Is Inflation Dead…Again?
I am not the first person to point out that the stock market, at outlandish multiples, is not behaving consistently with commodities markets that are flashing imminent depression. If we insist on anthropomorphizing the markets, it really makes no sense at all unless we posit that “the market” suffers from a split personality disorder of some kind. But that sort of thing happens all the time, in little ways.
But here is something that seems very weird to me. Prices of short-dated inflation swaps in the interbank market suggest that NSA headline inflation is going to rise less than 0.9% for the entire balance of 2023 (a 1.45% annualized rate). And actually, most of that rise will be in the next 2 months. The market is pricing that between June’s CPI print and December’s CPI print the overall price level will rise 0.23%…less than ½% annualized!
Now, eagle-eyed readers will notice that there was also a flat portion of 2022, covering roughly the same period. Headline inflation between June and December last year rose only 0.16%, leading to disappointing coupons on iBonds and producing proclamations that inflation was nearly beaten. Here’s the thing, though. The second half of 2022 it made perfect sense that headline inflation was mostly unchanged. Oil prices dropped from $120/bbl the first week of June, to $75 by mid-December. Nationwide, average unleaded gasoline prices dropped from $5 to $3.25 during that time period.
A comparable percentage decline would mean that gasoline would need to drop to $2.32 from the current $3.58 average price at the pump. To be sure, the gasoline futures market is in much steeper backwardation than normal, with about 44c in the curve from now until December compared with 28c from June to December 2024.[1] So that can’t be the whole source of this insouciance about inflation. If gasoline does decline that much, the inflation curve will be right…but there’s an easier way to trade that, and that’s to sell Nov or Dec RBOB gasoline futures.
So the flatness must be coming from elsewhere. It can’t be from piped gas, which has recently been a measurable lag, because Natural Gas prices have already crashed back to levels somewhat below the norm of the last 10 years. Prices of foodstuffs could fall back more, which would help food-at-home if it happened, but food-away-from-home tracks wages so it’s hard to get this huge of an effect from food.
Ergo…this really must be core. Except there, the only market where you can sort of trade core inflation rather than backing into it, the Kalshi exchange, has the current prices of m/m core at 0.35% in May, 0.32% in June, 0.57% in July, 0.45% in August, 0.35% in September, 0.18% in October, and 0.22% in November. (To be sure, those markets especially for later months are still fairly illiquid but getting better). That’s not drastically different from the 0.41% average over the last six months.
Markets, of course, trade where risk clears and not necessarily where “the market thinks” the price should be. I find it hard to understand though who it is who would have such an exposure to lower short-term prices that they would need to aggressively sell short-term inflation…unless it is large institutional owners of TIPS who are making a tactical view that near-term prints would be bad. Sure seems like a big punt, if so.
Naturally, it’s possible that inflation will suddenly flatline from here. I just don’t feel like that’s the ‘fair bet’. That is after all a key function of markets: offer attractive bets to people who don’t have a natural bias in the market in question, to offset the flows of those people who are willing to pay to reduce their risk in a particular direction. (This should not be taken to suggest that I don’t have a natural bias in the market; I do.)
There’s another reason that this matters right now. Recently, markets have also been starting to price the possibility that the Federal Reserve could continue to hike interest rates, despite fairly clear signals from the Chairman after the last meeting that a ‘pause’ was in the offing. That certainly makes sense to me, since 25bps or 50bps makes almost no difference and after one of the most-aggressive hiking cycles in history, putting rates at approximately long-term neutral at the short end, it would seem to be prudent to at least look around. If, in looking around, the Fed were to notice that the balance of the market is suggesting that inflation has a chance of going instantly and completely inert, it would seem to be even stranger to think that the FOMC is about to fire up the rate-hike machine again for another few hikes.
[1] N.b. – June to December on the futures curve isn’t the exact right comparison since prices at the pump lag wholesale futures prices, but it gives you an idea.
Social Security Solvency, Solved
I’m going to depart temporarily from my usual inflation-focused column to write about something that affects all Americans, and propose a simple solution to a bedeviling problem – a solution that is guaranteed to work.
The issue is Social Security. According to the US debt clock, which keeps track of this sort of thing, the present value of the (off balance sheet) Social Security obligation is $22.8trillion. What has happened is that over the years since the Social Security program was created, people are living longer and benefits have increased; a secondary problem that will someday solve itself is that the population pyramid in the US is almost inverted as the baby boom generation ages. Consequently, current workers have to contribute quite a bit to support retired workers, and this will get worse in the near future (since Social Security is not a savings program but a transfer program, the current workers plus taxpayers pay for retirees).
The full retirement age has been raised occasionally in the past, each time to ‘fix’ the system, and each time under a firestorm of controversy. Raising the retirement age temporarily improves the fiscal position of the program, but ultimately fails because people are living longer. That’s a good thing, but it’s really bad as the ‘retired’ population gets bigger and bigger and the US population growth rate grows more and more slowly.
To demonstrate the problem and my solution, I ran some relatively simple simulations. I started with the current US population distribution by age.[1] For each subsequent year, I applied the 2020 period life table for the Social Security area population, as used in the 2023 Trustees Report.[2] For simplicity I used the females table. For new births, I took the prior year’s 25-year-old cohort and multiplied by 1.1, which resulted in an average population growth rate of 0.3% per year (which was roughly the low set in the pandemic, so very conservative). This takes the population of the US from 332mm in 2021 to 815mm, three centuries from now. (Bear with me; I know it’s ridiculous to project anything 300 years from now but this is for demonstration purposes).
I am also assuming that the current average benefit of $20,326.56 stays constant in real terms, and discount all future benefits using a 2% real interest rate. It’s important to realize that in what follows, I am showing 2021 dollars. Nominal dollars would be a lot higher. Another caveat is that I am implicitly assuming that people who are 1 year old, who have accrued zero Social Security benefits, can still be expected to cost the system in an economic sense even though in an accounting sense the government does not yet have a liability to those future-workers. I am also assuming that the entire population eventually works and earns a Social Security benefit. As a consequence of these last two assumptions, my number for “Present Value of Real Social Security Benefits” is about 2.65x higher than the official number.
However, it’s not important to get the accounting exactly right as long as we have the dynamics approximately right. If it makes you feel better, divide all of the numbers in the following charts by 2.65. It won’t change their shape.
I am also not assuming any increase in longevity over time, which is unrealistic but I think is what the SSA also assumes. My solution is still absolute, as long as longevity doesn’t advance very rapidly, forever.
So, under those assumptions and a fixed retirement age of 67, here’s what the PV in 2021 dollars looks like over the next 300 years.
It’s really not as bad as all that – in terms of dollars/population, it’s pretty stable. But this assumes no increase in longevity or benefits, which has historically been a bad assumption. This is probably not sustainable. So let’s change the retirement age. In 2025, we increase the retirement age to 70, ignoring for now the utter predictability of the firestorm that would erupt, and fairly so, if we did this.
That doesn’t really change the picture much. It lowers the overall number but the number still grows. And it would be really difficult to get even this change. Anyone remotely close to retirement age would be furious at having that brass ring snatched from them. And this small effect is from only a three year increase in the retirement age! It’s no wonder that everyone talks about Social Security’s solvency, but no one does anything about it. Nothing that you could actually accomplish, seems to have a big enough effect to be worth doing.
Here is my proposal. Starting in 10 years, raise the full retirement age by just 1 month. But do it every year after that. And, here’s the key word: forever.
Someone who is 57 today would still retire at the age of 67, so it doesn’t really affect them. Someone who is 45 today would retire at 68. They’re not really happy about the extra year, but that’s better than the prior example which was 3 years. Someone who is 33 today would retire at 69. That’s still better than the prior proposal, for them. Someone who is 21 today would retire at 70. They’re no worse off, and arguably lots better off because the 20-somethings all assume there won’t be a Social Security when they are old enough to claim it. With this proposal, there would be. And unlike the current spastic attempts to repair the system, this would be predictable. (The legislative trick would be to make it very hard to change, but once it’s understood as a solution it will have momentum of its own – just like the Fed, in theory, could be changed but in practice it’s really hard to mess with).
The key word forever means that eventually, almost no one would get Social Security benefits and so the liability would dwindle to zero. But this would happen over generations. Would we leave our old folks penniless? Of course not – there are plenty of other safety nets to protect the truly needy. But we would remove the ‘entitlement’ part where everybody gets a slice because they paid into it.
