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!

• Another COVID-era #CPI report coming up this morning. After two big upside surprises versus economic forecasts, the forecasts this month are …lower.
• Last month, economists were looking for a “strong” 0.2%, something 0.21%-0.24%, and got close to 0.39%. That was a month after the 0.62% print.
• This month, the forecasts are for 0.2% on core, but a 1.7% y/y. We can look at the year-ago number and figure out that to keep 1.7% from rounding to 1.8%, core can’t be 0.21% or higher. So economists are clearly expecting a “soft” 0.2% on core.
• …something closer to what was normal before COVID. I’m still not sure we get normal.
• The “COVID categories” (hotels, airfares, etc) still haven’t fully recovered, and despite the recent bump in used car CPI it’s still well behind private surveys which continue to accelerate. Never know if that will happen THIS month but still looks like some room there.

• We’re also starting to see reports of pressure in medical care, which so far hasn’t made it into the CPI in a significant way. And the weakness in the dollar since spring will eventually help apparel a little.
• Now, we still have some near-term downside risk from housing, but more and more any weakness there (and it has been a touch soft, which makes the upside surprises even more surprising) looks transitory.
• We’ve all seen the reports of plummeting rents. But those are in cities, and it turns out that a lot of renters don’t live in cities. Outside of cities, rents don’t appear to be under pressure.
• If renters are being more delinquent such that landlords expect to collect less, this would pressure the measurement of rent inflation – but the NMHC tracker says the share paying rent through Oct 6 is the same level as in 2019.  https://nmhc.org/research-insight/nmhc-rent-payment-tracker/
• Meanwhile, there are signs from the housing market that there is actually upside risk ahead – I really meant to write a column this month on the housing indicators but just didn’t get to it.
• For example, one important longer-term driver of rents and OER and home prices is incomes, and incomes are very strong right now thanks to federal income replacement. Will they be this strong in 4 months? Probably not, but presently these incomes are driving housing outcomes.
• All that said, OER and primary rents have been a little weak recently and my gut is bracing for something even softer. But there’s no analysis there, just a concern. Even a little housing softness could produce a ‘soft’ 0.2%.
• Rents are really the only ‘normal’ thing that can drag this number lower. But this is the COVID era, and nothing is normal, so there can always be weird one-offs, in both directions. With M2 rising at 24% per year, these are more likely to be on the positive side.
• All of these one-offs on the high side are what inflation looks like, after all. Inflation is like microwave popcorn. The kernels go off one at a time, and each has a micro “explanation.” But eventually the bag is full, and the MACRO explanation was “heat.”
• Outside of rents, inflation is broadening, quickening, and deepening. It surprises me that it has happened so early…I thought it would take until 2021…but if we get a third surprise today then we’ll have to start thinking it’s here already.
• Do remember of course that the #Fed doesn’t care one bit about inflation. But if you do, and have interests in how to hedge/invest in the inflationary period approaching, visit https://enduringinvestments.com and drop me a line. Good luck today.
• Well, soft 0.2% it is. +0.19% on core CPI.

• y/y on core at 1.73%, so basically unchanged from last month.
• OK, so used cars was +6.7% m/m, even more than last month’s jump. Core goods, partly as a result, went from 0.4% y/y to 1.0% y/y. But core services plunged from 2.2% to 1.9%. And where?
• Yep, OER was only +0.06% m/m, which pushed the y/y down to 2.49% from 2.69%. Primary rents +0.12% m/m, so y/y fell to 2.72% from 2.95%. My gut was right – there was (near-term) downward pressure there.
• Lodging away from home, which had been recovering, slipped back some last month -0.38% m/m. I guess the end of the summer vacation season means it’s all business travelers, and not many of those.
• Apparel fell, -0.45% m/m, despite weaker dollar. But the real surprise might be medical care, which FELL despite lots of evidence that prices are increasing. Need some charts here.
• Physicians’ services -0.29% m/m. Really? Talk to any doctors who are doing price cuts recently?

• Amazing that we were able to get an 0.2% even with housing so soft (and again, the bigger indicators on housing are pointing higher). Core inflation ex-housing rose to 1.50% y/y. Disinflationary pulse from COVID basically over already.

