E-piphany

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy. Or, sign up for email updates to my occasional articles here. Investors with interests in this area be sure to stop by Enduring Investments or Enduring Intellectual Properties (updated sites coming soon). Plus…buy my book about money and inflation. The title of the book is What’s Wrong with Money? The Biggest Bubble of All; order from Amazon here.

• CPI day! Want to start today with a Happy Birthday to @btzucker , good friend and inflation trader extraordinaire at Barclays. And he does NOT look like he is 55.
• We are coming off not one not two but THREE surprisingly-high core CPI prints that each rounded up to 0.3%. The question today is, will we make it four?
• Last month, the big headliners were core goods, which jumped to 0.8% y/y – the highest in 6 years or so – and the fact that core ex-housing rose to 1.7%, also the highest in 6 years.
• Core goods may have some downward pressure from Used Cars this month, as recent surveys have shown some softness there and we have had two strong m/m prints in the CPI, but core goods also has upward tariffs pressure, and pharma recently has been recovering some.
• (The monetarist in me also wants to point out that we have M2 growth accelerating and near 6% y/y, and it’s also accelerating in Europe…but I also expect that declining interest rates are going to drag on money velocity. Neither of those is useful for forecasting 1 month tho)
• Now, one thing I am NOT paying much attention to is yesterday’s soggy PPI report. There’s just not a lot of information in the broad PPI, with respect to informing a CPI forecast. I mostly ignore PPI!
• The consensus forecast for today calls for a soft 0.2%. I don’t really object to that forecast. We are due for something other than 0.3%. But I would be surprised if we got something VERY soft. I think those 0.3%s are real.
• Unless we get less than 0.12%, though, we won’t see core CPI decline below 2.4% (rounded). And if we get 0.222% or above, we will see it round UP to 2.5%. That’s because we are dropping off one more softish number, from Sep 2018, in the y/y.
• Median, as a reminder, is 2.92%, the highest since late 2008. It’s going to take a lot to get back to a deflation scare, even if inflation markets are currently pricing a fairly rapid pivot lower in inflation. I don’t think they’re right. Good luck today.
• Obviously a pretty soft CPI figure. 0.13% on core, 2.36% y/y.

• This is not going to help the new 5yr TIPS when the auction is announced later. But let’s look at the breakdown. Core goods fell to 0.7% from 0.8%, and core services stable at 2.9%.
• As expected, CPI-Used Cars and Trucks was soft. -1.63% m/m in fact. That actually raises the y/y slightly though, to 2.61% from 2.08%. There’s more softness ahead.

• OER (+0.27%) and Primary rents (+0.35%) were both higher this month and the y/y increased to 3.40% and 3.83% respectively. So why was m/m so soft? Used cars is worth -0.05% or so, but we need more to offset the strong housing.
• (Lodging away from home also rebounded this month, +2.09% m/m vs -2.08% last month).
• Big drop in Pharma, which is surprising: -0.79% m/m, dropping y/y back to -0.31%. That’s still well off the lows of -1.64% a few months ago.
• Core ex-shelter dropped to 1.55% y/y from 1.70% y/y. That’s still higher than it has been for a couple of years.
• Apparel dropped -0.38% on the month. The new methodology is turning out to be more volatile than the old methodology, which is fine if apparel prices are really that volatile. I’m not sure they are. y/y for apparel back to -0.32%.
• Yeah, apparel is just reflecting the strong dollar, but I’m still surprised that we haven’t seen more trade-tension effect.

• So, Physicians’ services accelerated to 0.93% y/y from 0.71%. And Hospital Services roughly unchanged. Pharma as I said was down (in prescription, flat on non-prescription). Health Insurance still +18.8% y/y (was 18.6% last month).
• A reminder that “health insurance” is a residual, and you’re likely not seeing that kind of rise in your premiums. But I suspect it means that there are other uncaptured effects that should be allocated into different medical care buckets, or perhaps this leads those movements.
• So even with that pharma softness, overall Medical care (8.7% of the CPI) was exactly unchanged at 3.46% y/y.
• College Tuition and Fees decelerated to 2.44% from 2.51%. But that’s mostly seasonal adjustment – really, there’s only 1 College Tuition hike every year, and it just gets smeared over 12 months. Tuition is still outpacing core, but by less.
• Largest drops in core m/m were Women’s/Girls’ apparel(-18.7% annualized), Used Cars & Trucks(-17.9%), Infants’/Toddlers’ apparel(-13.4%), Misc Personal Goods(-12.1%), and Jewelry/Watches (-11.9%). Biggest gainers: Lodging away from home(+28.1%) & Men’s/Boys’ Apparel.(+25.5%)
• Here’s the thing. Median? It’s a little hard to tell because the median categories look like the regional housing indices, but I think it won’t be lower than +0.25% unless my seasonal is way off. And that will put y/y Median CPI at 3%.