Here’s what that picture looks like.
The problem goes away. It doesn’t go away immediately, and in fact over any one person’s life these nudges barely matter. But the liability is guaranteed to go away, unless lifespans start increasing faster than one month, every year. And frankly I’d still sign up for that! The fact that this doesn’t solve the problem immediately is a feature, not a bug: incremental change is digestible, and the trick is merely to make it repeatable.
This is how long-lived civilizations act. They operate on the scale of decades or centuries, instead of years or election cycles. We should use the power of time, and of compounding and discounting, wherever we can. We should use small nudges and behavioral tricks of forward commitment, for example, to make the solution tolerable. This is one way to do it – and a very simple way, at that.
[1] U.S. Census Bureau (2021). Sex by Age American Community Survey 1-year estimates. Retrieved from <https://censusreporter.org>
[2] Source: Social Security Administration
Summary of My Post-CPI Tweets (April 2023)
Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy, but subscribers to @InflGuyPlus get the tweets in real time and a conference call wrapping it all up by about the time the stock market opens. Subscribe by going to the shop at https://inflationguy.blog/shop/ , where you can also subscribe to the Enduring Investments Quarterly Inflation Outlook. Sign up for email updates to my occasional articles here. Individual and institutional investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments! Check out the Inflation Guy podcast!
- Welcome to the #CPI #inflation walkup for May (April’s figure).
- A reminder: At 8:30ET, when the data drops, I will post a number of charts and numbers, in fairly rapid-fire succession. Then I will retweet some of those charts with comments attached. Then I’ll run some other charts.
- After the tweeting dies down, I will have a private conference call for subscribers where I’ll quickly summarize the numbers. After my comments on the number, I will post a partial summary at https://inflationguy.blog and later will podcast a summary at http://inflationguy.podbean.com.
- Thanks again for subscribing!
- The market backdrop going into this one is very different from last month, when we were still dealing with panicky banking-collapse stuff. There are still some people selling that story, but there’s no real meat to it.
- But breakevens have come in, and real yields risen. And the Fed has tightened for what is likely the last time in the cycle. Some people are REALLY sold on the deflationary-depression scenario but right now shaping up to be a mildish recession with continued high inflation.
- That’s going to put the Fed in a classic bind, but with this Fed…maybe not really. I’ll say more about what I think about the Fed (big picture) in our Quarterly next week (subscribe at https://inflationguy.blog/shop/) but in sum I think O/N rates stay high all year.
- Next year, when inflation is still not coming down to their target (I think), they’ll have some decisions to make but for now, a mild recession won’t get them easing aggressively as they did under Greenspan/Bernanke/Yellen. It’ll be Silence of the Doves.
- The forecasts this month have amazing agreement in the headline figure, which is interesting because Kalshi and economists’ estimates have been rising meaningfully over the last week or so. I’ve been pretty consistent. I agree on headline. I’m significantly higher in core.
- Here’s why.
- Last month, core was a little soft, but not a ton. That in itself was remarkable, because rents decelerated a LOT m/m. And used cars was also a drag despite private surveys suggesting it should have been an add.
- So the fact that core was just a LITTLE soft was pretty amazing. Median (a better measure) dropped a lot because of rents, but the fact that core was resilient tells you there were some long-tail upsides. Diffusion indices are showing strongly that the peak is in, but…
- …but Core Goods having possibly bottomed (Used Cars should FINALLY deliver this month) means that the deceleration is going to be all rents and core services from here. So same stories but getting bigger going forward as the turn in Core Goods runs its course.
- And I do not believe in the sudden deceleration in rents – because nothing in rents happens suddenly. I think all the folks who have been looking for it for a while are succumbing to confirmation bias in thinking this is real.
- Maybe they’re right – another weak rents number will mean a lot to me. But I took note that the y/y rents figures still rose, which means that last year in the same month it was even weaker! That smacks to me of seasonal-adjustment issues.
- That doesn’t explain the full deceleration from 0.7 to 0.5 in rents, but it would explain some. I think we’re going to bounce back, but if we get another 0.48% on primary and OER, I’ll take notice.
- I also want to look at Food Away from Home. I wrote about this last week https://inflationguy.blog/2023/05/04/food-inflation-served-hot-and-cold/ – Food At Home and Food Away from Home have now diverged, and the FafH is tied more closely to wages.
- So: Core ex-rents, but also rents. And Food Away from Home as part of the Core ex-rents-imbued-with-momentum-from-wages meme.
- Do note that y/y core will decline even if we get my number (0.46%), and likely median also. It will help cement the idea the Fed is going to wait for a while.
- (Then again, last month I said I didn’t think they’d do 25bps because 25bps just doesn’t matter. But now we also have them signaling as much. It’ll take a lot to get them to move either direction soon.)
- Honestly, I need to step back and watch for a while myself. So far, the last few years have been relatively easy to call. But now we have a rapid rebound in velocity (which I expected) and declining M2 (which I did not).
- For the trajectory of inflation beyond this summer, we need to know which of these is going to win. I have trouble believing M2 will keep declining, especially as money demand gets adjusted to the new interest rate regime. But it’s an open question.
- And a very important question! And one that will not be resolved today! But it will be an interesting report I think – I’ll be back with more at 8:31ET. Good luck.
- okay. 0.409 on core…pretty darn good work by economists and Kalshi!
- Very nice jump from Used Cars…+4.5% m/m. So that’s an overdue catchup.
- OER 0.54 and Primary Rents +0.56 m/m. That’s a jump compared to the prior month, but quite a bit lower than trend. Some deceleration is probably happening, but last month was an illusion as to how much, probably from seasonal quirks.
- Core goods rose to 2.0% y/y (largely on the strength of the aforementioned Used Cars) and Core services fell to 6.8% y/y.
- Here is Core. This month right in trend. 0.4% is still almost 5% per year!
- Median retained most of its deceleration…but didn’t decelerate further m/m. Oddly, also 0.41% as with core. Normal warning: looks like one of the regional OERsis the median category – ergo, my estimate might be off since I have to guess at seasonals.
- Medical Care was the usual drag, but everything else was positive. There were some drags, but mainly the story here is rent deceleration.
- I noted the acceleration in core goods, which is mostly used cars this month. But I think the macro trend that we’ve seen most of the core goods deceleration is in place. Will it bounce to 5%? Probably not. But it’s no longer going to drag overall inflation lower.
- Primary Rents have officially peaked. OER, not yet. Soon. As with the overall inflation numbers, which peaked but won’t be declining as much as people were expecting, so it will be with rents.
- So in the so-called COVID categories, Airfares were -2.5% m/m; Lodging Away from Home -3.0%; Food @ Home -0.17%(sa) and Food Away from Home +0.37%(sa). This latter is a noticeable slowdown.
- Piece 1: As-expected look. I thought Food would add 0.03% to CPI but it actually added about 0.02% it appears. Nothing surprising in this.
- Piece 2 is Core Commodities – already commented on this.
- Core Services less ROS – this is starting to look less-horrible. Still, 5% isn’t lovely but this is the wage-driven piece. Taken together with the Food-Away-from-Home improvement, there seems to be some signs that the wage-price feedback is slowing some. And that’s good news.
- And rents are still high. While the Core Services piece is showing decent signs that it may have peaked, a deceleration in rents is still an article of faith. It will happen, but I don’t see it falling to 2% or lower, which is where some people think it’s going.
- (Some people still think housing is going to collapse. It’s not going to. Prices are already starting to rise again.)
- Core ex-housing went from 3.81% y/y to 3.75% y/y. Still pretty high even with the drag from core goods. Overall, the picture is IMPROVING but not good yet.
- …and that story, actually, supports the idea of a Fed pause. “We finally turned back the attackers from the walls. Now let’s wait and see if they regroup or if the battle is over.” That’s the wise course.
- You know, I gave economists a bit too much credit earlier. Their HEADLINE guesses were 0.41. Their core numbers were lower. We were about equally off. I was too high, because I thought rents would rebound more than they did. They were too low, for whatever reason.
- Sort of interesting that Recreation was +0.5% m/m. That’s a heterogenous category so it usually doesn’t do a lot. This month, Video and Audio was +0.45% (nsa) and Pets were +1.82%(nsa). Those are the two largest pieces of Recreation. Interesting bump from pets.
