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Neither Trumpets Nor Bomb Blasts

Today, finally, we can focus on the domestic situation. While the matters in Greece are far from resolved, and are generating the usual amount of chaotic-looking discussion about what exactly the “deal” is supposed to mean, and for who, and whether everyone who needs to be a party to the deal actually has in fact signed off on the deal. So far the early returns are not promising, but there were neither trumpets nor bomb blasts today and we will therefore leave it behind for a day.

It seems odd to actually think about the economic data for a change. Today’s Existing Home Sales data, though, are worth thinking about. With good weather providing a boost, January Existing Home Sales ran at only a 4.57mm seasonally-adjusted pace, below expectations and with a hefty downward revision to last month’s data. Unless the seasonal adjustments are being made based on the previously-misreported-by-NAR data…and I can’t imagine that mistake being made…this is simply a weak number. Bloomberg’s initial take was “Sales of Previously Owned U.S. Homes Increase in Sign Recovery Taking Hold,” but then they realized that the 4.57mm was below the previously-reported pace of December. That is, the only reason there was an “increase” is that last month’s data were revised lower. (Bloomberg later dampened down the headline).

The good news in the report is that housing inventory dropped to the lowest level since 2005. This provides a bit of support for home prices, but it also suggests that bank REO property isn’t yet coming to the market in any quantity. If that is the case, then one interpretation of the low sales figures could be that homebuyers are waiting for the foreclosed inventory to begin to hit the market. It’s not a bad strategy, if you see shadow supply that is suddenly freed, to let the supply be listed before negotiating on your dream home.

But perhaps I am reaching. European PMI data, out this morning, fell unexpectedly into contraction territory. It would not be a difficult stretch to imagine the economy stumbling over the next quarter or two; in fact, many observers have predicted just that. I suspect the U.S. will withstand a Greek default and potential Euro exit, but I also don’t expect strong growth. Weak growth, rising inflation is what I expect.

Consistent with that theme, for the second day in a row, equities struggled (today -0.3%) while commodities rallied (DJ-UBS +0.4%). Industrial metals led with a 2% gain while Energy commodities rose 0.6%. Front gasoline is now up 25% since mid-December.

The 10y Treasury note rallied a surprising 6bps to 2.00%; TIPS rallied more, so that 10-year breakevens (or inflation swaps) rose about 1bp. Again, this is somewhat interesting in the context of weaker housing and European PMI data, stronger bonds, and weaker equities. It is consistent with the notion that the underlying inflation process has some momentum. I want to share a chart here of one component of CPI, the Apparel major subgroup. Many of the economists who are calling for core inflation to moderate point to housing supply (as do I), but many of them also point to Apparel as a component that has recently been rising but which they expect to correct because everyone knows that Apparel prices never go anywhere. Or at least, they haven’t gone anywhere for a long time. The chart below (Source: BLS) illustrates the point.

From 2003 to 2011, Apparel prices were unchanged to lower. And from 1999-2003, they trended lower. Indeed, since 1994 or so Apparel prices have gone sideways or down. So it’s not an unreasonable supposition that a rise in Apparel prices ought to mean-revert, so any effect on core CPI ought to be ignored. Except for one thing, and that is that you can see from the chart Apparel prices haven’t always trended lower. It isn’t somehow a law of nature that Apparel prices decline all the time. Over the last two decades, as more and more clothing was produced and exported from developing Asia, there was a constant downward competitive pressure. But that may no longer be the case. The recent rise in the Apparel subcomponent looks to me a lot more like the pre-1993 period than it does the post-1993 period.

By the way, I picked from 1987 just because it was enough data to make the point. But so you don’t think 1987-1993 was the unusual part, here’s the whole chart back to 1960.

Rising apparel prices are much more normal than declining apparel prices, in the grand sweep of history.

Here’s another inflation-related story. The Atlanta Fed’s “macroblog” posted an item today entitled “Weighing the risks to the inflation outlook: Two views.” Since any hint that there might actually be two views among the one thousand economists at the Federal Reserve gets my attention, I read this story. It’s interesting for a couple of reasons. The humorous reason is that the authors seem to see nothing curious about their first chart, which shows that the respondent firms to their survey have had incredibly stable expectations for short-term inflation. Unreasonably stable. Suspiciously stable. As an econometrician, I’m tempted to throw out such obviously useless data, unless I first investigate and find there is a good reason that, with oil prices gyrating wildly and Europe imploding, business owners don’t change their opinions about year-ahead inflation.

But that’s not the main point here. The main point is the authors’ observation about the reason for the fact that longer-term expectations are higher, by a full percentage point, than the shorter-term expectations. They conclude that while they agree on the central tendency for inflation over the short and long term being in the 1-3% range, in the short-run the respondents give a slightly higher chance for a lower outcome than they do for a higher outcome…but in the long-run, the respondents give a much higher chance for a higher outcome (more than 3%) than for a lower outcome.

This is interesting because the Fed cannot affect prices in the very short term, and the respondents seem to be saying that they believe the Fed to be asymmetrically biased to increased inflation in the long-term. Of course, this comports with history, and it is a theme I have been hammering on for a while: whatever you think the likely outcome for inflation over the next 10 years, almost all of the long tails are to higher inflation rather than lower inflation. Accordingly, you can think of long-term inflation swaps or breakevens as consisting of a forward contract plus a call option on inflation. And I think that means market prices for long-term inflation ought to be a lot higher.

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