• The big difference between the monthly median and core figures is because the core is an average, and this month that average has a lot of tail categories on the low side while the middle didn’t move much.
• That’s why, when you look at the core CPI this month, there’s nothing that really jumps out (other than used cars) as being impactful. You have moves by volatile components, but small ones like jewelry and watches or Personal Care Products.
• Here is OER, in housing, versus our forecast. There’s no real slowdown happening here yet, and that’s going to keep core elevated for a while unless non-housing just collapses. And there’s no sign of that – core ex-housing, as I noted, is still around 1.4%.

• So, this is a fun chart. In white is the median CPI, nearing the highs from the mid-90s, early 2000s, and late 2000s. Now compare to the 5y Treasury yield in purple. Last time Median was near this level, 5s were 3-4%.

• Another fun chart. Inflation swaps vs Median CPI. Not sure I’ve ever seen a wider spread. Boy are investors bearish on inflation.

• Here is the distribution of inflation rates, by low-level components. You can see the long tails to the downside that are keeping core lower than where “most” prices are going. So inflation swaps aren’t as wrong as median makes them look…if the tails persist. Not sure?

• So four pieces: food & energy, about 21% of CPI.

• Core goods, about 19%. Backed off some, but still an important story.

• Core services less rent of shelter. About 27% of CPI. And right now, meandering. Real question is whether rise in health care inflation is going to pass through eventually to other components or if it is transitory. If the former, there’s a big potential upside here.

• And rent of shelter, about 33% of CPI. As noted, this ought to decelerate some, but no real indication it’s about to collapse. And you can’t get MUCH lower inflation unless it rolls over fairly hard.

• Really, the summary today is that there isn’t anything that looks like a sea change here. Most prices continue to accelerate. Now, next month the comparison is harder as Oct 2018 core was +0.196%. Month after was +0.235%. So some harder comps coming for core.
• That said, I continue to think that we’ll see steady to higher inflation for the balance of this year with an interim peak coming probably Q1-Q2 of next year. But the ensuing trough won’t be much of a trough, and the next peak will be higher.
• That’s all for today. Thanks for tuning in.

I don’t think there is anything in this report that should change any minds. The Fed ought to be giving inflation more credit and be more hesitant to be cutting rates, but they are focused on the wrong indicator (core PCE) and, after all, don’t really want to be the guys spoiling the party. I think they’ll be slow, but we’re entering a recession (if we’re not already in one) and since the Federal Reserve utterly believes that growth causes inflation, they will tend to ignore a continued rise in inflation as being transitory. Since they said it was transitory when it dipped a couple of years ago – and it really was – they will be perceived as having some credibility…but back then, there really was some reason to think that the dip was transitory (the weird cell phone inflation glitch, among them), and there’s no real sign right now that this increase in inflation is transitory.

Yes, I think inflation will peak in the first half of 2020, but I’m not looking for a massive deceleration from there. Indeed, given how low core PCE is relative to better measures of inflation, it’s entirely possible that it barely declines while things like Median and Sticky decelerate some. Again, I’m not looking for inflation or, for that matter, anything that would validate the very low inflation expectations embedded in market prices. The inflation swaps market is pricing something like 1.5% core inflation for the next 8 years. Core inflation is currently almost a full percentage point higher, and unlikely to decline to that level any time soon! And breakevens are even lower, so that if you think core inflation is going to average at least 1.25% for the next 10 years, you should own inflation-linked bonds rather than nominal Treasuries. I know that everyone hates TIPS right now, and everyone will tell you you’re crazy because “inflation isn’t going to go up.” If they’re right, you don’t lose anything, or very little; if they’re wrong, you have the last laugh. And much better performance.