLS. I spend a lot of time defending these guys (heck, I just wrote a column on “Why Hedonic Adjustment in the CPI Shouldn’t Tick You Off”) because the staff involved in calculating the CPI are solid non-partisan professionals (aka pointy-head types) who really are trying to get as close to the ‘right’ answer as actual data allows. I can’t say that’s true in this case. Now, maybe when we get more data we will discover that the economy has abruptly shifted into something like price stability on the way to outright deflation, and it just happened to have a major inflection in October when no one was looking. But to me, it just looks like bad data.
Policymakers still gotta make policy, even if garbage data is all they have. But the correct response to not knowing what’s happening is not to assume you know what’s really happening and act accordingly – the right approach to extremely wide error bars is to do nothing. The correct approach for the Fed is to do nothing until they have another 3-6 months of data and can start getting some confidence about current trends again. That’s not the world we live in. In this world, the Fed will recognize that the inflation data is squirrelly so their behavioral response will be to ignore it and in the policy context that means that they’ll make policy for a while here based solely on the labor market. Get ready for much more market volatility around the Payrolls report again! To me, that looks like it’s likely to be an ease in two of the next three meetings, before the FOMC needs to recognize that the new inflation data is still showing 3-4% inflation. It’s possible that the Committee could take a pause while they wait for the incoming Fed Chair in May. But the inflation data will not be an impediment to an ease, and will no longer be a strong argument for holding the line if growth data looks weak.
I may be being overgenerous here. It’s also possible this will reinforce the FOMC members’ priors since many of them were utterly convinced that inflation was going to drop significantly due to housing. This, in the presence of bad data, would be a pure error. But the result is the same: an easier Fed than is healthy for the monetary system right now.
There are lots of reasons to think that yields further out the curve will stay stable or rise. But yields at the short end should probably reflect easier money going forward.
Sorry I couldn’t be more help. Here’s looking forward to 2026!
Why Hedonic Adjustment in the CPI Shouldn’t Tick You Off
I’ve worked in the inflation field for about a quarter-century (depending on how you want to count it), and I can tell you that if you really want to start a food fight at an investment conference, mention the term ‘hedonic adjustment’ as it relates to the Consumer Price Index. Thanks to substantial counter-programming by people who want you to prefer their narrative on inflation and their inflation index, people who tend to hold to the “the government is making it up” narrative about inflation like to quote hedonic adjustment as one element of proof.
The first problem with this is that people seem to think that CPI is supposed to measure how their actual cash costs change every year. It isn’t. If you look at the price of anything, it represents a trade offered by the supplier of value for value: if you give me X dollars, I will give you the widget that paints your house in 6 hours. If you don’t think that widget is worth X dollars, then you don’t buy the widget.
But widgets change. If the same vendor offers the same widget, but thanks to improvements now will paint your house in 3 hours, and now costs Y dollars, you the buyer have the same evaluation to make except now it’s the value of a 3-hour paint job versus Y dollars instead of 6-hours versus X dollars. If you want to see how the trade changed, then you can’t just compare Y versus X. You have to compare the other side of the trade also. Or, to put it another way, the difference in price (Y-X) isn’t just due to the fact that the dollar is worth less now than it was, so that even the old version of the paint-widget would cost X’, but also because it’s a better widget. You the consumer see the price going up from X to Y, but that consists of inflation X’-X, plus quality improvement of Y-X’.
There are no two ways of looking at that. If you want to measure the change in cash outlays, just count your cash outlays. But if you’re trying to measure the change in the cost of living, then you need to try to hold the standard of living constant between measurements.
So any inflation measurement needs to account for the fact that widgets change, or it will perpetually exaggerate inflation.
Most of those adjustments are pretty straightforward. If your candy bar got 20% smaller, it’s easy to account for the additional inflation that implies. In fact most of these quality adjustments are called “quality adjustments.” It becomes a ”hedonic” adjustment when the widget has a lot of different elements that give it value. Think of a car, where having better fuel efficiency is valuable but so is an improvement in the dashboard entertainment system. When the price of the car changes, it’s much harder to figure out how much of that due to inflation (paying more to get the same stuff, X-X’ in the example above) and how much is due to the change in the components of the vehicle. Enter the econometrician, who applies fancy mathematics that you may be unsurprised to learn is called a ”hedonic regression.”
Now, just about 100% of the CPI basket is subject to quality adjustment when necessary. As I said, quality adjustment is necessary. But only a small fraction of the basket is adjusted using hedonic regression.
