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! Get the Inflation Guy app in your app store! Check out the Inflation Guy podcast!

• Welcome to the first #CPI Day of 2022 (although technically it’s really the last of 2021 since we’re releasing December #inflation figures). Exciting times, as headline inflation might sport a 7% handle and core inflation definitely will be well above 5% y/y.
• The last three numbers have been so broad, so worrisome OUTSIDE of the “Covid Categories”, that even the Federal Reserve is saying the right things. Will they really hike rates 4 times this year? I’m skeptical but we will see.
• Core CPI for October and November were 0.599% and 0.535% m/m, respectively…but most importantly, there wasn’t a clear outlier causing these jumps. Median inflation, which is unaffected by those tails, has had three straight months above 0.45% (5.4% annualized).
• Not only the Fed, but also the market, is finally starting to listen a little. This chart shows the changes from 1 month ago for real rates, inflation expectations, and nominal rates. All higher from mid-December.

• But the theme from economists over the next few months – brace for it – will be “But economists expect inflation to moderate in the months ahead.” You’ll see this everywhere.
• That’s because after easy year-ago comps for the next 3 months, they get difficult in April-June. So, while core inflation should get to 6% in early Q2, the y/y numbers PROBABLY won’t get worse than that (in 2022).
• So, mix that story with “see, the Fed is serious and inflation is already coming down” and you’ll get the touts for stonks going in full force. Don’t worry, be happy. Buy the stuff that Wall Street needs to sell. Etc.
• And there IS some good news. For example, the rate of increase in overland truckload rates is declining. Still high, but declining. Since trucking goes into all kinds of goods, it’s often a leader of the rate of change (not always).

• Similarly, some modest good news from global shipping rates, which are down from their highs although edging back up a little (chart shows east-west container rates).

• but … Other than those big base effects in April/May/June, there’s not a lot of reason to think the m/m #inflation figures will drop down to 0.15-0.2 again.
• Going forward there will be a peak…but won’t be as serious as you think. We can all imagine used cars fading eventually. But no one bothers to imagine what will go up. So if you forecast a reversion to the mean for the first and ignore the second, of COURSE you forecast a peak.
• Example: what about insurance? President Biden’s latest plan is to force insurance companies to provide 8 free COVID tests per person per month. Ignore whether the tests exist, but … Who do you think pays for that? Insurance company? Nope. More policy error.
• What about China re-shutting some parts of its economy due to Omicron? Remember, (as I wrote in February 2020): “COVID-19 in China is a Supply Shock to the World” https://inflationguy.blog/2020/02/25/covid-19-in-china-is-a-supply-shock-to-the-world/ This is not policy error, just bad luck. But bad luck happens.
• Last month I said “This is not about the pandemic any longer; it is about policy response to the pandemic. It is almost entirely policy error.” I feel strongly about this. While there is tough talk on this from the Fed, let’s see if it’s followed by tough action.
• I’m concerned about that, since the Fed is still getting the story wrong. Powell says higher labor costs are not driving inflation. Well – that’s because labor costs generally FOLLOW inflation. Labor pushes when they see their own cost of living going up. Not before.
• And thanks to workers’ pricing power, wage increases should rise around another 1% y/y by Q3, based on the current unemployment rate (green). This is good news for workers, bad news for consumers. Wages don’t cause inflation but they DO give it momentum.

• So inflation will peak around April, but core will ebb to maybe 4%, not 2%.
• Back to today’s number. Consensus is 0.4%/0.5% headline/core for the month and 7.0%/5.4% y/y. The ‘inside market’ is really 0.46-0.52 on core. The interbank market has the headline figure reaching 7.03%.
• But remember this is December, and there are lots of weird seasonals, so anything can happen.
• We are still watching rents, which should remain solid for a while here. Catching up from the end of the eviction moratorium, but there’s still plenty of heat in the housing market generally. And amazingly, we’re still watching used cars.
• Here’s a chart of the level of used car prices. Not exactly collapsing! I mean, wow! I don’t know anyone who thought we’d get another leg higher.

