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 very special #CPI day! Welcome to my data walk-up.
• Before we get started, let me tell you that I’ll be on @TDANetwork with @OJRenick this morning around 9:15ET. Accordingly, my post-CPI stuff might be slightly abbreviated. I’ll try to go quickly.
• Setting the stage: we’re coming off of three consecutive upside surprises to core CPI. In each case, the interbank market trade was closer than the economists. Three months of 0.34%, 0.92%, and 0.74% m/m were impressive. Core CPI is at its highest since June 1992.
• We were set to see the y/y figures rise on base effects anyway, but these were strong on a month/month basis – which have nothing to do with base effects.
• It’s true the m/m figures were clearly flattered by the “COVID categories” like airfares (+7% last month) and used cars (+7.3% last month). But while the “transitory” crowd wants you to think that is the whole story, it’s not.
• The truth is that the root cause here is phony demand caused by government spending financed by a loopy guy with a printing press. It is not “due to the reopening.”
• I thought I made the point pretty well in “We Were Shocked – Shocked! – that Massive Stimulus Caused Inflation” https://inflationguy.blog/2021/06/23/we-were-shocked-shocked-that-massive-stimulus-caused-inflation/
• In addition to the big outliers, there are a cluster of categories with y/y changes between 3% and 5%. Not all COVID categories! Our diffusion index is the highest since 2012.
• So what is up for today. The ‘comp’ from last year is a more normal one, at +0.24%. The consensus economist forecast is +0.4% on core CPI, with the interbank market trading just a smidge higher than that. This sort of print would put y/y core CPI at (gulp) 4.0%.
• Used cars still have some juice in them, based on Black Book and other numbers, so they’ll probably still be up in the ballpark of 3-4% m/m (huge error bars there). Still big, but getting to the end of the craziest m/m figures.
• I want to keep an eye on new cars. That category is less volatile than used cars, but larger (~3.75% of CPI) and it looked last month like it was starting to accelerate.
• There have been reports that some used car prices are above the prices of the same car, new. There are two ways that can change to something more normal. Used car prices can ebb, or new car prices can rise (or both, obviously). So keeping an eye on new cars.
• Car rental rates have also been skyrocketing due to the shrunken fleets, and the surge in vacationers with stimmy money. Rental companies need more new cars.
• But beyond the “COVID categories,” the key looking forward is (a) the breadth of the inflation increases, about which I’ve already commented, and (b) rents.
• The eviction moratorium is still in place until the end of July, so the big catch-up that will happen when non-payers are turned out in favor of payers will not happen for at least a month or two.
• But there is some evidence that the units that ARE turning over are at a high rent…so I suspect we will see more lift from rents this month, though the big months are ahead.
• The timing of the end of the moratorium and the catch-up in rents is interesting, because the “hard” comps from 2020 are coming up. July ’20 was +0.54 core and August was +0.35%. So y/y might decline a bit over next few months (though this isn’t guaranteed with recent trends!)
• Back at the beginning of the year, that was our expectation – a ‘fog of war’ from base effects causing a big jump then a big decline. However, the jump was bigger than expected and the decline may not be as impressive as we’d thought.
• Rent catch-up might be worth 0.9% or so on core, so depending on how long the catch-up takes, the turn in the base effects might not be as impressive as we thought just a few months ago.
• The Fed “cares” about such a move, especially if it’s broader… until stocks drop 5%. And then I suspect they’ll care more about keeping the wheels on the bus. So I’m not sure we’re about to see a sharp drop in QE very soon.
• OK that’s all for the walk-up. Number is in 5 minutes. I think we might get a 4th upside surprise, but this is almost anticlimactic. The rest of 2021 is all about the rents.
  • duh, 2022.
• And after August, the next 6 months of core CPI average just 0.1%. So folks, I don’t think we’ve seen the highs yet. If we average 0.3% per month on core, we could see 5% core CPI y/y by early 2021!

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• That’s a transitory bus that just hit us.
• 0.88% m/m on core, pushing the y/y to 4.453%. So if it makes you feel better, both were rounded higher.

• Well, CPI for Used Cars was +10.5% m/m, which is a lot more than I was looking for. That’s part of this.
• COVID- categories: airfares +2.7% m/m. Lodging Away from Home (was flattish last month) +6.95% m/m. New Cars and Trucks +1.97%. Car and Truck Rental +5.18%.
• Core Goods, thus, is at 8.7% y/y.
• Of course, ex-everything-except- Medical Care, we are in deflation. Medical Care CPI was -0.10% this month.
• Food Away from Home is up at a 4.23% y/y pace. But I am watching Food-at-Home, given the unrest we are starting to see around the world that smacks of the Arab Spring. Food-at-home was only +0.9% y/y.

