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, issuers and risk managers with interests in this area be sure to stop by Enduring Investments!

• #CPI Day, on 9/11. I don’t remember that ever happening before and I apologize in advance if my thoughts are more scattered than usual.
• There will be more people with attention on this #inflation number – or would be, if it wasn’t 9/11 – than there has been in some time since last month’s number was so incredible.
• Some people thought that August’s +0.62% rise in core CPI was just a snap-back from prior weakness, but an examination of the “covid components” made it clear that it wasn’t.
• While the categories that were depressed in March and April have rebounded some, most of the damage to pricing remains. Airfares have only recovered 20% of their “Covid decline”; Apparel 29%; Lodging Away from Home 14%; and Car/Truck Rental 66%.
• People made a big deal last month about the jump in Motor Vehicle Insurance, which is one damaged category that has recovered 85% of its prior losses – but that’s only 2% of core CPI. And that’s the one I’m least convinced really ought to return to normal!
• There was also strength in cellular telephone services, but that seems unlikely to be related to COVID. It could be a quirk, but that’s the only potentially quirky figure from last month. And there’s actually a chance that’s legit.
• Meanwhile, and significantly, Used Cars CPI is wayyyyyy behind where the Black Book survey says it will be in a few months. It may not happen this month. But I think 2 out of the next 3 CPI prints could get an 0.2%-0.3% bump to core above the baseline! Per month!
• Consensus for today’s release is 0.21%-0.25% or so on core CPI, which is in line with the year-ago number and with what had been the trend prior to Covid.
• This again seems low, if only because we still have Covid-categories to recover and the Used Cars effect to anticipate. But there are two downside risks too.
• The first is that many colleges – though not all – have cut tuitions this year as they go partly or entirely virtual. The adjustment happens once/year, right around now. The BLS is not making a quality adjustment so this could show up as a drop, or at least a below-trend rise.
• The risk with the bigger weight is in rents (and OER). Up until last month, rent delinquencies had been approximately normal but delinquencies have been rising a bit lately.
• Although QUOTED rents themselves have been rising outside of big cities, the BLS adjusts rents downward based on a landlord’s assessment of the likelihood of eventually receiving all of the rent. And those assessments are likely weakening.
• So, this COULD produce a weak rents reading. It’s still a smallish difference in delinquencies, and home prices are doing well, so it isn’t a big longer-term effect I don’t think. Unless cities make it harder on landlords to collect rent.
• So overall I think the forecasts seem conservative, but unlike last month there ARE some downside risks too. And, to be sure, the Fed doesn’t care about #inflation at all right now. See my very short summary of Average-Inflation Targeting here: Average-Inflation Targeting, In a Nutshell
• Anyway, that’s the walkup. Good luck. If you have interest in talking to us about how to hedge/invest in the inflationary period approaching, visit https://enduringinvestments.com
• Wellllllll I hate to say I told you so, but I told you so. Actually so did Druckenmiller. Did you see where he said we could see 5-10% inflation? Yikes.
• Core #CPI prints at +0.39%, raising y/y to 1.73%.

• So core prices rose 1%, that’s an annualized 6%, over the last two months. But the good news is that you haven’t yet missed the trade. Inflation markets still have very low opinions of inflation going forward.

• CPI for Used Cars and Trucks rose 5.4% m/m. That’s part of it. It increases the y/y for that category to 3.98% from -0.89%.
• Again, the used cars move isn’t surprising. And there’s more to come, as this chart makes plain.

• Now, Core Services as a whole fell to 2.2% y/y from 2.3%. That’s largely because Primary Rents rose only 0.09% m/m, which brings the y/y down to 2.95% from 3.12%. OER rose only 0.12%, pushing y/y to 2.69% from 2.80%.
• I noted that potential issue at the top. What’s amazing is that even with that slowdown – driven by rental delinquencies, and temporary given what’s happening to home prices – core inflation was STILL +0.4%.
• That means core-ex-shelter rose to 1.32% y/y. That’s up almost 1% from two months ago. Still low.
• Lodging Away from Home was +0.95% m/m, after +1.19% last month. That still keeps the y/y at -11.4%. So, in a nutshell, that covid-category still has “potential energy.” Apparel was +0.62% m/m, but y/y is still -5.88%, so same deal.
• Pharmaceuticals (“Medicinal Drugs”) rose +0.34% m/m, but that still drags down the y/y slightly. Doctors’ Services and Hospital Services didn’t repeat last month’s sharp rise, but they’re still rising.
• Overall, Medical Care was soft, partly because Health Insurance is finally slowing a little bit. And we’ll pause here for a 9/11 observance.
• So macro-wise, what’s interesting about this number is that the big honker of rents softened but we are starting to get RIGHT tails. So Median will likely be softer than Core again.
• So, college tuition and fees decelerated to 1.31% from 2.09%. That’s the smallest increase in generations. Importantly, it’s because they’re not quality-adjusting education; if they were, this would be a huge rise.