But it’s not even as bad as that. You hear a lot of grumbling about how “hedonic adjustment says the price of a computer is falling even though it’s staying the same or going up, so obviously inflation is really higher than the government says it is.” But you almost never hear anyone complain about hedonic adjustment to shelter. The BLS, you see, adjusts for the fact that the housing stock gets older, so that if you pay the same rent from year 1 to year 2 it actually works out to be inflation because you’re getting a slightly older apartment. The real kicker? The upward hedonic adjustment to shelter inflation comes very close to balancing the downward hedonic adjustment to computers and microwaves and things. In other words, if you outlawed hedonic adjustment it wouldn’t really change the CPI hardly at all. A 2006 paper by Johnson, Reed, and Stewart found that the “net effect of hedonics from 1999 onward…is estimated to be less than 1-hundredth of 1 percent per year, specifically +0.005 percent.”[1]
So honestly, the bottom line is that people yell about hedonic adjustment for the same reason they yell at referees. They have to yell at something when they don’t like the outcome!
Is hedonic adjustment “right?” That is, does it correctly determine how much of a price change is due to inflation and how much is due to quality changes? I can say with great certainty that it is not exactly right. It’s an estimate. Virtually every financial model is an estimate. The Black-Scholes option pricing model isn’t right either – in fact, we know that the Black-Scholes model isn’t just wrong, but it’s wrong in some very systematic ways. And yet, people continue to use Black-Scholes, because we understand the ways in which it’s not right and can adjust for it.[2]
Hedonic adjustment is also not “right.” But it’s a fair approach, and if you want to adjust the CPI by removing the downward hedonic adjustments while keeping the upward hedonic adjustments (to shelter) then you can make that adjustment mentally by just adding about +0.10% per annum to the CPI. Either way…it shouldn’t tick you off.
[1] Johnson, D.S., S.B. Reed, and K.J. Stewart. 2006. “Price Measurement in the United States: a Decade After the Boskin Report.” Monthly Labor Review (May): 10–19.
[2] One big way is that since actual market movements aren’t distributed normally, and the Black-Scholes model assumes they are, the price of options that are far out-of-the-money are systematically low. Or they would be, if we didn’t adjust for this known problem by applying a volatility smile to price out-of-the-money options.
Modeling Shortfall Risk versus Inflation – What a Good Hedge Looks Like
When people ask me about hedging inflation, they aren’t always asking what they think they’re asking. There are two approaches to addressing inflation in your portfolio so that the portfolio grows in real terms. One of the approaches is to try to simply outrun inflation: “If inflation averages 3%, and I have an investment that averages 5%, I’ve succeeded.” This mode of thinking derives, I think, from the fact that all of our education has been in nominal space and in most financial modeling problems inflation is just assumed rather than modeled as a random variable. It turns out to be a lot harder than it sounds to find an asset class or collection of asset classes that dependably beat inflation over moderate (10+ year) periods, because there is significant (inverse) correlation between inflation and the performance of many asset classes. Most obvious here are stocks and bonds, so if you build a 60-40 portfolio that “should” return 5% over the long term and figure that will beat inflation, you’ll be right…as long as inflation stays low. If inflation goes up, you won’t only lose purchasing power but you’ll lose actual nominal value, since equities and bonds both tend to decline when inflation goes up. Let’s put that aside for a second but I will come back to it.
The other approach to addressing inflation is to try to hedge inflation: exceed inflation by a little bit, but all the time, so that your returns go up when inflation goes up and your returns go down when inflation goes down, but you always are experiencing some positive real return.
The difference between the first approach and the second approach can be summarized by thinking about shortfall risk. As an investor, you care about the upside (in real terms) but most of us are risk-averse meaning that we care more about the downside. Ask most people whether they’d risk a 25% loss in their portfolio purchasing power to have a similar risk of gaining 25%, and they will experience a strong preference to avoid that coin flip. Risk aversion isn’t linear, so investors treat small gains and losses differently from large gains and losses, and of course it matters whether you’re barely covering your goals or easily exceeding them so that you’re ‘playing with house money.’ Many things, in other words, affect risk preferences. But the bottom line is that if you are trying to ‘hedge’ inflation, you care about your shortfall risk over some horizon. What is the probability that you underperform inflation – that is, lose value in real terms – by some given amount between now and a stated horizon?
Now we are going to get a little mathy, but for those who aren’t so mathy I will try to explain in English as well.