- Within Medical Care, Doctors’ Services was a drag and now is just +0.27% y/y! But Pharma added 0.42% m/m. The insurance drag continues to be what keeps that category inert (and, actually, it’s in core services ex rents so it’s also holding down “Supercore” some).
- Nothing really illuminating amongst the biggest gainers/decliners. Core categories Public Transportation was -46% (annualized monthly, which is what goes into median), Car/Truck rental -33%, Lodging Away from Home -30%.
- Gainers: Motor Vehicle Insurance +18%, Misc Pers Svcs +33%, Used Cares +69%. Actually some people say the insurance part is likely to continue for a bit. Lots of theft and higher car prices means that insurance rates need to rise too because cost-of-replacement is higher.
- Diffusion index down to 14!
- Okay, let’s try a conference call. Bottom line is I don’t think this figure is as good as stocks seem to think. But it DOES support the Fed-on-hold thesis. Still, it was a little higher than expected. Here is the conference number. I’ll start in 7 minutes.
Today’s number, while higher than expected on core by a little bit, was roughly in line with expectations. I was higher on my forecast than the consensus, because I thought rents would bounce back further and they didn’t; others were too high because they thought rents would keep dropping. I think that’s the main difference. Most of the rest of what is happening in the number was roughly what people expected. It was nice to see Used Cars bounce, since they were about 2 months behind what the private surveys were promising us – so not really a surprise.
While this is an expected number, that’s not saying it’s a wonderful figure. 0.4% monthly on core CPI…which is where we have been for the last 5 months…still gets you only to about 5% core for the year. That’s not where the Fed wants to see it.
On the other hand, it’s also clearly off the boil and most of the CPI is decelerating at least a little bit. It’s nice to see core services ex-rents (so-called “supercore”) decelerating, although we should remember that includes Health Insurance which is in the midst of a year-long mechanical adjustment that will swing the other way in about 6 months. But overall, the arrows are pointing in the right direction.
That’s distinctly unlike what was happening with the “transitory” nonsense, when the great bulk of the CPI was moving in the wrong direction – and not just the transitory pieces. So this is welcome.
And it supports the Fed’s decision to pause in rate hikes while continuing to slowly reduce its balance sheet. As long as the numbers continue to decline and nothing blows up that demands the Fed’s immediate attention, rates will stay on hold. I don’t think a minor recession, with inflation at 5%, will get the Fed to ease. Now, 6 months from now when it becomes obvious that inflation isn’t going back to the Fed’s target they’ll have some decisions to make, but that’s a story that will play out in slow motion. For now, we have a figure that supports ex-post-facto what the Fed chose to do this month.
Food Inflation Served Hot and Cold
Well, the Fed is done raising interest rates. They aren’t quite done tightening yet, because the Federal Reserve is going to continue to shrink its balance sheet slowly. That’s important. The fact that the Fed is no longer hiking rates, but is continuing to normalize its balance sheet, is quietly impressive to me. It makes me wonder whether someone at the Fed understands that saturating the economy with bank reserves means that today’s tightening is fundamentally different from the tightening of yesteryear, which was a money phenomenon and not a rates phenomenon.
We may never know, but I do have to admit that Chairman Powell impressed me a little in his post-FOMC presser. Not impressed me like ‘he’s the greatest’ but impressed me like ‘this is what I’d hoped we were getting.’ I wrote back in 2017 that the fact he is not an economics PhD was a positive…although the fact that he did not know anything about macroeconomics before joining the Fed suggested that he has learned economics in an echo chamber from some of the most blinkered non-monetarists on the planet, whose main claim to fame is that their forecasts have been consistently, and sometimes colossally, wrong for a long period of time. Still, he has a different background and that always offers hope.
The conduct of monetary policy under Powell has certainly been different than it was under his predecessors. We have to give him that! In any event, he said several things that impressed me because they surprised me. I’ll have more details and specifics in our Quarterly Inflation Outlook released a few days after CPI this month (you can subscribe at https://inflationguy.blog/shop/ ).
But today, I’m here to talk about food inflation. Normally, food inflation along with energy is deducted from the CPI to produce Core CPI, which is more stable and therefore should give better signals with less noise as long as food and energy inflation are mostly mean-reverting. And normally, they are. Energy is famously mean-reverting; the nationwide average price of a gallon of gasoline right now is $3.574, which is down 5 cents from…April 2008. There is a lot of noise and not much signal, so it makes sense to deduct.
Similarly, food inflation has a large commodity component and is also very volatile. It is not as volatile as is energy, partly because we don’t consume most of the foods that we buy in pure commodity form but rather in a packaged form; also foodstuffs are much more heterogeneous than gasoline and so branding matters a lot. Still, the food component of CPI is pretty volatile and normally fairly mean reverting although unlike energy it definitely has an upward tilt over time.
For some time now, though, food prices have been consistently adding to overall inflation. In mid-2021, trailing 12-month CPI for the “Food” subindex was about 2%; by late 2022 that was up to 11%! Recently, though, Food has started to come back to earth a little bit. The reason why is interesting and illuminating.
“Food,” which is 13.5% of the CPI, has two primary subgroups. “Food at home” is 8.7% of the CPI (about 2/3 of “Food”) and “Food away from home” is 4.8% of the CPI. The recent deceleration in the Food category has come entirely from “Food at home” (see chart, source BLS). That group got to about 14% y/y inflation, but most recently has fallen to a mere 8%. The steadier “Food away from home” is still plugging away, last at 8.8% y/y…a new high, actually.
As you might expect, while “Food at home” does not directly track, say, wholesale cattle or wheat prices, persistent changes in commodities prices does eventually percolate into pricing. The following chart shows a very simple relationship between “Food at home” and the Bloomberg Commodity Index “Agriculture” subindex (which tracks the performance of coffee, corn, wheat, beans, bean oil, cattle, hogs, cotton, and sugar. Aside from cotton, that list comprises a good part of what Americans buy to eat at home. So it isn’t terribly surprising that, at least for large movements in prices, these things eventually show up in the prices of things we buy. In this chart, the commodity index is lagged 12 months and shown on the right-hand scale. As an aside, consider how little of the price of what we buy must represent the actual commodity cost, if a 60% rise in commodities prices only results in a 14% increase in the price of Food at home, a full year later!
That chart says that “Food at home” should continue to decelerate and be a gentle drag for another year. On the other hand, “Food away from home” has completely different drivers that aren’t related to commodities prices hardly at all.
In contrast to the prior observation, consider how much of “Food away from home” must be labor, if the correlation between labor inflation and “Food away from home” is so high and of such a similar scale. Of course, we know that to be the case: the labor shortage hit the restaurant industry very hard and those effects are still being felt. There is not yet any sign of a decline in wage growth among these workers, and consequently there is not any sign of a deceleration in inflation of “Food away from home.” It should continue to be additive to CPI for a while.
The dichotomy between these two parts of the “Food” category is, of course, exactly what concerns the Federal Reserve and other economists who examine inflation. I’ve written about it here (and spoken about it on my podcast) a bunch of times: core services ex housing is where the wage-price feedback loop lives. It’s where the persistence of inflation comes from, and that is why it is the Fed’s main focus. Although I was writing about this before the Fed ever mentioned it, I have to give them credit – I thought they would seize on the fact that energy prices are pulling down overall inflation, or that rents may be decelerating soon, and use that as an excuse to take their usual dovish turn. They have not. The Fed actually seems to be focused on the right thing.
Maybe Powell is different, after all.
No Need to Rob Peter to Pay Paul
So, I suppose the good news is that policymakers have stopped pretending that prices will go back down to the pre-pandemic levels. My friend Andy Fately (@fx_poet) in his daily note today called to my attention these dark remarks from Bank of England Chief “Economist” Huw Pill:
“If the cost of what you’re buying has gone up compared to what you’re selling, you’re going to be worse off…So somehow in the UK, someone needs to accept that they’re worse off and stop trying to maintain their real spending power by bidding up prices, whether higher wages or passing the energy costs through on to customers…And what we’re facing now is that reluctance to accept that, yes, we’re all worse off, and we all have to take our share.”
I think it’s worth stopping to re-read those words again. There are two implications that immediately leap out to me.