• And even the rate of change is reaching new highs. So we will likely get another push in the CPI from used autos, and new cars as well since they’re a substitute.

• But most important in today’s #CPI remains the breadth. That’s the main focus today. If we get 0.7% but it’s all used cars, that’s not nearly as significant as if we get 0.4% and there are no outliers at all. That has been the recent story and I expect it to continue.
• Good luck!  I will have a summary of all my tweets at https://mikeashton.wordpress.com  sometime mid-morning and then I plan to put out an Inflation Guy podcast  (https://inflationguy.podbean.com) sometime today. Like, click subscribe, all that.
• Also look for the Inflation Guy app in your app store (once we get enough users we will probably do livestreams to those users, rather than on Twitter).
• And finally, book your free place at the Institutional Fixed Income Virtual Summit on January 22nd. https://lnkd.in/dab2WfEP

• Hey! I finished with the walk-up early. Still time to grab a coffee. Number in 7 minutes.

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• A bit higher than expected 0.5%/0.6% on core. Headline did get to 7%, core hit 5.5%. Bloomberg kinda slow-rolling the seasonally-adjusted core number so  don’t know the 2nd digit yet.
• OK, here we go. The seasonally-adjusted core number, m/m, was 0.5501. So it just BARELY squeaked out the 0.6%. Still, higher than expected but not drastically.

• Jumping out at me is the 1.72% rise in Apparel prices m/m. Apparel is only 2.7% of the basket but has been in deflation for years, punctuated by occasional attempts at price increases. Right now Apparel is +5.8% y/y. Some of that is likely shipping b/c apparel isn’t made here.

• Used Cars, true to form, +3.5% m/m after +2.5% last month. Y/Y up to 37.3%. New cars +1% m/m.
• Overall, core goods and services continue to look…um…disturbing?

• Here is core services by itself. 4% looks like the big level. However, it’s no longer the case that this inflation is all about goods. Ergo, it isn’t all about supply chain.

• OK in the COVID categories, 1.18% m/m from lodging away from home; +2.72% m/m from airfares. Car and truck RENTAL though was -5.3% m/m. That’s only 0.13% of CPI though!
• Rents: Primary rents +0.39%, 3.33% y/y. That’s slightly lower than the last couple of months but still pretty hot. Owners’ Equivalent Rent +0.40%, 3.79% y/y. Ditto – lower but still hot. 4.8% annualized from a third of core would make it hard to get core back to 2%!
• Medical Care was +0.28% m/m. But Pharma (+0.01%), Doctors’ Services (-0.05%), and Hospital Services (+0.16%) were all lower. Which means it came from insurance.
• Here is medical insurance, y/y. Up 1.6% m/m. Medical insurance is a residual in the CPI (not directly calculated), but this is where added costs to insurance companies is showing up.

• So core inflation at 5.5% is still “the highest since 1991”, but starting next month it will probably be “the highest since 1982” since the 1991 high was 5.6%.
• Vehicle insurance (-16.8% one-month change, annualized) and Car and Truck Rental (-48%) were the only core categories that fell more than 10% annualized.
• Categories that ROSE >10% annualized: Jewelry/Watches (+59%),Used Cars/Trucks(+51%),Womens/Girls Apparel(+30%),Public Transport(+26%),Motor Vehicle Parts/Equip (+21%),Footwear(+20%),Lodging Away from Home(+15%),Household Furnishings(+14%),Mens/Boys Apparel(+14%),New Cars(12%)
• I am afraid this also looks like we are going to have another 0.45% or so on Median inflation. Hard to tell b/c regional OERs are the median categories it looks like, so it might be as low as 0.38% but unlikely I think.
• Core ex-housing is +6.4% y/y. It’s worth remembering that core is currently being pulled DOWN by rents.