If you want to evaluate the probability of asset B underperforming asset A by some given amount over some period, of course you need an estimate of the expected returns of A and B, or how they’re expected to drift relative to one another. That determines your jumping off point. Let’s suppose that A and B have the same expected return. The next thing that determines the frequency and severity of a shortfall of B versus A is the volatility of the spread between them, which is driven by (a) how correlated A and B are, and (b) how volatile each of them is. If they are highly correlated but B is far more volatile than A, you can have a large shortfall if B just has a bad day. If they aren’t very correlated, then when B happens to zig lower as A zags higher, you’ll get a shortfall even if they have similar volatilities. Essentially, we are valuing a spread or Margrabe option and like any option, we need a volatility parameter. In this case, it’s the volatility of the spread we care about, so we can evaluate “what’s the likelihood that the B-A spread is negative.”
If “SA” is the value of an inflation index (or an indexed token like USDi), and “SB” is the value of the hedging asset, then if distributions of A and B are approximately normal,[1] the option value is
C = SA N(d1) – SB N(d2), where
and
and, crucially, is the volatility of the ratio of A to B, which is a formula that will be familiar to travelers in traditional finance and depends on the individual asset volatilities and the correlation () between them:
For this ‘shortfall’ option to be as small as possible, assets A and B should have small volatilities () and a high correlation () between them.
In plain English terms: imagine two drunk guys walking down the boardwalk. What determines how far away they are from each other at any given time? Assuming no drift, it will depend on how much they’re weaving (volatility) and how much they’re weaving in the same pattern (correlation). If they’re holding hands (imposing high correlation), they’ll never get too far away from each other. And if neither one is very drunk (low volatility) they also won’t stray very far from each other. On the other hand, if both are wildly drunk and they don’t know each other, the spread between them will be wildly variable.
We aren’t trying to evaluate the spread between drunks, though. Let’s take this thought process and apply it to the inflation-hedging problem with an example. Suppose you are considering which of two assets is a better ‘hedge’ for inflation: the “INFL” ETF, or a mystery fund – let’s call it “EUSIT.”[2] Here is relevant data for these two assets, and for CPI. These are 3-year returns, volatilities, and month/month correlations, ending November 2025:
Using this data, we can see that the spread volatility (the result of the last formula listed above) for INFL versus CPI is 15.2%, while the spread volatility for EUSIT vs CPI is 1.1%. The Mystery Private Fund is the drunk holding hands with the other drunk, with neither of them that drunk; but INFL is really smashed (14.9% vol) and tending to zig when the CPI drunk zags (negative correlation).
Let’s extend this out one year, assume that INFL, EUSIT, and CPI all have the same expected returns, volatilities, and correlations. Practical question: What is the probability that your investment in INFL or EUSIT underperforms inflation?
For INFL: based on prior returns, it is expected to outperform CPI by 8.99% (11.97% – 2.98%). With a spread volatility of 15.2%, underperforming inflation (a spread of 0% or less) would mean an outcome that is 0.59 standard deviations below the mean. The probability of a draw from a normal distribution being 0.59 standard deviations below the mean is about 33.5%, which means that if you hedge your inflation exposure with INFL, you’ll underperform inflation about one year in three. Your chances of underperforming inflation by 10% or more in a given year is about 18%.
For EUSIT: based on prior returns, it is expected to outperform CPI by 3.15% (6.13% – 2.98%). With a spread volatility of 1.1%, underperforming inflation (a spread of 0% or less) would mean an outcome that is 2.86 standard deviations below the mean. The probability of a draw from a normal distribution being 2.86 standard deviations below the mean is about 0.66%, which means that if you hedge your inflation exposure with EUSIT, you’ll underperform inflation for a full year about once every 151 years. Your chances of underperforming inflation by 10%…even by 5% for that matter…is essentially zero.
Put a star by this paragraph: the assumptions here are key and I am making no claims about either of these strategies having those same characteristics going forward. This is only to illustrate the point that if you want an inflation hedge, meaning that you want to minimize shortfall risk, then it is very important to look at the volatility and correlation to CPI of your intended hedge. Having a better return is important, but less important than you think it is: at a 5-year horizon, the INFL ETF would be expected to outperform inflation (if we think 12% and 3% are decent long-term projections too) by about 60% compounded, but the spread standard deviation is now 15.2% times the square root of 5 years, so you’re only about 1.76 standard deviations above zero and thus you still have an 8% chance of underperforming inflation at the 5-year horizon! On the other hand, your chance of outperforming inflation by a huge amount, if you use the Mystery Fund, is also very small while that possibility exists if you use INFL. That’s what a hedge does: you give up the possibility of big outperformance to ‘buy back’ the chance of underperformance. If you are risk averse, that is a good trade because you’re giving up the less-salient part of your gains (big outperformance) to protect against the more-salient part (big underperformance).
