E-piphany

Below is a summary of my post-CPI tweets. You can follow me @inflation_guy :

• 1y inflation swaps and gasoline futures imply a 1-year core inflation rate of 0.83%. Wonder how much of that we will get today.
• Very weak CPI on first blush: headline -0.3%, near expectations, but core 0.07%, pushing y/y core down to 1.71% from 1.81%.
• Ignore the “BIGGEST DROP SINCE DECEMBER 2008” headlines. That’s only headline CPI, which doesn’t matter. Core still +1.7% and median ~2.3%
• Amazing how core simply refuses to converge with median. Whopping fall in used cars and trucks and apparel – which is dollar related.
• Core services +2.5%, unch; core goods -0.5%, lowest since 2008. But this time, we’re in a recovery.
• Medical Care Commodities, which had been what was dragging down core, back up to 3.1% y/y. So we’re taking turns keeping core below median.
• Core ex-housing declines to +0.800%, a new low.
• That’s a new post-2004 low on core ex-shelter.
• Accel major groups: Food, Med Care (22.5%) Decel: Housing, Apparel, Transp, Recreation, Educ/Comm, Other (77.5%). BUT…
• But in housing, Primary Rents 3.482% from 3.343%, big jump. Owners’ Equiv to 2.707% from 2.723%, but will follow primaries.
• Less-persistent stuff in housing responsible for decline: Lodging away from home, Household insurance, household energy, furnishings.
• Real story today is probably Apparel, which is clearly a dollar story. Y/y goes to -0.4% from +0.6%. Small weight, but outlier.
• Similarly used cars and trucks, -3.1% from -1.7% y/y (new vehicles was unch at 0.6% y/y).
• On the other hand, every part of Medical Care increased. That drag on core is over.
• Curious is that airfares dropped: -3.9% from -2.8%. SHOULD happen due to energy price declines, but in my own shopping I haven’t seen it.
• I don’t see persistence in the drags on core CPI. There’s a rotation in tail-event drags, which is why median is still well above 2%.
• We continue to focus on median as a better and more stable measure of inflation.
• Back of the envelope calc for median CPI is +0.23% m/m, increasing y/y to 2.34%. Let’s see how close I get. Number around noon. [Ed. note: figure actually came in around 0.15%, 2.25% y/y. Not sure where I am going wrong methodologically but the general point remains: Median continues to run hotter than core, and around 2.3%.]

Quite a few tweets this morning! The number was clearly roughly in-line on a headline basis: gasoline prices have dropped sharply, in line with crude oil prices. How much? Motor Fuel dropped from -5.0% y/y to -10.5% y/y. The monthly decline was over 6%, and so a decline in headline inflation on a month/month basis was all but certain. Had core inflation been as low now as it was in 2010, we would have seen a year-on-year headline price decline (as it is, headline CPI is +1.3% y/y).

However, core inflation is not as low as it was in 2010. It continues to surprise us by failing to converge upwards to median CPI. Last year, the reason core CPI was inordinately low compared to the better measure of central tendency (median) was that Medical Care inflation was weak thanks to the effects of the sequester. But that effect is now gone. Medical Care inflation is back to 2.5% on a year-on-year basis; this month’s print was the highest in over a year. The chart below (Source: Bloomberg) shows the y/y change in Medical Care Commodities (e.g. pharmaceuticals) – back to normal.

The 2013 dip is very clear there, and the return to form is what we expected, and the reason we expected core inflation to return to median CPI. But it hasn’t yet; indeed, core is below median by around 0.6%, the biggest spread since 2009. Now, it may be that core is simply going to stay below median for an extended period of time as one category after another takes turns dragging core lower. From 1994-2009, core was almost always lower than median. That was a period of disinflationary tendencies, and the fact that different categories kept trading off to drag core CPI lower was one sign of these tendencies.

I do not think we are in the same circumstances today. Although private debt levels remain very high (weren’t we supposed to have had deleveraging over the past six years? Hasn’t happened!), public debt levels have risen dramatically and the latter tends to be associated with inflation, not deflation. Money supply, especially here in the US, has also been growing at a pace that is unsustainable in the long run and it seems unlikely that the Fed can really restrain it until they drain all of the excess reserves from the system. These are inflationary tendencies. The risk, though, is that the feeble money growth in Europe could suck much of this liquidity away and move global inflation lower. This is an especially acute risk if Japan’s monetary authorities lose their nerve or if other central banks rein in money growth. In such a case, global inflation would decline so that, while US inflation rises relatively, it falls absolutely. I don’t consider this a major risk, but it is a risk which is growing in significance.

Of course, all of that and more is priced into inflation-linked bond and derivative markets, as well as in commodities. Only a massive and inexplicable plunge in core inflation could render the market-based forecasts correct – and there is no sign of that. Housing inflation continues to rise, and the soonest we can see that peaking is late next year. Getting core inflation to decline appreciably while housing inflation is 2.6% and rising is very unlikely! Accordingly, we see inflation-linked assets as extremely cheap currently.