• Folks, grab the reins on the change in the CPI weightings. They are a totally normal biannual thing. The changes will be larger this time than normal because consumption patterns changed – but there’s no conspiracy. Consumption patterns DID change. That’s all that’s happening.
• Stories remain approximately the same for the four-pieces charts. The first is Food & Energy – most volatile, and the best chance for dropping the y/y headline number. But still, pretty ugly and this likely affects wage negotiations as people pay more for food and gas!

• Core goods – a chunk is new and used autos. And there is upward pressure from shipping and trucking rates. But those are ebbing a little. This will eventually come back to earth, on a rate of change basis, but that doesn’t mean the price LEVELS will decline.

• Core services ex-rents. This is still looking a little perky although not breaking to new highs like a lot of the rest of the index. Medical Care is actually holding down inflation. But uptick in health insurance is concerning.

• Rent of Shelter – totally expected if you’ve been watching housing. Still has more to go! Again, it’s going to be hard to get core CPI back to 2% while rents are running 4-5% or more.

• Slight good news on distribution. The weight of the consumption basket that’s inflating more-slowly than 3% is back above 25%!

• OK, one more chart and then a quick wrap-up. Remember later to check out the summary at https://mikeashton.wordpress.com  and look for the podcast version of it at https://inflationguy.podbean.com
• I said the most important part of this report was the breadth. And it was again a very broad report; Median CPI will again be around 0.4%-0.5%. The Enduring Investments Inflation Diffusion Index reached a modest new high.

• There is nothing in today’s number that suggests the underlying inflation pressures are ebbing. The y/y change will eventually come down because the comps will get more difficult, but there is NO SIGN that core will be dropping back to 2%.
• My base case is that we end 2022 with something like a 4% core inflation rate. Could be as low as 3.5%, but the potential miss on the upside is larger than that.
• The Fed is talking tough, but talk is cheap. They’re still easing at this hour! Eventually they’ll stop digging the hole. When will they start filling it in – not by raising rates which has small effect if any on inflation, but by selling bonds? Don’t hold your breath.
• I think they’ll raise rates once or twice, maybe even thrice if bond and stock markets don’t seem to mind. But eventually, they’ll mind because discount rates matter. When that happens, I can’t imagine the Fed keeps sticking the knife in.
• We have Volcker-like inflation, but we have no Volcker.
• And that’s the problem. Thanks for tuning in! If you’re curious about what we do at Enduring Investments, come by http://enduringinvestments.com and say hi. I do these tweet storms for many reasons – but some of those reasons are commercial! See you soon.

This was, sadly, not a very surprising report. Inflationary pressures remain broad and deep, and the Fed today is still purchasing bonds and adding more reserves to the system. The FOMC is in a bit of a pickle since they labored so long under the false “inflation is transitory” story. The fact that they couldn’t foresee that the natural consequence of massive fiscal stimulus financed by massive monetary stimulus would be inflation is mind-boggling, but it does seem that they really did think that inflation was transitory and caused by supply-chain issues. Amazing.

So now, they’re behind the curve and really need to catch up and get ahead of this process. The inflation mindset is becoming entrenched (and I think already has), and all the Fed can do is talk about how they’re going to be gradual, gradual, a few hikes this year; maybe they’ll eventually think about shrinking the balance sheet; please don’t panic please don’t panic please don’t panic. But the slower the Fed goes, the harder they’ll have to squeeze liquidity to get inflation out of the system. And that will break a few eggs.

Volcker was not afraid to break some eggs. He saw that it was better to break eggs now than to be unable to afford eggs tomorrow. I do not currently see anyone at the Federal Reserve, or in central banking circles generally, made of that stern stuff. Ask me what inflation this year will be and I will say 4-5% on core. Ask me what it will be next year and I’ll say, probably about the same. Ask me what inflation will be in 2025 and I will say…

Do you have a Volcker? Because if not, we’re Volcked.