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Summary (and Extension) of My Post-CPI Tweets

Below is a summary (and extension) of my post-CPI tweets today. You can follow me @inflation_guy.

  • CPI +0.3%/+0.1% with y/y core figure dropping to 1.9%. That will be only by a couple hundredths on rounding, but it’s still a decline.
  • Looks like core was 0.129% rounded to 3 decimal places. y/y went from 1.956% to 1.933% so a marginal decline.
  • RT of Bloomberg Markets @themoneygame: Consumer Price Changes By Item http://read.bi/1nx0sUf 
  • Core goods still -0.2%, core services still +2.7%, unchanged from last month. [ed note: I reversed these initially; corrected here]
  • All of this a mild miss for the Street, which was looking for +0.19% or so, but I though the Street was more likely low.
  • Major groups accel: Apparel, Recreation, Educ/Comm, Other (19.7%). Decel: Food/Bev, Transp, Med Care (38.9%), Housing flat.
  • There’s your real story. Recent drivers: medical care, which is a base effect and oddly reversed. That’s temporary. Also>>
  • >>big fall in non-rental/OER parts of housing: insurance, lodging away from home, appliances. Those are not as persistent as rents.
  • Primary rents went to 3.153% from 3.058%; OER unch at 2.640% from 2.638%. The rest will mean-revert.
  • College tuition and fes at 4.142% from 4.001%.
  • 60.5% of all low-level categories accelerating (down from 70.5%). Still broad but not as broad.
  • Actually looks like Median CPI could downtick today.

This is why I try very hard to resist the urge to forecast the monthly CPI, and admonish investors (and even traders) to resist trading on the data. Chairman Yellen is right about this: the data are noisy, so one month can be almost anywhere. This month, there was a reversal in the recent rise in y/y medical care inflation. But that rise was due to base effects, which aren’t going away, so forecasting medical care inflation to continue to accelerate is more a statement of mathematical likelihood than it is an economic forecast. And it’s all the more surprising then when it reverses.

This month’s figure makes it a fair bit harder for my forecast of near-3% for 2014 on core or median inflation to come to pass, although it bears noting that median inflation (even though it may downtick later today) is still within striking distance. Since median is currently the better measure, and will be for much of this year, I won’t back off my forecast yet. Another weak month, though, would cause me to ratchet down the target simply because it becomes harder to hit as time becomes shorter.

However, I expect several months this year will exceed +0.3% on core inflation. And it is worth remembering that core inflation faces easy year-ago comparisons for the rest of the year. In July of last year, the seasonally-adjusted m/m core inflation figure was +0.167%; in August it was +0.138%; in September it was 0.132%; in October +0.124%; in November +0.175%; and in December +0.101%. So, even if core inflation only averages +0.2% for the rest of the year, core will still be at 2.3% by year-end. If core inflation averages what it has been for the last four months, we’ll be at 2.4%. What that means is that (a) my forecast of something near 3% doesn’t represent a massive acceleration, although we only have half a year to get there, and (b) anyone forecasting less than 2.3% by year-end is actually forecasting a deceleration in inflation from recent trends.

The breadth indicators also took a mild breather this month, with the proportion of the CPI that is accelerating (looking at low-level categories) dropping to around 60% from around 70% in May. As with the other analysis, however, we should be careful not to read too much into one month since this figure also jumps around a lot. Interestingly, the proportion of categories where the year-on-year change is at least 2 standard deviations above zero – so that we can reject the ‘deflation’ meme for these categories – is basically unchanged from last month at 24%. As the chart below shows, we last saw a level this high in 2006, which is also the last time that core CPI ran at 3%.


Housing inflation is now back below my model’s projections, inflation breadth is still high, and the persistent parts of CPI are maintaining their levels or advancing while a few of the skittish parts are retreating (or at least not yet converging to the mean). There is nothing here to indicate that the three months of accelerating core CPI were the aberration; in fact to me it appears that the June figure was the aberration. That question will be answered over the balance of the year. In the meantime, inflation markets remain priced at levels so low that even if you’re wrong in betting on higher inflation, you don’t lose much but if you’re right, you do very well. In my view (although admittedly I may be biased), most investors remain significantly underweight protection against this particular risk.

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  1. Eric
    July 28, 2014 at 3:26 am

    Hi Mike,

    I dont know how often you read Hussmans weekly comment. (I read both of you guys pretty regularly). This week he has some comments on inflation. Im curious what you think of them. He basically agrees with your inflation mechanism thesis. (this line reminded me of many of your comments: “(remember that rising interest rates are often a symptom and accelerant, not a cure, for inflation),” but he also thinks we could see a repeat of 07-08 creating a rush for cash. He thinks the pent up inflation is going to have to wait for the next economic cycle to really get going.


    • July 28, 2014 at 8:39 am

      I do like Hussman. In this article, I really like this paragraph (partly because it’s so similar to stuff I have written in the past): “A few notes on valuation and investment returns. First, as I’ve noted frequently in recent comments, it’s quite reasonable to argue that lower interest rates can “justify” higher valuations, provided that one also recognizes that those higher valuations will still be associated with commensurately lower future equity returns. At present, we estimate zero or negative nominal total returns for the S&P 500 on horizons of 8 years or less, and about 1.9% annual total returns over the next decade. If these prospects seem “fair” given the level of interest rates, that’s fine – one can then say that low interest rates justify current valuations – but that doesn’t change the outcome: the S&P 500 can still be expected to experience zero or negative total returns on horizons shorter than about 8 years (and even that assumes that corporate revenues and nominal GDP grow at their historical norm of about 6% annually in the interim).”

      On inflation, he lists four things that can cause higher inflation. The only problem is that there is no evidence for two of them (because they’re always coincident with the other two, so there is no independent series that is disentangled). I don’t think that growth metrics matter much, if at all. I may be wrong.

      Our models indicate inflation is coming now. It might well be that the current inflation peaks at only 3% or 4%, setting up a bigger peak in the next cycle. In that case, we might say that Hussman and Ashton are both right, since I am certainly not at this point predicting anything much above 4% on core inflation (but I would also note that core inflation moves slowly enough that a forecast of >4% would be more than a year away, so it’s simply too early to make a forecast >5%).

      Regarding a rush for cash – the market meme is that the crisis caused a collapse in velocity (in other words, a rush for cash), that evidently never reversed. But the velocity and interest rate series moved in almost perfect concert at that time – meaning that you don’t have to postulate a “rush for cash” in order to explain the decline in velocity. The drop in interest rates was sufficient to cause the decline in velocity – you don’t need a “market panic” explanation. And personally, I think if a simple explanation works then one usually shouldn’t look for a more prosaic one. The upshot of that is that if we get another market panic, but interest rates do not decline, it isn’t clear to me that velocity will decline. The demand for real cash balances (which is the inverse of velocity) is already very high, anyway!

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