• Meat, poultry, fish, and eggs were +2.6% m/m, but most of the food-at-home category was reasonably well-behaved.
• I haven’t mentioned rents yet because they were reasonably ham-on-rye. OER was +0.32% m/m, pushing the y/y to 2.34%; that’s a pretty normal monthly figure. Primary Rents, more directly affected by a spike in asking rents, was +0.23% m/m. So nothing there yet.
• Core CPI ex-housing was 5.81% y/y, the highest since 1984. Of course it’s those COVID categories so this doesn’t tell us anything we didn’t already know. We’re going to want to look at the breadth.
• Health Insurance was -1% m/m, and is now -6.9% y/y. Remember this was over 20% a while back and I THOUGHT that meant we’d eventually see pass-through to the other medical categories since Insurance is a residual. I’ve been wrong on that. No idea what is happening in med care.
• So, we have a huge core number. What about median? In an inflationary cycle we’d expect core to be above median but a rise in median should still happen. Not worrisome yet…I am estimating +0.24% m/m for median this month.
• at about 9:15ET, so as I said earlier this is a bit abbreviated. Apologies for that.
• I have to go get ready to be on @TDANetwork
• But here’s a quick summary: there’s nothing NOT scary about 0.9% on core. Except that there didn’t seem to be a lot of signs of further broadening of price pressures, and the pressure on rents hasn’t shown up yet. Indeed, Used Cars might have overextended & be due for a retrace.
• We know what will lead the headlines! And four misses to the upside in a row runs the risk of un-anchoring expectations… but the next few months, post-eviction-moratorium, will be very important. Next two months will be tougher comps. But…0.9% would still beat them!

It was a quick one today. It is funny to think that just a few months ago, any 0.9% print on core CPI would have been interesting! Over the last quarter, prices have risen at a 10% annualized pace. Over Q2, core prices rose more (2.55%) than in the prior 18 months combined.

And yet, the 0.9% print was not too unusual. As noted, used car prices were up a lot more than I expected; basically, the entire spike in private surveys has now passed through to the CPI. Unless used car prices continue to rise at a similarly-blistering pace, that category probably shouldn’t add a lot to core CPI going forward.

New cars, on the other hand, are accelerating – the price of a substitute good normally does move in concert with the reference good – as the chart below shows. This is a potential source of surprises going forward. Or if not “surprises,” at least continuing momentum from the car crunch.

Other “COVID categories” were also bubbly. But that wasn’t surprising in itself. What I was on the lookout for was, as I said earlier, (a) a further broadening of price pressures, and/or (b) an early acceleration in rents even before the eviction moratorium expires, as various measures of asking rent suggest should be starting to happen. The chart below, of the Enduring Investments Inflation Diffusion Index, shows that the index was roughly unchanged this month near recent highs…so, no evidence yet of further broadening of inflation.

And, as noted above, Primary Rents and Owners’ Equivalent Rent were similar to the pre-COVID trend, but not yet reflecting the dynamics in the housing market. They almost always do, albeit with a lag. Our model below shows the effect of the moratorium as the difference between the current OER level and the model level, but note that the model also continues to rise for quite a while here. This is why it’s fairly easy to forecast that core inflation is going to stay elevated for a lot longer than the market is pricing. If the model is right, and rents rise at 4.75%, then if all core-ex-shelter components rise at only 2% the overall core index would still be at 3.1%. So when I predicted on TD Ameritrade Network this morning that core inflation for 2022 would average above 3% – a level it had not printed for even a single month in the last quarter-century until the last few months – I have some fair confidence in that. (Of course, the model could be completely wrong, or core-ex-shelter could be in outright deflation. But it’s also possible that core-ex-shelter could be rising at 3%).

This seems a good time to point out that 5-year breakevens are at 2.61% and 10-year breakevens are at 2.37%. There’s a lot of mean-reversion priced into those levels, and no long-tail-upsides.

This month, in short, we had COVID categories, broad inflation but no additional broadening, and no movement yet in rents. As far as 0.9s go, it was not too worrisome. On the other hand, if prices rise at a pace of 10% for very long then the Fed’s precious “anchored inflation expectations” are at serious risk. Ergo, I expect the Fed to start sounding more hawkish now. I also expect that they will drop the hawkish talk once stocks drop 5%. If stocks drop 10%, they’ll start actively talking about additional stimulus. This Fed is not of the talk-softly-but-carry-a-big-stick school. They’re of the talk-loudly-but-run-if-they-call-your-bluff type.