• College tuition and fees fell to 0.71% y/y from 1.31%. This is clearly a quality effect that isn’t being captured by a quality adjustment, and the BLS knows it but can’t figure an easy fix for what is a 1-year problem. Remote-learning isn’t worth the same as in-person.
• Tuition had been under pressure anyway because endowment returns had been fantastic for a while, but this dip is because colleges can’t charge the same for e-college.
• Motor vehicle insurance continues to be a drag on services inflation. People are just not driving as much, and insurance companies are rebating premiums. Biggest 1m declines this month were Infants/Toddlers Apparel (-36% annualized) and Motor Vehicle Insurance (-35%).
• The surprising part of that might be the fact that Motor Vehicle Insurance has a 1.7% weight in the CPI. That seems like a lot, but we only notice it once a year when we get the renewal.
• Biggest core gainers this month were Motor Vehicle Fees (+10% annualized 1m change) – governments gotta make it somewhere! – Public transportation, jewelry, car & truck rental, used cars, leased cars, miscellaneous personal goods.
• Health insurance is also finally coming off the boil.

• m/m decline in health insurance (NSA) is largest in a long long time.

• …I guess that decline in health insurance is because people aren’t going to the doctor for minor maladies as much? But of course remember health insurance in the CPI is a residual, not a direct measurement of premiums.
• So here is OER versus our ensemble model. This month I REALLY have to do a column on housing, because the right side of this graph has been revising HIGHER while the spot numbers have been surprising lower. There are big reasons to think rents are NOT about to decline hard.

• Forgot to mention one of the covid categories: airfares were -2.0% m/m after +1.2% last month.
• The jump in used car CPI was, as I noted up top, not really surprising. But it looks like we’ve squeezed most of that lemon (no car pun intended) unless the private surveys keep accelerating.

• So, despite an as-expected number, bond breakevens have plunged 3.5bps since the print. Investors are conditioned to not ever take inflation breakevens much above 2% or swaps above 2.5%, no matter the outlook. That’s a gonna hurt.

• Sorry for the break – calculations. Here’s a fun one. It’s our measure of perceived inflation minus core inflation (consider it “inflation angst”), versus the subsequent return to gold.

• Four pieces: Food & Energy, trendless.

• Core goods, impressive. Although a lot of that is used cars. Pharmaceuticals pretty soft, import prices not worrisome yet. Apparel soft. So this might be best we can expect from this piece, about 20% of the CPI.

• Core services less rent of shelter. Settled back a bit, although as noted I’m skeptical that medical care costs are about to go into retreat…

• And finally, rent of shelter. A lot of this deceleration is hotels, but as noted earlier rents are definitely soft and that’s the big story this month.

• So, to sum up: housing inflation looks soft, but forward-looking indicators there are pretty solid as long as incomes don’t collapse again (they’ll decelerate and maybe even decline, just need them to not collapse). Outside of housing, there’s broadening of price pressures.
• Yes, core goods exaggerates where those pressures are at the moment, but they are definitely there. And with money supply rolling 24% y/y, it’s going to persist. The question for Keynesians is: where is the deflation, man? We never even got close!
• Thanks for tuning in. Have a great day.

Later this month, I definitely need to talk more about housing. Since housing is always the biggest and slowest piece of consumption, any argument about meaningful disinflation or inflation must include a discussion about housing. Right now, when there isn’t an overall inflationary or disinflationary trend, the slow waves in rents are really the main driver of core, and everything else is noise around that trend. When we get into a more-extended inflationary or disinflationary trend, then housing will likely follow the overall underlying trend. This hasn’t happened, though, in decades – which is why most models of rental inflation now tend to be built on a nominal frame rather than in real terms. But I digress.

Most of the main rebound of the “Covid” categories seems to be over. While those categories – apparel, airfares, lodging away from home, food away from home – still sport prices below their pre-Covid levels, it may be that they just don’t come all the way back any time soon. Ergo, the potential for upside surprises from those categories, going forward, is lessened. Similarly, I’m not sure we have a lot more upside to used car prices, as CPI has mostly caught up to the private surveys (of course, used car prices might still go higher, but at least the CPI has caught up to what we already knew). So, again, we come back to rents. Will rents continue to decelerate? The headlines suggest an implosion of the rental property market. But in the meantime, the median price of existing home sales was recently reported as +11.4% y/y, the biggest jump since 2013 (and back then, we were still rebounding from the financial crisis). Home prices and rents cannot diverge for long; they are substitutes.

And with the money supply spiraling higher at an all-time record pace, it is hard to imagine that hard assets like homes will see prices decline, or even level off. Think about it this way: if you have an exchange rate between apples and bananas, say 1:1, and suddenly there is a bumper crop of bananas, then you’d expect the price of bananas fall relative to apples. Right now there is a bumper crop of money, and so it’s reasonable to expect the price of money to fall relative to the price of real assets like houses (each dollar buys fewer houses). Of course, what that means is that the price of houses, in dollar terms, ought to keep rising.

If that happens, then the recent softening of rents is likely to be temporary. That’s the next phase of the inflation puzzle – looking for the rebound in rents.