The first is that this is scary-full-Socialist. “We all have to take our share” is so anti-capitalist, anti-freedom, anti-individualist that it reeks of something that came from the pages of Atlas Shrugged. No, thank you, I don’t care to take my share of your screw-up. I would like to defend my money, and my real spending power, and my real lifestyle. If that comes at the cost of your lifestyle, Mr. Pill, then I’m sorry.
But the second point is that…it doesn’t come at the cost of someone else’s lifestyle. This is why I put “economist” in quotation marks above. There is still a lot of confusion out there between the price level and inflation, and what a change in the price level means, but if you’re an economist there shouldn’t be.
You see statements like this everywhere…”food prices are up 18%. If people are spending 18% more on food, it means they’re spending less elsewhere.” “Rents are up 17%. If people are spending 17% more on rent, it means they’re spending less elsewhere.” “Pet food is up 21%. If people are spending 21% more on pet food, it means they’re spending less elsewhere.” “New vehicle prices are up 22%. If people are spending 22% more on new vehicles, it means they’re spending less elsewhere.” “Price of appliances are up 19%. If people are spending 19% more on new appliances, it means they’re spending less elsewhere.”
You get my point. All of those, incidentally, are actual aggregate price changes since the end of 2019.
This is where an actual economist should step in and say “if the amount of money in circulation is up 37%, why does spending 18% more on good or service A mean that we have to spend less on good or service B?” In fact, this is only true if the growth in the aggregate amount of money is distributed highly unevenly. In ‘normal’ times, that might be a defensible assumption but during the pandemic money was distributed remarkably evenly.
Okay…the amount of money in circulation is a ‘stock’ number and the prices of stuff changing over time is a ‘flow’ number, which is why money velocity also matters. M*V is up about 24% since the end of 2019. So a 20% rise in prices shouldn’t be surprising, and since there’s lots more money out there a 20% rise in the price of one good does not imply you need to spend less on another good. That’s only true in a non-inflationary environment. The world has changed. You need to learn to think in real terms, especially if you are a “Chief Economist.”
(N.b. to be sure, this is somewhat definitional since we define V as PQ/M, but the overarching point is that with 40% more money in the system, it should be not the slightest bit surprising to see prices up 20%. And, if velocity really does act like a spring storing potential energy, then we should eventually expect to see prices up more like 30-40%.)
Here’s a little bonus thought.
Rents are +17%, which is roughly in line with a general rise in the prices of goods and services. Home prices are up about 36% (using Shiller 20-City Home Price Index), which is roughly in line with the raw increase in M2.
Proposition: since the price of unproductive real assets is essentially an exchange rate of dollars:asset – which means that an increase in a real asset’s price is the inverse of the dollar’s decrease – then the price of a real asset should reflect the stock of money since price is dictated by the relative scarcity of the quantity of dollars versus the real asset. But the price of a consumer good or service should reflect the flow of money, so something more like the MV/Q concept.
Implication:
Discuss.
Who’s Afraid of De-Dollarization?
Do we need to worry about the end of dollar dominance in international trade – the de-dollarization of global finance?
I am hoping to do a podcast on this topic in a few weeks, featuring a guest who is actually an expert on foreign exchange and who can push back on my thought processes (or, less likely, echo them) – but the topic seems timely now. There is widespread discussion and concern in some quarters, as China and Russia push forward efforts to establish the Chinese Yuan as an alternative currency for international trade settlement, that this could spell the sunset of the dollar’s dominance. Some of the more animated commentators declare that de-dollarization will dramatically and immediately eviscerate the standard of living in the United States and condemn the nation to be an also-ran third-rate economy as its citizens descend into unspeakable squalor.
Obviously, such ghoulish prognostications are ridiculously overdone for the purpose of generating clicks. But how much of it is true, at least on some level? What would happen if, tomorrow, the US dollar lost its status as the world’s primary reserve currency?
One thing that wouldn’t change at all is the quantity of dollars in circulation. That’s a number that the Federal Reserve exerts some control over (they used to have almost total control, when banks were reserve-constrained; now that banks have far more reserves than they need, they can lend as much as they like, creating as many floating dollars as they like, constrained only by their balance sheet). The holders of dollars have absolutely no control over the amount of them in circulation! If Party A doesn’t like owning dollars, they can sell their dollars – but they have to sell it to some Party B, who then holds the dollars.
What also wouldn’t change immediately is how many dollar reserves every country holds. From time to time, people get concerned that “China is going to sell all of its dollars.” But China got those dollars because they sell us more stuff than we sell them, which causes them to accumulate dollars over time. How can China get rid of their dollars? Their options are fairly limited:
- They can start buying more from us than they sell to us. We’ve been trying to get them to do this for years! Seems unlikely.
- They can buy from us, stuff priced in dollars, but only sell goods to us that are priced in Yuan. To get Yuan, a US purchaser would have to sell dollars to buy Yuan. Since China doesn’t want to be the other side of that trade (which would leave them with the same amount of dollars), the US purchaser would have to go elsewhere to buy Yuan. This would strengthen the Yuan. This is also something we’ve been trying to get them to do for years! The Bank of China stops the Yuan from strengthening against the dollar by…selling Yuan and buying dollars. Hmmm.
- They can just hit the bid and sell dollars against all sorts of other currencies. This would greatly weaken the dollar, and is perhaps the biggest fear of many of the people worried about de-dollarization.
Supposing that China decided on #3, they would be making US industry much more competitive around the world against all of the currencies that China was buying. Foreign buyers of US products would now be able to buy US goods much more cheaply. It would cause more inflation in the US, but it would take a large dollar decline to drastically increase US inflation since foreign trade is a smaller part of the US economy than it is for many other countries.
A much lower dollar, making US prices look lower to non-US customers, would help balance the US trade deficit. Yay!
A tendency towards balance of the trade deficit would have ancillary impacts. When the US government runs a fiscal deficit, it borrows from essentially two places: domestic savers and foreign savers. Foreigners, having a surplus of dollars (since they have trade surpluses with us), buy Treasuries among other things. If the trade deficit went down drastically, so would foreign demand for US Treasuries. That in turn would (unless the government started to balance its fiscal deficit) cause higher interest rates, which would be necessary to induce domestic savers to buy more Treasuries. Or, if domestic savers were not up to the task, the buyer of last resort would be…the Federal Reserve, which could buy those bonds with printed money. And that’s a really bad outcome.
Now, does any of this cause a collapse of the American system or spell an end to US hegemony? No. If policymakers respond to such an event by refusing to get the fiscal house in order, then things could get ugly. But it would be hard to blame that outcome on the end of the dollar as the medium of international trade – blame would more appropriately be directed at the failure of domestic policymakers to adjust in response.
In the end, it is hard to escape the idea that good or bad economic and inflation outcomes in the United States track mainly, one way or the other, back to domestic policy decisions. Whether the US economic system remains a dominant one is…fortunately or unfortunately…in our hands, not in the hands of foreign state actors.
Summary of My Post-CPI Tweets (March 2023)
Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy, but subscribers to @InflGuyPlus get the tweets in real time and a conference call wrapping it all up by about the time the stock market opens. Subscribe by going to the shop at https://inflationguy.blog/shop/ , where you can also subscribe to the Enduring Investments Quarterly Inflation Outlook. Sign up for email updates to my occasional articles here. Individual and institutional investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments! Check out the Inflation Guy podcast!
Note that since the post-8:30am charts were tweeted rapidly and commentary added to it by later re-tweets, the summary below is rearranged to eliminate the redundancy and improve readability.
- Welcome to the #CPI #inflation walkup for April! (March’s CPI figure)
- A reminder to subscribers of the tweet schedule: At 8:30ET, when the data drops, I will post a number of charts and numbers, in fairly rapid-fire succession. Then I will retweet some of those charts with comments attached. Then I’ll run some other charts.
- There is a small wrinkle this month: I am going to be a guest on a Twitter space hosted by @Unusual_Whales while I’m busy tweeting. That shouldn’t impact you subscribers. Tune in if you want!
- After the tweeting dies down, I will have a private conference call for subscribers where I’ll quickly summarize the numbers. After my comments on the number, I will post a partial summary at https://inflationguy.blog and later will podcast a summary at inflationguy.podbean.com .
- I will also record that call for later call-in if you’re not available (and of course later there will be my tweet summary, and my podcast, so you can consume my opinions however suits you).
