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.
The Fault, Dear Brutus, is in R*
I want to say something briefly about the “neutral rate of interest,” which has recently become grist for financial television because of new Trump-appointed Fed Governor Stephen Miran’s speech a couple of days ago in which he opined that the neutral rate of interest is much lower than the Fed believes it is, and that therefore the Fed funds target should be more like 2%-2.25% right now instead of 4.25%.
Cue the usual media clowns screaming that this is evidence of how Trump appointees do not properly respect the academic work of their presumed betters.
If that was all this is, then I would wholeheartedly support Miran’s suggestion. Most of the academic work in monetary finance is just plain wrong, or worse it’s the wrong answer to the wrong question being asked. And that’s what we have here. Anyone who thinks that Miran is an economic-denialist should read the speech. It is mostly a well-reasoned argument about all the reasons that the neutral rate may be lower now than it has been in the past. And I applaud him when he comments “I don’t want to imply more precision than I think it possible in economics.” Indeed, if we were to be honest about the degree of precision with which we measure the economy in real time and the precision of the models (even assuming they’re parameterized properly, which is questionable), the Fed would almost never be able to decisively reject the null hypothesis that nothing important has changed and therefore no rate change is required!
I can’t say that I agree with Miran’s argument though. Not because it’s wrong, but because it’s completely irrelevant.
Sometimes I think that geeks with their models is just another form of ‘boys with their toys.’ And that is what is happening here. The “neutral rate of interest” is a concept that is cousin to NAIRU, the non-accelerating-inflation rate of unemployment. The neutral rate, often called ‘r-star’ r* (which is your clue that we’re arguing about models), is the theoretical interest rate that represents perfect balance, where the economy will neither tend to generate inflation, nor tend to generate unemployment. Like I said, it’s just like NAIRU which is a level of unemployment below which inflation accelerates. And they have something else in common: they are totally unobservable.
Now, lots of things are unobservable. For example, gravity is unobservable. Yet we have a very precise estimate of the gravitational constant[1] because we can make lots of really precise measurements and work it out. Economists would love for you to think that what they’re doing with r* is similar to calibrating our estimate of the gravitational constant. It’s not remotely similar, for (at least) two enormous reasons:
- Measuring the gravitational constant is only possible because we know (as much as anything can be known) what the formula is that we are calibrating. Fg=Gm1m2/r2. So all we have to do is measure the masses, measure the distance between the centers of gravity, and infer the force from something else.[2] Then we can back into G, the gravitational constant. Here’s the thing. The theory of how interest rates affect inflation and growth, despite being ensconced in literally-weighty economics tomes, is just a theory. Actually, several different theories. And, by the way, a theory with a terrible record of actually working. To calibrate r*, the hand-waving that is being done is ‘assume that interest rates affect the economy through a James and Bartles equilibrium…’ or something like that. It is an assumption that we shouldn’t accept. And if we don’t accept it, calibrating r* is just masturbation via mathematics.[3]
- With the gravitational constant, every subsequent measurement and experiment confirms the original measurement. Every use of the model and the constant in real life, say by sending a spacecraft slingshotting around Jupiter to visit Pluto, works with ridiculous precision. On the other hand, r* has approximately a zero percent success rate in forecasting actual outcomes with anything like useful precision, and every person who measures r* gets something totally different. And r* – if it is even a real thing, which I don’t think it is – evidently moves all the time, and no one knows how. Which is Miran’s point, but the upshot is really that monetary economists should stop pretending that they know what they’re doing.
In short, we are arguing about an unmeasurable mental construct that has no useful track record of success, and we are using that mental construct to argue about whether policy rates should be at 2% or 4%. Actually, even worse, Miran says that the market rate he looks at is the 5y, 5y forward real interest rate extracted from TIPS. The Fed has nothing to do with that rate. But if that’s what he is looking at why are we arguing about overnight rates?