• The BLS looked at adjusting for quality in tuitions, but decided it’s too difficult esp if this is a passing effect. If it’s not, then they’ll have to look more deeply at it. But if next year is normal, this drop will be reversed and then some. COSTS of colleges are rising.
• I mentioned earlier the fact that core goods inflation was positive y/y, largely on the strength of cars. This is close to the prior trend, but judging from lagged import prices possibly unsustainable.

• However, the softness in shelter is probably also not sustainable. Even just focusing on rents (and not lodging away from home), the underlying trends are just not suggesting the recent deceleration is the start of something bigger.

• Again, home prices are doing fine, and home prices and rentals are substitutes. They don’t diverge for long. The eviction-stay orders are probably contributing to delinquencies, which pulls down measured rents.
• So here are the four-pieces charts, which are telling some interesting stories at the moment. First, Food & Energy.

• Piece 2: Core goods. Sharp higher on cars. We have more of the cars effect, but then some softness perhaps. But in the big picture, it’s hard to imagine this staying weak with trade frictions.

• Core Services less Rent of Shelter. Has bounced back, but Medical Care hasn’t really seen the strong uptrend I would have expected in the wake of COVID. Maybe that waits until after COVID.

• Piece 4: Rent of Shelter, the piece that ordinarily moves the slowest. It looks dramatic, but again a lot of that is lodging away from home. But rents and OER also softening. Consider me a big skeptic that we’re about to see this decelerate in a lasting way.

• OK, here’s something interesting. First chart is distribution of y/y price changes by category. Still some left tail but it’s starting to spread out. So for the second chart…

• This chart shows the distribution of price changes, ex-rents. The rent categories are huge, and when they are both between 2.5% and 3.0% it is hard to see the underlying distribution. This is interesting because it’s all over the place.

• The median of that last picture is between 2.0% and 2.5%, so it isn’t as if rents are totally changing the picture, especially now as the left tails diminish and we start to pick up some right tails.
• So to repeat one thing I said up top, to sum up: the Fed doesn’t give two pence for any of this. The move to AIT makes official policy what was unofficial, that they’re going to ignore inflation until it’s really hot.
• I think there’s a good chance they get their wish. I haven’t mentioned at all today the crazy explosion in the money supply. Yes, it is slowing a LITTLE, but the last 13 weeks it’s still rising at 11% so that’s hardly tight money.

• Unless something dramatic changes in the next couple of weeks, the Q3 average of M2 will be ~4% above (16% annualized) the Q2 average.
• Money velocity in Q3 will be up, compared to Q2. The models on this are wild, but right now looks like 1.105 compared to 1.097 in Q2. That’s enough, with that money growth, to support the real growth AND a rise in prices. And that’s why we’re seeing prices rise.
• …Don’t even ask about Q4 if we continue at this pace of money growth. It’s worth listening to Druckenmiller and other smart people who remember past inflation episodes. Inflation is not dead – not when monetary and fiscal authorities are misbehaving. And misbehaving they are.
• That’s all for me today. Will be interesting to see if forecasts for Core CPI next month are still 0.2%, or if expectations increase. Again, this happened today EVEN THOUGH rents slowed. By the way, at this hour 10-year breakevens are…LOWER. Plenty of time to board the train!

So we have a second month of inflation ‘surprising’ to the upside. Let’s think about how the forecasters got to their 0.2% guesses, and what went wrong. Any economist worth his or her salt knows that used cars was going to contribute to core inflation this month and next, although it might have been one more month of lag. And the softening in rents, due to delinquencies, was again not super-surprising. But they’re not worth the same. The 5.4% rise in Used Car prices m/m is worth about 0.17% on core CPI, while the deceleration in Rents from 0.23% per month to 0.11% per month is worth only about 0.05% on core CPI.

The easiest way to get to a m/m forecast of +0.22%, then, is to believe one of three things. Either you thought Used Car prices weren’t really going to reflect the private surveys (but as the chart above illustrates, there’s a very tight correlation), or you thought that rents were going to completely fall out of bed and actually decline month/month, or you correctly forecast those numbers but put the net on top of a much lower trend assumption. That is, if you thought that the real underlying trend is more like 0.1% per month on core inflation, then you could get 0.1% + 0.17% (cars) – 0.05% (rents) and get to +0.22%.

That’s not implausible – most forecasters, being Keynesians, are thoroughly convinced that we can’t possibly have inflation with such a large output gap.

(Yes, there’s a fourth way to get that number, and that’s to have identified something else that one thought was going to be an outlier – maybe a better recovery in Lodging Away from Home or Airfares, for example. But I don’t think that was the cause in most cases).

It will be interesting to see how long economists insist on being surprised in this way. At some point, forecasters start to correct persistent misses. But the fact that inflation markets themselves are still demonstrating a hard disbelief that inflation can exceed the Fed’s target for long means there is a deep wellspring of skepticism in the investing and economist communities. There’s still time to get inexpensive inflation protection. On the flip side, investors who do not start to invest in at least some ‘inflation insurance’ will have a harder and harder time explaining why. They can’t lean on “we were all surprised, but the markets adjusted too quickly.” They haven’t! But they will.

There’s still time. But the time is getting shorter.