- Thanks again for subscribing! And now for the walkup.(Some of this I’ve related over the last few days and am summarizing/repeating here.)
- The whole banking-collapse thing seems to have blown over for now, but interest rates are still lower than they were a month ago. And breakevens are higher. This is one reason stocks are doing well – steady infl expectations and lower real yields is a sweet cocktail for equities.
- It’s also likely fleeting, but it helps explain why the market is doing so well for now.
- Today’s CPI print might be very interesting. There are a lot of crosscurrents and everyone seems to be interpreting them differently. The spread isn’t super wide, but the swaps market is almost a full 0.1% below economists’ estimate for headline inflation.
- (The swaps market tends to be more accurate than economists in this regard, but I hope this month they aren’t because I have the over.)
- The drag on inflation is not going to come from food; raw foods are again spiking and there’s still the wage issues for food-away-from-home. I have gasoline adding 3bps, while some others see it flat or subtracting slightly. But the big drag is piped gas.
- As I noted on Monday, piped gas is part of household energy and normally it is too small to matter. But the massive recent decline pulled down February CPI and should pull down March. I have the effect worth 13bps.
- But also, lower utilities implies that primary rents will have a small tailwind UPWARD and most people will ignore that. The reason it happens is the BLS backs out utilities when rents include utilities, so sharply lower utilities implies slightly higher rents.
- Anyway, that’s the big drag. But why does the swap market see it as so much bigger than economists do? That’s odd. Or it could imply the Street sees a real drag on core…but that’s a hard sell right now.
- Last month, Used Cars did not rise along with the private indices, but those indices rose again and so it’s likely we’ve seen the end of the price retracement from Used Cars. Indeed, Core Goods is showing signs that it is not going to gently go to -1%.
- Heck, in my view the economists are too low on core anyway – they’re 0.05% below the traders on Kalshi’s core inflation market, and 0.1% below me. Is it possible we can get 0.4% or lower on core? Sure. But there are a lot of upward pressures.
- This chart shows median wages minus median CPI. For years, it has been stable at about 1%, other than in the aftermath of disaster. Right now it isn’t, b/c Median CPI is still rising while median wages have ebbed although just a little.
- Now, this chart might say something different to you than to me. My interpretation is that employees will fight against further declines in wage growth, until inflation comes down. But you might argue that this gives room for CPI to decelerate.
- Since we are focused on the wage-price feedback loop in core-services-ex-shelter (as I was saying long before the cool kids dubbed it “supercore”), the resolution of this question is very, very important.
- Anyway, I think we will see 0.5% on core inflation. But even if we only see 0.4%, y/y core will rise. Not many will get too exercised about that, though, because the easy comps are coming. By May, we will likely see y/y core start declining again.
- Of course, I’m focused on median CPI, which is still hitting new highs. But it also should start ebbing soon. As always, the question is “how much” and I continue to say “not as much as the market is pricing in.” With breakevens in the low 2s, they’re very cheap in my view.
- We will see what the number brings. But unless it’s even higher than I have it, and with an alarming breadth, I think the Fed is likely done hiking. As I said last month, 25bps doesn’t do anything at this stage anyway.
- But +0.5% on core will be taken very badly by the stock market, I think, and probably pretty bad for bonds as well. Everyone wants fervently to believe with the inflation swaps market that this inflation episode is over.
- Doesn’t look like it to me. Not yet! Good luck today and I’ll be back live at 8:31ET.
- Definitely better than expected. Swap market as usual is closer than economists…and core was actually was .053%
- m/m CPI: 0.053% m/m Core CPI: 0.385%
- Kneejerk observations: Used Cars dragged again (?). RENTS WERE SHARPLY LOWER FROM TREND. Medical Care was a drag.
- Last 12 core CPI figures
- Inflation Swap market gets closest-to-the-pin. In fact, Headline rounded UP to 0.1%. Core was actually kinda close to expectations (but lower than I thought!).
- M/M, Y/Y, and prior Y/Y for 8 major subgroups
- The big story here is going to be housing. Housing 0.3% m/m is a big decline. Some of that is piped gas, but…
- Core Goods: 1.53% y/y Core Services: 7.13% y/y
- Now, notice that core goods turned up. That’s even though CPI for Used Cars declined. Again, that is unexpected since private surveys have said used car prices are going back up.
- Primary Rents: 8.81% y/y OER: 8.04% y/y
- …still not peaked, but peaking? Actually y/y higher this month, so it’s possible there’s some seasonality issue.
- Further: Primary Rents 0.49% M/M, 8.81% Y/Y (8.76% last) OER 0.48% M/M, 8.04% Y/Y (8.01% last) Lodging Away From Home 2.7% M/M, 7.3% Y/Y (6.7% last)
- (This really is the big story today. Actually, core being that high despite housing…is surprising.)
- Actually core ex-shelter rose very slightly to 3.81% y/y.
- Here is my early and automated guess at Median CPI for this month: 0.401%
- Some ‘COVID’ Categories: Airfares 3.96% M/M (6.38% Last) Lodging Away from Home 2.7% M/M (2.26% Last) Used Cars/Trucks -0.88% M/M (-2.77% Last) New Cars/Trucks 0.38% M/M (0.18% Last)
- Piece 1: Food & Energy: 2.63% y/y
- A lot of the recent plunge here is piped gas…which is just about done.
- Piece 2: Core Commodities: 1.53% y/y
- Piece 3: Core Services less Rent of Shelter: 5.53% y/y
- Supercore coming down! But just a little. Still not sure this is thrilling enough for the Fed.
- Piece 4: Rent of Shelter: 8.26% y/y
- The distribution here is going to be really important. Unfortunately my data scraper is having a strange issue and that feeds my distribution stuff. Obviously the middle shifted, which is why median CPI decelerated, but I want to see the diffusion stuff. Tech delay for me…
- Piped gas actually fell only -8.0% m/m NSA, versus -9.3% last month. I thought it was going to be greater, so there was a slightly SMALLER drag on headline than I expected there.
- Also encouraging is that Food and Beverages was only 0.02% m/m. I’m a little surprised by that, but it’s good news. Non-core of course.
- I will say the bottom line is that IF the housing data is real, then this is a really happy inflation number. But outside of the housing data…core was still 0.4%! So not GREAT data. The distribution data will be important, which is why it’s even more frustrating atm.
- I can also report that the biggest decliners in core m/m were Car/Truck Rental (-37% annualized monthly change), Energy Services (-24%), Misc Personal Goods (-14%) and Used Cars/Trucks (-10%). Latter I’ve already mentioned is really odd.
- Biggest gainers are Public Transportation (+46%), Lodging Away from Home (+38%), Motor Vehicle Insurance (+16%), Mens/Boys Apparel (+13%), and Personal Care Products (+10%).
- We are obviously not going to have the conference call today…too late to be of any use. But I have some thoughts anyway about the Fed and the positive market reaction.
- Totally understand the positive market reaction. The headline figure ALMOST rounded to unchanged, and core was a little light although not very much. The rally makes sense.
- The dive in longer-term breakevens doesn’t, as much. If you think this big deceleration in shelter is real then it means inflation is probably peaking even in a median sense…but long-term breakevens already impound a 2.2% average inflation rate.
- There is nothing to make me think that rents are going to go flat, with median wages rising at 6% and home prices advancing again. This is not 2009-10 and there is still a big shortage in shelter and plenty of income to support rents. So 2%…is still very unlikely IMO.
- That said, let’s think about the Fed. Start from the premise that their model is assuming high-frequency rent data is predictive, even though it’s been predicting rent deceleration for a long time and this is the first sign of it.
- But if your null is “I’m waiting for rental inflation to turn” and then you see a sign of a turn…well, it’s bad econometrics to “confirm” a hypothesis but that’s how humans work. I think this makes a further hike fairly unlikely unless the Fed wants to make a symbolic gesture.
- With Fed funds at 5% and at least SOME concerns about banking, the juice doesn’t seem to be worth the squeeze to hike again. Which is, of course, why markets are ebullient today.
- I don’t think we’re out of the woods on inflation yet. I should have missed this number by a LOT more than I did given I was 0.25% off on the largest part of core. It means the strength is still broad.
- But the question has never been “WILL inflation go back down someday.” It has been about WHEN. And how far…but not so many people are questioning that when it goes back down, it’ll go to 2%.