So getting back to answering the question that we started with: what does a good inflation hedge look like?
- It has highly positive correlation to inflation at whatever horizon you’re focused on
- It has low volatility
- It outperforms, or at least doesn’t underperform, inflation over time
To this, I’ll add a fourth characteristic. It’s almost humorous, because hedges that fit those three characteristics are themselves quite rare. But the fourth one I would add is that it has convexity to higher inflation; that is, it does better at an increasing rate, the higher inflation gets. An inflation option, in other words.
Most of us should be happy with three! But at least now you’ll know how to evaluate whether you’re really getting a hedge, or something that will hopefully perform so well that you won’t care that it isn’t a hedge.
[1] I also conveniently wave away some complexities like the relative growth rates and the time value of money to make the math clearer with respect to volatility and correlation, which is my point here.
[2] Mystery fund is a private 3(c)1 fund available to verified accredited investors via a subscription agreement.
Mamdani’s Effect on the CPI
Surprising no one, and yet shocking many, avowed socialist Zohran Mamdani won the election yesterday to become Mayor of the largest city in the United States.[1]
Probably the main reason for Mamdani’s victory is that he pursued the tried-and-true method of giving out free stuff, and a whole generation of Americans who have systematically been poorly educated in history and economics said “that sounds awesome.” So, now we will see whether socialism will work for the first time ever.
This is an inflation blog, so I want to review briefly the effects of price controls on inflation – and indirectly, on inflation instruments. It’s interesting because we actually have some direct and recent experience with what were effectively price controls: the Biden Administration’s ‘eviction moratorium’ during COVID, that prevented landlords from tossing out renters who weren’t paying their rent. Really, it’s a pretty amazing thing that says a lot about Americans that the vast majority of renters continued to pay rent anyway.[2] An ancillary effect, though, was that landlords had no leverage to raise rents and therefore, rents stopped going up. Unsurprisingly (and here is where the lesson should have been learned), when the eviction moratorium was lifted rents re-accelerated. In the chart below, note how in 2021 effective rents declined while asking rents went up – but the red line eventually rebounded and exceeded the prior trend.
I actually haven’t looked at that chart in a little while. It’s fascinating to me that ‘asking rents’ (which come from the Census department) have maintained their divergence from ‘effective rents’ (sourced from Reis Inc). I wonder if some of that is the effect of the LA wildfires. In any case, not today’s article. The point is that the effective price controls on rents did have an effect on measured rents, but it didn’t change the economics and eventually prices caught up.
Back in 2022, I produced an excellent podcast episode entitled Ep. 37: Bad Idea of the Year – Wage and Price Controls. In it, I discussed some of the trial balloons that had been floated by the Administration and some of the really bad economics that was being used to support the idea. This is a part of the transcript (from Turboscribe.ai), and I still love the analogy:
“But the basics of how it works are very simple to visualize. Price is a teeter-totter, okay? It’s a seesaw. On one side of the seesaw sits all of the buyers. On the other side sits all of the sellers. If there are lots more buyers jumping onto one side, then the teeter-totter drops on that side, and the fulcrum, in order to make everything balance, the fulcrum has to move. And if you move the fulcrum, then you can get that to balance even with more buyers and fewer sellers.
It just means that the fulcrum, which is price, has to move in one direction. If then people, those buyers drop off, then the fulcrum moves back the other direction. If more sellers jump onto the teeter-totter, the fulcrum moves the other direction as well.
So it’s a simple way to visualize it…and yes, there are all kinds of complexities in the real world. There’s behavioral, there’s stickiness that happens, but that’s the fundamental theory of price, is what I’ve just given you, is that price is the fulcrum that balances the buyers and sellers.
So what price controls say is that, well, we don’t like where this balanced. We have too many buyers, not enough sellers, and the fulcrum has moved way over to one side and we don’t think it should be there. So we’re going to take the fulcrum and we’re going to move it to where we like it. And guess what happens? There’s no balance. All of a sudden, if you move the fulcrum away, then all of a sudden, the side with all the buyers goes down and goes thunk on the ground. There’s no balance.
“How do you then balance it? If you say that the fulcrum has to be in this location, how do you balance the teeter-totter? Well, you have to take buyers away. And you take buyers away by making a shortage. And so those buyers can’t buy anything. And then voila. So if you force the price, then the quantity has to change. And if you let both things happen, then it will magically go and balance. If it’s truly a free market and there’s good information and all that stuff.