I should say that if there is such a thing as a ‘neutral rate’ that neither stimulates nor dampens output and inflation, I would prefer to get there by first principles. It makes sense to me that the neutral long-term real rate should be something like the long-run real growth rate of the economy. And if that’s true, then Miran is probably at least directionally accurate because as our working population levels off and shrinks, the economy’s natural growth rate declines (unless productivity conveniently surges) since output is just the product of the number of hours worked times the output per hour. But I can’t imagine that the economy ‘cares’ (if I may anthropomorphize the economy) about a 1% change in the long-run real or nominal interest rate, at least on any time scale that a monetary policymaker can operate at.
The best answer here is that whether Miran is right or not, the Fed should just pick a level of interest rates…I’m good with 3-4% at the short end…and then change its meeting schedule to once every other year.
[1] Which may in fact not be constant, but that’s a topic for someone else’s blog.
[2] In the first experiment to measure gravity, which yours truly replicated for a science fair project in high school, Henry Cavendish in 1797 figured the force in this equation by measuring the torsion force exerted by the string from which his two-mass barbell was suspended, with one of those masses attracted to another nearby mass.
[3] Yeah, I said it.
Inflation Guy’s CPI Summary (August 2025)
Before I begin talking about today’s CPI, a quick word about the 24th anniversary of the terrorist attacks of 9/11. As someone who worked 1 block from the Towers, I can tell you it’s a day I will never forget and filled with images I can never erase. But I also remember that in the weeks that followed, the country was unified in a way I’d never seen. Rudy Giuliani was “America’s Mayor” for his courage and steady hand during the disaster and in the period that followed. When I traveled to the Midwest, menus were filled with ‘Freedom Fries’ and strangers asked with concern about my family and friends when they heard I was from New York. It seems crazy to me that only 24 years removed from that, the country is divided in a way I’ve never seen. Everyone said “we will never forget.” And then they forgot.
But I do not forget. I give prayers and thanks for the brave first responders I saw that day and for the families of those who didn’t return. And you should too.
All of which makes the monthly CPI report seem very small. In truth, it is small all of a sudden. From being one of the most-important releases for a couple of years because of the Fed’s assumed reaction function, it has abruptly been pushed to the back. This is partly because of the weak Employment data and the massive downward revisions to the prior data but that point is reinforced by the Fed’s recent adjustment to the inflation targeting framework, in which they removed any imperative to make up for periods of high inflation by engineering lower inflation so that the reaction function is basically one way. (See my writeup on this at https://inflationguy.blog/2025/09/02/the-fate-of-fait-was-fated/.) I guess there’s an ironic parallelism here. After the inflationary 1970s and the pain of bringing inflation back down, the Fed said “we will never forget.” And then they forgot.
But I do not forget. And neither should you. An investor’s nominal returns are irrelevant (except to the IRS). What matters is real returns, and a period of higher and less-stable inflation has historically resulted in lower asset prices since the most important indicator of future returns over normal investing horizons is starting price. If markets need to adjust to higher inflation to give higher nominal returns, the easiest way to do that is to lower the starting price. So whether the Fed cares, we should.
And with that – we came into today with real yields having fallen some 20bps this month, but with inflation expectations having not declined much at all. Obviously, that’s the market’s reaction to the presumed tilt of the Fed.
The CPI report was slightly above expectations, which were already somewhat higher than in prior months. So when people tell you this was a ‘small miss higher,’ that’s mainly because economists adjusted their expectations, not because the number was similar to prior months. Month/month headline inflation (seasonally adjusted) was +0.382% (expectations were +0.33%), with core at +0.346% (expectations were +0.31%). Markets have not reacted poorly to this figure, but I wonder if core had been slightly higher and rounded to +0.4% if we’d have seen more introspection.
But as I said, this is a ‘small miss’ but that does not mean it was a small number. Indeed, with the exception of the jump in January associated with tariff noise, this is the highest core figure in 17 months.
There were a number of upside categories, but one of them was not Medical Care. Some people had been looking for a move higher here, and Doctor’s Services rose a bit, but Medicinal Drugs fell -0.372% m/m and is now down year/year. That surprises me, but there are a lot of pressures on the drug industry right now and it is going to take a while to see how it shakes out.