- There’s just no natural reason that should happen. It’s a pleasant wish, but there’s no mechanism to cause inflation to go to the Fed’s target naturally. And as I’ve shown recently, there’s actually not much evidence that inflation mean reverts at all…even if the mean IS 2%.
- So…good news today, and the Fed will take it as such. As will markets. But here is the chart of m/m primary rents. This doesn’t seem entirely plausible to me. Give me another month or two and I’ll be a believer.
- Anyway, thanks for tuning in, and bearing with me despite the tech issues. I will update the diffusion index when I get the problem fixed.
Today’s inflation data was clearly positive, but how positive it is depends on whether rents are suddenly decelerating in the way the data says they did in March. That seems implausible to me, but it’s possible. As I said above, the question was never whether inflation would stop going up, but when, and how far it falls back. We thought median inflation had peaked in September, and then it went higher. It now looks like it has peaked again – and this is likely the case. But we’ve been fooled before.
Here’s a crucial point to keep in mind, though, when we are predicting Fed action. What’s their null? If my null hypothesis is that inflation is unlikely to slow below 4%, say, then I need a lot more evidence before I stop hiking rates. I know that many of you reading this fall into that camp. But does that mindset characterize the central bank’s thinking? What I think we know about the Fed right now is that they are moderately (but only moderately) concerned about the banking system; they are concerned about core services ex-shelter because of the wage-price feedback loop I’ve been highlighting since long before they did; and they believe that higher-frequency data on rents suggests that rent inflation should be ebbing ‘soon.’ Chairman Powell has said all of these things.
So if that’s the case, how does it frame today’s data?
There’s nothing new in this about banking. But there does seem to be information which would confirm what I am assuming to be the Fed’s ‘priors’ about rents. To me, that one month doesn’t mean a lot, but to someone who has been expecting a deceleration, this probably looks like one. There’s also nothing here about wages per se, although “supercore” is decelerating some. However, I think the Fed already believes wages are declining, because they tend to focus more on “Average Hourly Earnings” from the Employment report. That’s a terrible measure, but it’s widely used. (In fact, for most economic data you want to ignore “average” measures if the composition can change a lot from report to report, like the employment report can). Here’s a chart of AHE, against my preferred measure of median wages of continuously-employed persons, from the Atlanta Fed (in blue).
If I’m right and the Fed is focusing on the black line rather than the blue line, and I’m right about how they are thinking about rents, then I think if you took a poll of Fed thinkers you’d find that most of them think they’ve broken the back of inflation and the only question is how quickly it gets back to 2%. I suspect most of them would prefer to keep rates where they are, and not lower them quickly, because you want to keep the pressure on…but I believe the argument for pushing rates a lot higher is substantially weakened by recent data – that is, if you share those priors.
My view is unchanged, although I will keep an eye on rents. My model has them coming down to 4% or so, but then my model never had them getting much higher than 5%. Some of that is an overshoot thanks to the correction after the eviction moratorium was lifted, but a lot of that in my opinion is supported by the big shortage of shelter and by strong wage growth. I’m not sure why we’d expect rents to fall drastically, especially if a landlord’s cost of financing and of maintenance are still rising. Overall, I think inflation is in retreat thanks to a contracting money supply although that is offset by the rebound in money velocity. But I don’t expect inflation to get to 2% any time this year or in 2024. More likely, we will settle in around 4%-5% later this year. That’s my null hypothesis!
The Phillips Curve is Still Working Just Fine
About five and a half years ago, I wrote a blog article entitled “The Phillips Curve is Working Just Fine, Thanks”, in response to the exhaustively-repeated nonsense that the ‘Phillips Curve is Broken.’ This nonsense never really goes away, but last week Fed Governor Waller delivered a speech on “The Unstable Phillips Curve,” derived from the same nonsense, and I felt duty-bound to resurrect my prior article and update it. The Phillips Curve has not been unstable at all, over the last quarter century at least. Here is my original article, linked here:
I must say that it is discouraging how often I have to write about the Phillips Curve.
The Phillips Curve is a very simple idea and a very powerful model. It simply says that when labor is in short supply, its price goes up. In other words: labor, like everything else, is traded in the context of supply and demand, and the price is sensitive to the balance of supply and demand.
Somewhere along the line, people decided that what Phillips really meant was that low unemployment caused consumer price inflation. It turns out that doesn’t really work (see chart, source BLS, showing unemployment versus CPI since 1997).
Accordingly, since the Phillips Curve is “broken,” lots of work has been done to resurrect it by “augmenting” it with expectations. This also does not work, although if you add enough variables to any model you will eventually get a decent fit.
And so here we are, with Federal Reserve officials and blue-chip economists alike bemoaning that the Fed has “only one model, and it’s broken,” when it never really worked in the first place. (Incidentally, the monetary model that relates money and velocity (via interest rates) to the price level works quite well, but apparently they haven’t gotten around to rediscovering monetarism at the Fed).
But the problem is not in our stars, but in ourselves. There is nothing wrong with the Phillips Curve. The title of William Phillips’ original paper is “The Relation between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861-1957.” Note that there is nothing in that title about consumer inflation! Here is the actual Phillips Curve in the US over the last 20 years, relating the Unemployment Rate to wages 9 months later.
The trendline here is a simple power function and actually resembles the shape of Phillips’ original curve. The R-squared of 0.91, I think, sufficiently rehabilitates Phillips. Don’t you?
I haven’t done anything tricky here. The Atlanta Fed Wage Growth Tracker is a relevant measure of wages which tracks the change in the wages of continuously-employed persons, and so avoids composition effects such as the fact that when unemployment drops, lower-quality workers (who earn lower wages) are the last to be hired. The 9-month lag is a reasonable response time for employers to respond to labor conditions when they are changing rapidly such as in 2009…but even with no lag, the R-squared is still 0.73 or so, despite the rapid changes in the Unemployment Rate in 2008-09.
So let Phillips rest in peace with his considerable contribution in place. Blame the lack of inflation on someone else.
Before I add to my rant, let me update the chart above with data since then, including the pandemic. The green dots in the chart below correspond to the dots in the chart above; the blue dots are for the period since then.
Amazingly, even during the pandemic and post-pandemic period, the Phillips Curve did a pretty decent job of describing the basic shape of this relationship. The dots overall are a bit higher; that’s attributable I think to the fact that inflation itself is higher and I’ve done this chart in nominal terms. There is some money illusion operating (or else the latest dots would be a lot higher), but it’s still a pretty nice fit, considering. I’ve preserved the prior regression line, but it doesn’t really shift very much.
In fact, the deviation prior to the pandemic – the little knot of blue dots to the left – are somewhat more surprising in a way, given the much lower economic volatility that there was when those points were laid down. But in any event, though, there is nothing obviously wrong with the Phillips Curve.
Now, it is true that the Unemployment Rate and the rate of consumer inflation have not been particularly well-behaved. But that isn’t a new phenomenon; that particular inconvenience has been that way for decades. The reason is pretty straightforward, and only confusing if you spent too much time getting a PhD and getting taught dumb things: the connection between wages and prices is not 1:1. It’s not constant. And there’s no particular reason that it should be, because labor is just one input into production costs, and the cost of production just affects the supply side of the supply/demand interplay which determines price. The really weird thing is that anyone ever thought that prices would be set by taking the current wage cost and adding a simple and stable markup.
A wage is just the price of labor, which is set in the market for labor, which involves the demand for labor and the supply of labor. The supply of labor changes very slowly. The demand for labor moves with the economic cycle. When the economic cycle is ebbing, the demand for labor falls – and that causes the quantity of labor demanded to decline (the unemployment rate goes up) as it also causes the price of labor to fall. That’s what happens when a demand curve shifts leftward on a mostly-static supply curve: Q down, P down. When the economic cycle is flowing, the demand for labor rises, which causes the quantity of labor demanded to increase (the unemployment rate declines) and the price of labor to rise. It isn’t that hard. In fact, you learn that in pretty much the first semester of economics.
It’s those later semesters that screw up economists, encouraging them to design complicated models that are very pretty but don’t necessarily relate to real-world dynamics. We should not be at all surprised when those models don’t work in the real world.
But don’t blame Phillips.
