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A Bad Day At The Federal Reserve

There will be many more days ahead for the Fed, and many of them will have plenty of good news. It is a mistake to trya and read too much into one day’s economic releases. With that said, here is my attempt to do exactly that.

I tweeted the following real-time reactions (@inflation_guy) following the CPI release this morning:

  • Ready for an exciting day…CPI, Claims, Philly Fed, a 30-year TIPS auction, wild commodity swings, 3 Fed Presidents…buckle up!
  • Hello! Core inflation +0.3%, higher-than-expected. Look out above.
  • Apparel +0.8%. Some will pooh-pooh the number on that basis, but Apparel has been trending higher for more than a year.
  • To be fair, core inflation BARELY rounded up to +0.3%. But the market was looking for +0.16% or +0.17%.
  • Core Services remains at +2.5% y/y, but core goods ticks up to +0.4%. The recovery of core goods has been something we’re looking for.
  • Somewhat surprisingly, the +0.251% rise in core inflation did so without having a rise in Owners’ Equiv Rent. Went from 2.1% y/y to 2.08%
  • Accel Inflation: Housing, Apparel, Educ/Commun, Other (54.7% of basket); Decel: Food/Bev, Transp, Med Care, Rec (45.3% of basket)
  • In Transp, the drag was almost all fuel. New/used Cars, maintenance, insurance, airline fares, inter- and intracity transp all up.
  • What’s amazing in the CPI today is how much it did with how little from the main driver of housing. That uptick is yet to come.
  • …and, next month, headline will get upward pressure from the steep rise in gasoline, which also dampens discretionary spending.

The primary takeaway from the CPI release is this: yes, core inflation surprised a little bit on the high side. But it did so without the support of the main factor that I think will push core inflation almost certainly higher going forward: housing. Rents (both primary and OER) neither accelerated nor decelerated this month from the prior year-on-year pace. And yet, there is really no temporary factor that pushed inflation higher this month. It was fairly broad-based. Apparel stood out on the month-to-month change perspective, but here is the chart (source Bloomberg) on Apparel:


This month doesn’t appear to me as too much of a true outlier. The underlying dynamic there has simply changed.

So this month core inflation stayed at 1.9%; next month it is very likely to return to 2.0% as we are dropping off the weak February change from last year. And all of that, before the housing inflation hits the data.

Speaking of housing inflation, there is no sign yet of that abating. In today’s Existing Home Sales report, the year-on-year change in Median Existing Home Sales Prices rose to 12.61%, another post-2005 record, and the highest real price increase ever, outside of 2005. This is happening because the inventory of new homes has dropped to almost a record low – really! Sure, the chart below (source Bloomberg) ignores “shadow inventory,” but it is starting to look more like the inventory of new homes now.


Some of that is seasonal, but there’s no doubt that lower inventories are now helping the home pricing dynamic. And, as I’ve shown previously, the inventory of existing homes actually has a nice relationship with shelter inflation 1-2 years later (Source: Enduring Investments):


The current level of inventories translates into a 3.6% expected rise in CPI-Shelter over the course of 2014. So you see, we’re not only firing inflationary rounds but we’re also continuing to feed more ammunition into the gun for next year. Our model of housing inflation projects Owners’ Equivalent Rent no lower than 3% by year-end 2013. And if that happens, there is no way that overall core inflation is going to be at 2%.

Now, in addition to the bad news on prices and the news on home prices that are probably seen at the Fed as a guarded positive (after all, it means the mortgage crisis is essentially over as more borrowers will be ‘above water’ again every month hereafter), there was also a mild surprise on the high side from Initial Claims (362k versus 355k) and a bad miss on the Philly Fed index for February. This latter was expected at +1.0 after -5.8 last month; instead it dropped to -12.5. Philadelphia-area manufacturers have reported softening business conditions in three of the last four months, suggesting that December’s pop to +4.6 was the outlier. Now, there were similar one-month dips in August of 2011 and June of 2012, so we’ll have to see if it is sustained…but it is consistent with the report out of Wal-Mart and the worsening of business conditions in Europe.

Higher prices (and more coming, on the headline side, as retail gasoline prices have now risen in 35 consecutive days) and lower business activity. This is exactly the opposite of what the Fed wants. It has been a bad day at the Fed.

However, it is exactly what traditional monetarism expects: accommodative monetary policy leads to higher prices (check), and has no effect on real activity in the absence of money illusion (check). So score one point for Friedman today.

And so, what else would you expect after such a day? Bond yields are declining, inflation breakevens are narrowing, and industrial commodities (metals and energy) are sliding. As with so much else these days, that makes no sense, unless you just don’t know what’s going on. When we encounter these bouts with irrationality (or, more fairly, thick-headedness), the market can be frustrating for a long time – and the ultimate denouement can sometimes be jarring. As I said earlier in this post: buckle up!


  1. Andy
    February 21, 2013 at 12:34 pm

    I don’t know why you are worried about something silly like the inflation readings, after all, central bank leaders around the world have proven that they are essentially unconcerned with inflation when there is a growth issue. After all, was it not the highly regarded Mark Carney, soon to be Governor of the BOE, who just told us that a “flexible” inflation policy is a reasonable accommodation in a period of slow growth. Don’t you think that Chairman Ben speaks to his counterparts frequently and is a keen observer of how markets respond to comments like that? Despite all the angst from the minutes yesterday, I would be willing to wager that the Fed keeps policy easy far longer than currently expected because I fear that unemployment will not decline at the preferred rate and hang on above 7% for much longer. In fact, Barclays economists now peg 7% as the new NAIRU. Certainly based on the lethargy of this recovery, that seems very viable.

    All for inflation and Inflation for all will be the new BIS motto

    • February 21, 2013 at 12:44 pm

      Andy – Absolutely…I don’t think there’s much chance that the Fed starts an exit very soon. It’s too late anyway to avoid “unanchoring” inflation expectations.

  2. Lee
    February 21, 2013 at 2:22 pm

    Nice tracking of inflation on your part. Does your unanchoring remark above mean that Fed is probably trying the higher inflation expectation concept? Will it only run for 3 months?

    • February 21, 2013 at 4:31 pm

      I don’t think they’re trying to unanchor, but my point is that with a year or two of ammunition in the gun, they can’t really stop it now.

  3. James A. Kostohryz
    February 21, 2013 at 5:07 pm

    Excellent post, Michael. As you know, I am also looking for the core to push up agains the Fed’s comfort level by the end of 2013. I am especially looking at the tradeable goods sector with foreign content and/or content that is priced internationally (i.e. commodities). I also think inflationary expectations may be ripe for an upward move which would just magnify any cost-push impetus. Like you, I am pretty surprised that TIPS are ALREADY starting to reflect some sort of heightened expectations. Having said that, I do not know how much we can trust the TIPS market as an indicator of the sort of inflationary expectations that count in the real economy. But it is something that has caught my eye.

    • February 21, 2013 at 6:32 pm

      i can’t decide whether to be excited that this is good for my business, or depressed for my country and my children.

  4. rich t
    February 21, 2013 at 6:35 pm

    Really interesting article, Mike. Looks like some stagflation in the pipeline…

  5. March 12, 2013 at 10:29 am

    In case you didn’t see this… here are a couple of Fed economists arguing exactly the opposite! http://macroblog.typepad.com/macroblog/2013/03/you-say-youre-a-homeowner-and-not-a-renter-think-again.html

    • March 12, 2013 at 11:32 am

      i saw that. Loved the way they started with good reasoning and talked themselves into the ‘inflation is contained’ argument!

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