“So does this solve the problem to push the fulcrum to one side and say, oh, there’s no inflation and to make it balanced, we shove everybody off the teeter-totter by creating a shortage? It doesn’t solve the problem. And furthermore, the people that you’ve pushed off the teeter-totter who can’t get access to the thing anymore are pretty upset. They should be upset because before they had a way to get what they wanted and what they were willing to pay for. And now they can’t because you’ve shoved them off the teeter-totter. You’ve created a shortage.”
That was a public service announcement, just to remind you why price controls don’t work. That doesn’t mean they aren’t really good politics, especially if you can leave the removal of the controls to the next guy who ‘causes’ the inflation when they come off. And it’s the politics, not the economics, that leads to this dumb idea being tried over and over despite a roughly 0% record of success.[3]
Because can price controls affect price indices? You betcha. If you make it illegal to move prices, then at least official prices will not move. So let’s consider the potential impact of Mamdani freezing rents and grocery prices, for example.
New York City is about 7% of the CPI sample. Technically, it’s New York-Newark-Jersey City but we know most of that is NYC. In the New York consumption basket, Rent of Primary Residence is about 11%, 28% is Owners’ Equivalent Rent, and 8% is Food at Home. So, if rents and grocery prices were frozen, about 19% of the NY CPI would go to zero month/month right away (at least officially – the best tomatoes will be sold on the black market for a premium of course and the best catch of the day will be sold in NJ…[4]) And since OER is based on a survey of primary rents, eventually 47% or so of the NY CPI basket will go to zero price change. I’m ignoring the quality adjustments in the housing stock, which have the effect of increasing OER inflation slightly.[5]
The effect of this on the national CPI: if 47% of the NY basket goes from, say, 4% inflation to 0%, and NY is 7% of the national CPI, then the really-rough effect on the US CPI would be 47% x -4% x 7% = -13bps per year. Obviously that’s extremely rough, but I’m just aiming for an order of magnitude calculation. 13bps is small, but noticeable. Probably not tradeable.
But here is something that’s interesting and potentially tradeable. New York City is about 30% of the Case-Shiller 10-City Home Price Index. Let’s suppose that home prices in New York over the next year drop, say, 10%.[6] That move would cause the nationwide Case-Shiller (10-city) index to drop 3%, or to rise 3% less than it otherwise would. Here’s what is interesting. The chart below shows the February 2027 NYC Metro Case-Shiller futures contract, which trades on the CME (and settles to the index for December 2026, which is released in February 2027).
There has been exactly zero price effect of the Mamdani victory. To be sure, open interest in the NYC contract – in all of the Case-Shiller contracts, for that matter – is extremely low but there is an active market-maker and the current price as I write this is 344.40 bid/351.60 offer. The last print of the S&P Cotality Case-Shiller New York Home Price NSA Index, for August 2025, was 334.08. On the bid side, then, the market is paying 3.1% higher prices than the current index. That seems sporty to me. Why would home prices rise if rents are frozen? Why would they rise if people are leaving the city?
As always, my musings here are not trade recommendations; do your own research. Disclosure: I do not currently have a position either long or short in any housing futures contract, nor does any account or fund that I or Enduring Investments manages, nor do I currently have plans to initiate any position.
[1] New York, at least for now.
[2] At the time, we worried about what would happen with the CPI since a renter paying zero rent is not skipped but the rent goes into the calculation as a zero. So you could in theory have had 10% of the basket going to zero, which would have destroyed the inflation market.
[3] If you listen to the episode: I also love my thermometer analogy.
[4] Also, though rents will stop rising the quality of the apartments will deteriorate since landlords will skimp on maintenance. Mamdani has a plan for that, though – he has said the city will order maintenance to be done and if it isn’t, the city will seize the property. Just in case there was any question who really owns any property that you can’t pick up and transport elsewhere.
[5] N.b. – the increase in the CPI nationally from the owned-housing quality adjustment almost exactly cancels the decrease from quality/hedonic adjustments in other parts of the CPI. Yet another reason that the whining about hedonic adjustment being used to ‘manipulate CPI lower’ makes no sense.
[6] You can easily make a case for a much steeper drop if the city increases property taxes to make up for declining income tax collections, not to mention if the exodus from the city looks anything like the 9% of the population who claim they’d move if Mamdani won, or if the finance industry continues to relocate to Dallas and Miami.