Homes Have Gotten Cheaper by Running in Place
As the Fed started lifting interest rates aggressively in early 2022, pundits almost universally declared the end of the housing market. Taking the rather lazy approach of projecting what happened in 2008-2010 and just changing the year, utter disaster was forecast for home construction, home sales, and home prices. The more clever analyses mused about how the higher interest cost of a mortgage lowered the amount of home that can be bought by a given payment, and suggested that home buyers would naturally back up their bids by that much and sellers would be obliged to hit those bids.
The Case-Shiller Home Price futures, which are (thinly) traded on the CME,[1] went from pricing in additional upward movement in home prices to pricing in a collapse worse than the post-financial-crisis debacle. For example, the February 2024 futures dropped 22% between May and November 2022. Keep in mind that these futures track nominal prices, so at the worst levels the futures market was pricing in something like a 25% drop in real prices.
That was never going to happen, especially in a housing market that was much, much tighter than in 2007. In the summer of 2007 there were approximately 3.4 million existing homes on the market; in the summer of 2022 the figure was about 1.2 million. And, as it turns out, homeowners did not hit any bid that was shown, which would have been irrational in an inflationary environment. Nominal home prices are sticky on the downside anyway, because buyers don’t like to sell below other recent prices which serve as an ‘anchor’ for their expectations. All of which is to say that 2007 really was an amazing outlier in a lot of ways: price, activity, builder activity, financial buyer activity, mortgage structuring, and home inventory. The current situation is much different.
Naturally, we all know that now as we have noticed that home prices have not in fact collapsed. But they have declined in real terms, because the overall price level has advanced while home prices have been flat. Given the level of inflation, this has actually changed the level of home valuation fairly substantially in a short period of time and I thought it worth pointing out.
Consider the following chart (Source: BLS, ADP, National Association of Realtors, author’s calculations). It plots the Existing Home Sales Median Price divided by the Median Annual Wage. I’ve used the Atlanta Fed’s Median Wage figures and converted them to annual wages so that the series matches, for the most recent point, the median annual wage reported by ADP.) By doing this, we can see roughly how many years’ wages it would take to purchase the median home outright. Note that one of the series is seasonally-adjusted and one is not, which causes the scalloping effect you see. I could correct for this, but figure this is close enough to make the main point.
And the main point is that as home prices have stagnated and wages have been rising rapidly to keep pace with inflation, the cost of a home relative to the wages people are receiving has dropped pretty sharply.
Although this measure doesn’t tell the whole story, you can see how there was a reasonable concern that home prices may have been getting ahead of themselves somewhat (although with extremely low inventory, that’s not necessarily unsustainable in the medium-term). However, since last summer homes have gotten much cheaper, by just staying in one place.
Don’t get locked in on the nominal price. That’s called money illusion, and in an inflationary environment it leads to mistakes.
[1] In full disclosure, we use the housing futures for one of our strategies.
Summary of My Post-CPI Tweets (February 2023)
Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy, but subscribers to @InflGuyPlus get the tweets in real time and a conference call wrapping it all up by about the time the stock market opens. Subscribe by going to the shop at https://inflationguy.blog/shop/ , where you can also subscribe to the Enduring Investments Quarterly Inflation Outlook. Sign up for email updates to my occasional articles here. Individual and institutional investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments! Check out the Inflation Guy podcast!
- Welcome to the #CPI #inflation walkup! To be sure, the importance of this data point in the short run is much less than it was a week ago, but it would be a mistake to lose sight of inflation now that the Fed is likely moving from QT to QE again.
- A reminder to subscribers of the tweet schedule: At 8:30ET, when the data drops, I will post a number of charts and numbers, in fairly rapid-fire succession. Then I will retweet some of those charts with comments attached. Then I’ll run some other charts.
- Afterwards (recently it’s been 9:30ish) I will have a private conference call for subscribers where I’ll quickly summarize the numbers.
- After my comments on the number, I will post a partial summary at https://inflationguy.blog and later will podcast a summary at inflationguy.podbean.com .
- I am also going to try and record the conference call for later. I think I’ve figured out how to do that. If I’m successful, I’ll tweet that later also.
- Thanks again for subscribing! And now for the walkup.
- This picture of the last month has changed quite a bit over the last few days! Suddenly, rates have reversed and the nominal curve is steepening. The inflation market readings are…of sketchy quality at the moment.
- Now, the swap market has also re-priced the inflation trough: instead of 2.65% in June (was in low 2s not long ago), the infl swap market now has y/y bottoming at 3.34% b/c of base effects before bouncing to 3.7% & then down to 3.15% by year-end. I think that’s pretty unlikely.
- Let’s remember that Median CPI reached a new high JUST LAST MONTH, contrary to expectations (including mine). The disturbing inflation trend is what had persuaded investors…until late last week…that the Fed might abruptly lurch back to a 50bp hike.
- These are real trends…so I’m not sure why economists are acting as if they are still certain that inflation is decelerating. The evidence that it is, so far at least, is sparse.
- Also, this month not only did the Manheim used car index rise again, but Black Book (historically a better fit although BLS has changed their sampling source so we’re not sure) also did. I have that adding 0.04%-0.05% to core.
- But maybe this is a good time to step back a bit, because of the diminished importance of this report (to be sure, if we get a clean 0.5%, it’s going to be very problematic for the Fed which means it should also be problematic for equity investors).
- Over the last few days we’ve read a lot about how banks are seeing deposits leave for higher-yielding opportunities. This is completely expected: as interest rates rise, the demand for real cash balances declines.
- You may have heard me say that before. But it’s really Friedman who said that first: velocity is the inverse of the demand for real cash balances. DEPOSITS LEAVING FOR HIGHER YIELDS IS EXACTLY WHAT HIGHER VELOCITY MEANS.
- And it is the reason for the very high correlation of velocity with interest rates.
- So the backdrop is this: money may be declining slightly but velocity is rebounding hard. Exactly as we should expect. Our model is shown here – it’s heavily influenced by interest rates (but not only interest rates).
- And if the Fed is going to move from its modest QT to QE, especially if they don’t ALSO slash rates back towards zero, then the inflationary impulse has little reason to fade.
- You know, I said back when the Fed started hiking that they would stop once the market forced them to. What has been amazing is that there were no accidents until now, so the market let them go for it. And in the long run this is good news – rates nearer neutral.
- But we have now had some bumps (and to be fair, I said no accidents until now but of course if the FDIC and Fed had been doing their job and monitoring duration gaps…this accident started many many months ago).
- With respect to how the Fed responds to this number: it is important to remember that the IMPACT ON INFLATION of an incremental 25bps or 50bps is almost zero. Especially in the short run. It might even be precisely zero.
- But the impact of 25bps or 50bps on attitudes, on deposit flight, and on liquidity hoarding could be severe, in the short run. On the other hand, if the Fed stands pat and does nothing but end QT, it might smack of panic.
- If I were at the Fed, I’d be deciding between 25bps and 0bps. And the only decent argument for 25bps is that it evinces a “business as usual” air. It won’t affect 2023 inflation at all (even using the Fed’s models which assume rates affect inflation).
- Here are the forecasts I have for the number – I tweeted this yesterday too. I’m a full 0.1% higher on core than the Street economists, market, and Kalshi. But I’m in-line on headline. So obviously as noted above I see the risks as higher.
- Market reactions? If we get my number or higher, it creates an obvious dilemma for the Fed and that means bad things for the market no matter how the Fed resolves that. Do they ignore inflation or ignore market stability?
- If we get lower than the economists’ expectation (on core), then it’s good news for the market because MAYBE it means the Fed isn’t in quite such a bad box and can do more to support liquidity (read: support the mo mo stock guys).
- So – maybe this report is important after all! Good luck today. I will be back live at 8:31ET.
- Well, headline was below core!
- Waiting for database to update but on a glance this doesn’t look good. Core was an upside surprise slightly and that was with used cars a DRAG.
- m/m CPI: 0.37% m/m Core CPI: 0.452%
- Last 12 core CPI figures
- So this to me looks like bad news. I don’t see the deceleration that everyone was looking for. We will look at some of the breakdown in a minute.
- M/M, Y/Y, and prior Y/Y for 8 major subgroups
- Standing out a couple of things: Apparel (small weight) jumps again…surprising. And Medical Care is back to a drag…some of that is insurance adjustment (-4.07% m/m, pretty normal) and some is Doctors Services (-0.52% m/m), while Pharma (0.14%) only a small add.