Core goods prices continued to accelerate. On a y/y basis, core goods are +1.54%. With the exception of the COVID spike, this is the highest level of core goods inflation since 2012. Some of that is definitely due to tariffs, and that will trickle in for a while. But the long-wave concern is that deglobalization/re-onshoring of production means that it will be very hard to get core goods inflation back to the persistent mild deflation we had enjoyed for a very long time. And without that, it is very hard to get core inflation to 2%, especially if core services (+3.59% y/y) stops improving as the chart sort of hints it might.
One surprise you will hear a lot about is Owners Equivalent Rent, which was +0.38% m/m. Primary Rents were +0.30% m/m. Both of those are higher than the recent figures, but this looks like some residual seasonal-adjustment issues to me. The y/y for both continues to decline, albeit at a slowing rate, which means that the number we dropped off from last year was higher than the upside surprise of today.
Rents are on schedule.
We also saw another jump from airfares, +5.87% m/m, and Lodging Away from Home (+2.92% m/m) finally rebounded after months of weakness. Used cars were +1.04% m/m, and new cars +0.28%. When you look at all of the pieces, it adds up to Median CPI being almost the same as last month: my early guess is +0.276% m/m.
Turn that picture any way you want to. I don’t see a downtrend.
When we break down inflation into the four main pieces, none of them is in deflation and none seems to be an overt drag or pulling everything else up. Food and Energy is +2.16% y/y. Core goods is +1.54% y/y. Core services less rents (aka Supercore, chart below) is +3.56% y/y. And Rent of Shelter is +3.61%. How do you want to get inflation to 2% from those pieces?
Long-time readers will know this does not surprise me. Median CPI will be around 3.6% y/y again. That’s where we are. We overshot my ‘high 3s, low 4s’ target to the downside a bit, but we’re back up in the mid-to-high 3s. I’ll take that as a win.
I want to share the money supply chart. On an annualized basis, we’re near 6% y/y over the last six months. That is back to pre-COVID levels, and is too fast in this environment. You can’t get 2% inflation with deglobalization and sour demographics if you’re running the monetary playbook from when you had globalization and positive or neutral demographics.
And finally, we now know USDi’s price through the end of October.
So what does all of this mean for policy? Well, see what I said above about inflation targeting and the change of the Fed’s operating framework. The most important things to the FOMC right now are, in order:
- Employment
- Politics, and jockeying for position to be named next Fed Chair
- Internal modeling about tariffs, inflation expectations, rents, etc.
- Actual inflation numbers, like CPI
35th or so in importance is “the quantity of money,” if it’s on the list at all. You can probably glean from my list that I think the Fed is likely to ease. Let me make clear that I do not think that a wise Fed chair would even consider easing with median inflation steadying around 3.6%, and a 50bps cut would be laughable. However, this is not a wise Fed chairman, and this one is going to ease. In my gut, I think the Fed will cut 25bps but with several dissents for 50bps. I would not be shocked with a 50bps ease even though it is completely boneheaded to do it with inflation still running hot with no clear path for it to decline to what used to be the target.
But that’s the point I suppose. Is there even a target, if the Fed doesn’t mind missing it?
One final announcement. If you’re an investor in cryptocurrencies (in particular, stable or flatcoins) and have a Telegram account, consider joining the read-only USDi_Coin room https://t.me/USDi_Coin where the USDi Coin price is updated every four hours or so…and where many of these charts are also posted shortly after CPI just as I used to do on Twitter.
The Fate of FAIT was Fated
Growth in the US is ebbing, and it is likely only the AI boom that is keeping us from recording a small recession. Unemployment is still rising, although slowly, and credit delinquencies are rising. Because the services sector and the goods sector are still asynchronous – a holdover from the COVID period – we haven’t seen an aggregate contraction, but it will happen eventually. That doesn’t concern me. Recessions happen. It is only worrisome because equity markets are so ‘fully valued’ that an adjustment to a recession could be rough. On the other hand, all signs point to the Federal Reserve starting to ease, and this may support stocks. I would go so far as to say that investors are counting on that.