Inflation Guy’s CPI Summary (September 2025)
Well, it seems like it’s been a while since the last CPI update! Thanks to the government shutdown, it has been since this data is a week and a half later than it was scheduled to be. The importance of the CPI release is obvious, but it was reinforced by the fact it’s the only one the government is calling people back to release. It isn’t that we don’t have reasonably-accurate alternative ways to measure price pressures, though – it’s because unlike Payrolls and most other government releases that are important touchpoints for economists, the CPI is an important legal touchpoint for contracts, bonds, and legal obligations of the federal government. In this case, September’s data is a crucial number needed to calculate COLA adjustments for Social Security for next year. If this had been October’s data? I’m not sure they call back workers to release it. But that’s next month’s problem.
Speaking of next month’s problem: the government shutdown did not affect data gathering for this month’s number; they had to recall the people to collate the data and publish it but not the collectors. So the quality of the data should be fine. The data-quality question is much murkier when we look forward to next month, but since much less of the data collection is done by guys with clipboards these days, it might not be as bad as you think. Still, that will be the concern for the October CPI released next month. Like I said: next month’s problem!
Heading into the release, consensus was for +0.37% on headline CPI (SA) and +0.29% on core. I have to admit that I was confiding to people that this seemed sporty because the prior month had seen a surprising acceleration in rents that could be reversed, indications are that Used Cars would be a drag, and Food at Home also looked soft (I was right on 2 out of 3 – Food at Home was an add). That told us going in that if we were going to get to +0.29% core, either I had to be wrong on most of that or core goods ex-used cars was going to have to be pretty strong. Tariffs definitely are helping to push that narrow group of the consumption basket higher. But is that enough? Let’s see.
The backdrop going into the data was that rates have been generally softening, and the inflation swaps curve has been steepening (lessening its inversion, with near-term inflation pricing dropping more than longer-term inflation expectations). That’s consistent with a return to normalcy…but it’s really happening because energy prices have dropped quite a bit until the last couple of weeks, and that has a more immediate impact on the front of the inflation curve. The mean reversion time for energy prices is something like 15 months, so by the time you’ve gotten a few years out the curve today’s lower gasoline prices shouldn’t much affect your expectations of inflation forwards. But it affects inflation spot, which propagates through the forwards.
Actual print: SA CPI +0.31%; SA Core +0.227%. Softer than expected, and it took only a moment to see that a big part of that was due to a sharp deceleration in Owners’ Equivalent Rent (see chart). Some of that was the give-back I expected, but it was more than that and so we should put this in the back of our minds for next month – we’re probably due a reversal in the other direction over the next month or two.
Interestingly, even with the miss the Core CPI time series doesn’t look terribly weak. I mean, +0.227%, repeated for a year, still gives you 2.7% core CPI. And we won’t get downside drags from cars and housing every month.
Interesting jump in apparel this month. It’s a small category and always volatile, but since we also import almost all of our apparel it’s one place I look for tariff effects. But note the y/y numbers are still very low and in fact decelerated with this jump, implying last year’s bump in September was even larger. That’s a seasonally-adjusted figure, but I wonder if the problem here is that seasonal adjustment is failing us. Maybe pre-holiday mark-ups (from which we can show great discounts in a month!) are happening earlier. In any event it’s only 2.5% of the CPI so probably not worth too much computational cycles.
Core goods inflation rose slightly to +1.54% y/y, and core services declined to 3.47% y/y. The latter is mostly and maybe entirely due to housing, which is a core service. The former is interesting because Used Cars/Trucks was -0.41% m/m. That was expected, but it means that other core goods were more buoyant.
So here are OER and Primary Rents. 3.76% y/y (only +0.13% m/m) and 3.4% y/y (only +0.2% m/m). You can’t really tell a lot about the miss today from this chart – I showed the m/m series earlier, and the bottom line is that this continues to level out. I think the flattening is going to be more dramatic over the next 3-6 months but we’ll see. Lodging Away from Home rose again, +1.3% m/m, and is now flat y/y.
At this point, I’m thinking: with rents a downside surprise and Used Cars a downside surprise, this isn’t that bad a miss. In other words, if you’d told me we were going to get those numbers from rents and cars I would have thought core would be a lot weaker than +0.23% m/m.
Earlier I showed the last 12 Core CPIs. My guess at Median looks better, but that’s mostly because the median category is West Urban OER and even split up, an aberration in OER – and that’s what I think this is – is enough to sway Median CPI. It also means my estimate of median, +0.213% m/m, might be off because the Cleveland Fed separately estimates the seasonals for the regional OERs and so I have to guess at that part. My guess will take y/y Median CPI to 3.5% from 3.6%. And the Fed is easing. Hmm.