- Core Goods: 1.03% y/y Core Services: 7.26% y/y
- We start to see the problem here: any drag continues to be in core goods. Core goods does not have unlimited downside especially with the USD on the back foot. Core services…no sign of slowing.
- Primary Rents: 8.76% y/y OER: 8.01% y/y
- And rents…still accelerating y/y.
- Further: Primary Rents 0.76% M/M, 8.76% Y/Y (8.56% last) OER 0.7% M/M, 8.01% Y/Y (7.76% last) Lodging Away From Home 2.3% M/M, 6.7% Y/Y (7.7% last)
- Last month, OER and Primary Rents had slipped a bit and econs assumed that was the start of the deceleration. Maybe, but they re-accelerated a bit this month. Lodging away from home a decent m/m jump, but actually declined y/y so you can see that’s seasonal.
- Some ‘COVID’ Categories: Airfares 6.38% M/M (-2.15% Last) Lodging Away from Home 2.26% M/M (1.2% Last) Used Cars/Trucks -2.77% M/M (-1.94% Last) New Cars/Trucks 0.18% M/M (0.23% Last)
- FINALLY we see the rise in airfares that has been long overdue. I expected this to add 0.01% to core; it actually added 0.05%. Those who want to say this is a good number will screech “outlier!” but really it’s just catching up. The outlier is used cars.
- Both the Manheim and Black Book surveys clearly showed an increase in used car prices. But the BLS has recently changed methodologies on autos. Not clear what they’re using. Maybe it’s just timing and used will add back next month. We will see.
- Here is my early and automated guess at Median CPI for this month: 0.634%
- Now, the caveat to this chart is that I was off last month (the actual figure reported is shown), but that was January. I think I’ll be better on February. I have the median category as Food Away from Home. This chart is bad news for the deceleration crowd, and for the Fed.
- Piece 1: Food & Energy: 7.97% y/y
- OK, Food and Energy is decelerating, but both still contributed high rates of change. Energy will oscillate. It is uncomfortable that Food is still adding.
- Piece 2: Core Commodities: 1.03% y/y
- This is the reason headline was lower than expected. Core goods – in this case largely Used Cars, which I thought would add 0.05% and instead subtracted 0.09% from core. That’s a -14bps swing. +5bps from airfares, but health insurance was a drag…and we were still >consensus.
- Piece 3: Core Services less Rent of Shelter: 5.96% y/y
- …and this is the engine that NEEDS to be heading sharply lower if we’re going to get to 3.15% by end of year. It’s drooping, but not hard.
- Piece 4: Rent of Shelter: 8.18% y/y
- …and I already talked about this. No deceleration evident. As an aside, it’s not clear why we would see one with rising landlord costs, a shortage of housing, and robust wage gains, but…it’s an article of faith out there.
- Core inflation ex-shelter decelerated from 3.94% y/y to 3.74% y/y. That’s good news, although mainly it serves to amplify Used Cars…but look, even if you take out the big add from sticky shelter, we’re still not anywhere near target.
- Equity investors seem to love this figure. Be kind. They’re not thinking clearly these days. It’s a bad number that makes the Fed’s job really difficult.
- Note that Nick Timiraos didn’t signal anything yesterday…that means the Fed hasn’t decided yet. Which means they cared about this number. Which means to me that we’re likely getting 25bps, not 0bps. Now, maybe they just wanted to watch banking for another few days, but…
- …the inflation news isn’t good. As I said up top, 25bps doesn’t mean anything to inflation, but if they skip then it means we are back in QE and hold onto your hats because inflation is going to be a problem for a while.
- Even if they hike, they will probably arrest QT – and that was the only part of policy that was helping. Higher rates was just accelerating velocity. But I digress. Point is, this is a bad print for a Fed hoping for an all-clear hint.
- The only core categories with annualized monthly changes lower than -10% was Used Cars and Trucks (-29%). Core categories ABOVE +10% annualized monthly: Public Transport (+46%), Lodging AFH (+31%), Jewelry/Watches (+20%), Misc Personal Svcs (+17.7%), Footwear (+18%), >>>
- Women’s/Girls’ Apparel (+15%), Tobacco and Smoking Products (+13%), Recreation (+11%), Motor Vehicle Insurance (+11%), Infants’/Toddlers’ Apparel (+11%), and Misc Personal Goods (+10%). Although I also have South Urban OER at +10%, using my seasonality estimate.
- On the Medical Care piece, we really should keep in mind this steady drag from the crazy Health Insurance plug estimate for this year. It’ll almost certainly be an add next year. Imagine where we’d be on core if that was merely flat rather than in unprecedented deflation.
- Let’s go back to median for a bit. The m/m Median was 0.63% (my estimate), which is right in line with last month. The caveat is that the median category was Food Away from Home but that was surrounded by a couple of OER categories which are the ones I have to estimate. [Corrected from original tweet, which cited 0.55% as my median estimate]
- I can’t re-emphasize this enough. Inflation still hasn’t PEAKED, much less started to decline.
- One place we had seen some improvement was in narrowing BREADTH of inflation. Still broad, but narrower. However, this month it broadened again just a bit and the EIIDI ticked higher. Higher median, broader inflation…and that’s with Used Cars a strange drag.
- Stocks still don’t get it, but breakevens do. The 10y BEI is +7bps today. ESH3 is +49 points though!
- We’ll stop it there for now. Conference call will be at 9:30ET (10 minutes). (518) [redacted] Access Code [redacted]. I will be trying to record this one for playback for subscribers who can’t tune in then.
- The conference call recording seemed to go well. If you want to listen to it, you can call the playback number at (757) 841-1077, access code 736735. The recording is about 12 minutes long.
In retrospect, my forecast of 0.4% on seasonally-adjusted headline and 0.5% on core looks pretty good…but that’s only because we got significant downward one-offs, notably from Used Cars. If Used Cars had come in where I was expecting (+1.4%) instead of where it actually came in (-2.8%), and the rest of the report had been the same, then core inflation would have been 0.6% and we would be having a very different discussion right now.
As it is, this is not the number that the Fed needed. Inflation has not yet peaked, and that’s with Health Insurance providing a 4-5bps drag every month. That’s with Used Cars showing a drag instead of the contribution I expected. The “transitory” folks will be pointing to rents and saying that it seems ridiculous, and ‘clearly must decline,’ but that’s not as clear to me. Landlords are facing increased costs for maintenance, financing, energy, taxes; there is a shortage of housing so there is a line of tenants waiting to rent, and wage growth remains robust so these tenants can pay. Why should rents decelerate or even (as some people have been declaring) decline?
Apparel was also a surprising add. Its weight is low but the strength is surprising. A chart of the apparel index is below. Clothing prices now are higher than they’ve been since 2000. The USA imports almost all of its apparel. This is a picture of the effect of deglobalization, perhaps.
So all of this isn’t what the Fed wanted to see. A nice, soft inflation report would have allowed the Fed to gracefully turn to supporting markets and banks, and put the inflation fight on hold at least temporarily. But the water is still boiling and the pot needs to be attended. I think it would be difficult for the Fed to eschew any rate hike at all, given this context. However, I do believe they’ll stop QT – selling bonds will only make the mark-to-market of bank securities holdings worse.
But in the bigger picture, the FOMC at some point needs to address the question of why nearly 500bps of rate hikes have had no measurable effect on inflation. Are the lags just much longer than they thought, and longer than in the past? That seems a difficult argument. But it may be more palatable to them than considering whether increasing interest rates by fiat while maintaining huge quantities of excess reserves is a strategy that – as monetarists would say and have been saying – should not have a significant effect on inflation. The Fed models of monetary policy transmission have been terribly inaccurate. The right thing to do is to go back to first principles and ask whether the models are wrong, especially since there is a cogent alternative theory that could be considered.
Back when I wrote What’s Wrong With Money?, my prescription for unwinding the extraordinary largesse of the global financial crisis – never mind the orders-of-magnitude larger QE of COVID policy response – was exactly the opposite. I said the Fed should decrease the money supply, while holding interest rates down (since, if interest rates rise, velocity should be expected to rise as well and this will exacerbate the problem in the short-term). The Fed has done the opposite, and seem so far to be getting the exact opposite result than they want.
Just sayin’.