That is a rather ordinary problem. The bigger problem has not yet been realized by equity markets, but as we look at long maturities on the yield curve we see that yields are near the highs of the year even with the Fed expected to ease. That is not normal. When the Fed eases the curve tends to steepen, because however long the period of lower short rates, it will be a larger proportion of a shorter-maturity instrument. But long rates still decline in that case, normally.
You can insert your favorite story here, about how foreign investors hate Trump, or people are worried about inflation, or the credit profile of the United States. My preferred explanation (see “The Twin Deficits – One Out of Two IS Bad”) is that if you reduce the trade deficit sharply but do not reduce the budget deficit equally sharply, then the balance must be made up by domestic savers and that implies a higher rate of interest.
There’s also some reason to be wary of the turn higher in inflation, even though that was entirely foreseen (see “Ep. 145: Beware the Coming Inflation Bounce”) and a good part due to base effects. There are, though, some signs of underlying secular rather than cyclical pressures on prices. For example thanks partly to AI electricity prices started accelerating higher in 2021 but unlike other parts of the CPI have continued to rise. The CPI for Electricity stands 35% above the level of year-end 2020, and well beyond the long-term trend. Beef prices are 41% higher and still rising.
Of course, there are always prices that are rising but there are two reasons I am more concerned about this now. The first is that the money supply has returned to a positive and rising growth rate and is at a level inconsistent with long-term price stability even before the Fed renews its easing campaign.
Five percent was once a nice level for M2 growth, when demographics and globalization were following winds. Now they are headwinds and we need to be lower. Still, I wouldn’t get panicky about 5%. Get to 8% and I’ll be more concerned. But the reason that might happen concerns changes happening at the central bank.
What gets the headlines is the continual pressure that the Trump Administration is putting on Fed Chairman Powell and others on the Federal Reserve Board, several of whom are jockeying to be dovish enough to be selected as the next Fed Chair. But the much more important development was the 5-year review of the Fed’s operating framework, which Powell discussed at his Jackson Hole speech. The significance of this was seeming lost on most investors, although 10-year breakevens have gradually risen and are up at 2.42%, and other than in the post-COVID surge they’ve not been much higher than that since 2012 or so.
These are 10-year breakevens, so this isn’t a tariff effect. What’s going on here? Not much, yet, but…there is the change in the Fed’s framework, which I think is important.
Five years ago, the Fed abandoned a specific inflation target in favor of “Flexible Average Inflation Targeting”, or FAIT, which basically said “we are targeting 2% inflation, but only over time. So when inflation is too low for a while, then it’s okay to let it run hot for a while later.” At the time, this was a clear sign that monetarists – who don’t necessarily believe there is a tradeoff between inflation and growth like the Keynesians do – were losing the battle. More flexibility to respond to inflation ‘tactically’ is not something that we needed, and it wasn’t clear how that would be a helpful change anyway.
But the current 5-year framework adjustment is worse. It basically abandoned the good part of FAIT, which was any kind of soft commitment to be hawkish in the future if necessary. In Powell’s words – and I’m not making this up – “…we returned to a framework of flexible inflation targeting and eliminated the ‘makeup’ strategy.”
Yep, that’s what he said.
There is a lot more in Powell’s explanation, but most of it all leans in the same direction. For all my historical criticism of former Chairman Greenspan, he deserves credit for this: he used to say that achieving low and stable inflation was key to achieving maximum stable employment over time. Thus, inflation was primary, not secondary, in achieving the dual mandate. Now, the Fed ostensibly wants to target a low level of inflation…because that’s what central banks are supposed to do…but recognizes that sometimes they’ll want to emphasize lower rates to help Employment – and the important part is that as I just noted, they won’t ‘make up’ for running too much liquidity now by running less liquidity later. Does anyone want to take the other side of the bet that the Fed will have an easier time lowering rates and keeping them low, than raising them and keeping them high? Accordingly, the long-term inflation outlook just got worse. I don’t think we are returning to the 1970s, but we aren’t returning to 2% any time soon – and the Fed is okay with that!
FAIT was never a very good idea, and I didn’t think it would survive the first time inflation ran too high and dictated an extended period of very tight money. It didn’t. I didn’t think they’d actively make it worse, and maybe the joke’s on me. They always make it worse.