Here are the four-pieces charts. Food and Energy +2.99% y/y. Core Commodities +1.54%. Core Services less Rent of Shelter (Supercore) +3.37%. Rent of Shelter +3.53%. These are the four pieces that add up to CPI. None of them looks terrible except for Core Goods, and there’s limited upside to that – and it has a short period, so in a year it’s likely to be lower. I do think that going forward, core goods remains positive instead of the steady deflation it was in for decades, but not big positive. However, you need it to be negative if you want inflation at 2%, unless you get core-services-ex-rents a lot lower (but that’s highly wage-driven, and reversing illegal immigration helps support that piece somewhat) or rent of shelter a lot lower. The latter is certainly receding but it’s not going to go a lot lower.
I don’t usually spend a lot of time talking about energy, because that’s a hedgeable piece (largely – gasoline is a big part of energy and that’s easy to hedge with a little lag; electricity is harder). This month, Energy was +0.12% NSA. But next month, we’ll see a decent drag because of the sharp drop in gasoline over the last few weeks. That’s a little early compared to the usual seasonal, and it may mean we get the usual December drop in gasoline in October CPI.
Except…that I think the White House has teased that we might not get October CPI at all, just skip it, because of the difficulty gathering data. If that is true, the fallback mechanisms will kick in. See my piece on what that means, here, but the bigger point is that you wouldn’t get my scintillating commentary. I guess again that’s not this month’s problem.
Now, I have to show this almost by habit, and because the economists expecting housing deflation will be dancing in the streets. Take pictures, and show them again next year. They never learn. Housing inflation is slowing but there is no sign rents are going to come anywhere near deflation. Except maybe on a weighted basis if Mamdani gets elected Mayor of New York City and freezes rents. But then we’ll have to start looking rents ex-NYC.
How disinflationary a period are we in? Wellllll…of the item categories in the median CPI calculation, there were zero core categories that decelerated faster than 10% annualized over the last month (-0.833% or faster). On the plus side, there were Personal Care Services (+11.9% m/m annualized), Footwear (+12.0%), Motor Vehicle Fees (+14.2%), Tenants’ and Household Insurance (+15.2%), Lodging Away from Home (+17.5%), Miscellaneous Personal Goods (+17.9%), Men’s and Boys’ Apparel (+19.3%), and Public Transportation (+21.5%). These are small categories for the most part – but not all import goods and interesting in that the tails are all to the upside. That’s not the way a disinflationary economy usually looks, although I don’t want to overstate the importance of a single month!
Here’s the observation about long tails compressed into a single number, the Enduring Investments’ Inflation Diffusion Index. It’s signaling upward pressure.
Below is a chart of the overall distribution. The two big spikes in the middle are mainly rents and OER. But take those away and you can see there’s not a lot of categories in the 1-3% range, and a decent weight in the 5-6% range. This doesn’t really look like a price system settling back down placidly to 2%.
Now, the stock market clearly loves this, which makes sense. The Fed is going to ease, probably twice more this year. But that was already baked into the cake in my mind, because the Fed no longer targets 2% inflation. Remember that in the most-recent change to the 5-year operating framework the Fed, in Chairman Powell’s words, “…returned to a framework of flexible inflation targeting and eliminated the ‘makeup’ strategy.” I talk more about that here: https://inflationguy.blog/2025/09/02/the-fate-of-fait-was-fated/ Ergo, the Fed doesn’t really care if we get to 2%. They’d prefer to not see inflation head higher, but they can spin a story to themselves that even though median inflation is in the mid-to-high 3s, “the process of inflation anchoring is underway” or somesuch nonsense. As long as it’s not hitting them in the face that inflation is going up, they’ll keep relying on their models that say it should be going down. N.b., those are the same models that said inflation shouldn’t have gone up that much to begin with, and should have been transitory, but we all know “Ph.D.” stands for “Pile it higher and Deeper.”
Eventually, inflation going up probably will hit them in the face. But that’s such a 2026 problem.
Does Crypto Expand the Money Supply?
We live in interesting times, and let’s face it: mostly, in a good way. It doesn’t have to stay that way, naturally, and it won’t stay that way naturally.
This has always been the weak spot in any system that insists on centralized management of certain functions. Of course, that’s the fundamental flaw and conceit of socialism: it relies on the active intercession of omniscient beings to order activities better than the masses of private actors can. Usually, “better” means “less volatile” to the policymakers who set up the committees of omniscient beings (personally, I would say “better” means “less fragile,” which is the opposite of “less volatile”).
The best argument for using the collective wisdom of the anointed few is to prevent the tragedy of the commons, where individuals making private decisions can impact the use of public goods. And that brings us to money.
I think it is a fascinating question whether ‘money’ is a public good, which should be regulated and controlled. Or is a particular currency, such as the US Dollar, the public good which should be regulated and controlled? The argument the Federal Reserve would make is that, absent the control of the Federal Open Market Committee, the money supply would grow or shrink in dangerous and random ways. Or at least, that would be the argument they would make, if they cared about the stock of money any more.
There is no plausible argument in my mind that “interest rates”, which is what the Fed now works to control, is a public good that is better managed by the Smart Guys. So, weirdly, the Fed now manages something which they don’t have any knowledge about that should supersede private market actors (rates), but does not purport to manage something they could plausibly argue is a common good that no one directly controls (money).
** Separate question: are the Cognoscenti at the Fed any good at it? Chairman Powell said yesterday that the Fed is likely to stop running down its balance sheet soon. With the balance sheet still at 22% of GDP, compared with the pre-GFC normal of about 6% – see chart – “Until the job is done” has apparently become “until it’s time for my smoke break, and then you’re on your own.” What’s the matter with kids today?
So the answer to this ‘separate question’, as inflation remains at the highest level of this millennium and is now headed higher, is “of course they’re not. Why are we even asking that question?”
I actually want to go slightly further. The Fed no longer tries to control the money supply, which at least they might have an argument for doing, in preference to managing interest rates against the market-clearing actions of private actors. But over time (and accompanied by the whining and moaning of central bankers), the concept of money has gotten squishier and squishier. One of the reasons that central bankers want to control crypto is that they fear the power of money loose in the wild (ironically, given that they stopped worrying about money a long time ago), untamed by the Anointed Stewards of Money.
The question is, does crypto expand the money supply? For the purposes of this question, let’s ignore the official definitions of money, M1, M2, M3, etc and just focus on ‘spendable balances.’
If you give me a dollar, in exchange for something that feels like a dollar and that you can spend (say, a stablecoin like USDC), have we increased the money supply? The answer depends on what I do with that dollar. If it is deployed to a vault, then obviously the number of ‘dollarish’ units in circulation haven’t changed. You have minted $1000 USDC, but there are now $1000 USD that are sequestered in a vault and not spendable. The amount of spendable money hasn’t changed. If instead that $1000 goes to buy a Treasury bill from the government, then it is going to the government to spend. Normally, buying Treasuries doesn’t change the amount of spendable dollars, because in buying a Tbill I am deferring my decision to spend (instead, I hold securities) and delegating that decision to spend to the government. I exchange my future spending for the government’s current spending, and in the future that transaction is reversed when the Tbill matures. Some people think that means that Treasury issuance increases inflation because it increases money, but it doesn’t. The Treasury bill is just a token representing my deferral of spending into the future.
But if I was able to buy that Tbill because I issued a USDC token, which you can spend, and then gave the fiat money I received from you to the government in exchange for a Tbill, then I have doubled the number of spendable dollars in circulation: $1000 in the form of USDC, and $1000 in the form of dollars sent to the Treasury which will be spent. Essentially, what has happened is zero-reserve banking. If I were a bank and you deposited $1000, I could lend out only, say, $900 of that (“fractional reserve banking) and in principle the Fed can control that multiplier by changing the reserve requirement.[1] But now you’ve deposited $1000 and I am lending 100% of that to the government. Stablecoin manufacturers in this way are basically banks issuing their own currencies. Now, a lot of that money is going abroad, but it looks like money to me.
Worse are the vaporware crypto issuers who simply create supply out of thin air. If people accept bitcoin as money, rather than as a speculative chip to trade around, then I have created money with no reserves whatsoever, and no limit on how much ‘money’ I can so create.
If this is true, then the irony is that crypto – which was inspired originally by the desire to remove money from the ministrations of the Very Smart Bankers who could ruin money by creating too much of it – could be the very tool that creates the inflation its originators wanted to protect against. In that kind of world, I really don’t understand the use of a nominally-anchored stablecoin. If the overall money supply growth is unbounded and now essentially uncontrollable (once the size of the crypto world gets sufficiently big), then holding something that is pegged to the sinking ship seems counterintuitive to me.
While I didn’t start this article with the intention of pointing out that our USDi coin is a raft rather than an anchor (like stablecoins), it does seem to be relevant here to mention that you can now mint USDi directly from our website: https://usdicoin.com/coin . And, while the increase of USDi will contribute to the overall money supply – at least it has a built-in defense!
[1] …but it doesn’t really work like that any more. The Fed still has a dial to turn that limits how much lending can happen on a given depository base but it isn’t as clean as it was when there was a simple reserve requirement. This is well beyond the point of this article.
