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!

• Suddenly, going to #CPI Day is like going to the circus! Not least because of all the clowns opining about #inflation. For me, it’s just one more day as the Inflation Guy; it’s just that I have more company now since it seems EVERYBODY is an inflation guy all of a sudden.
• Today we will set some more multi-decade highs in CPI, and in core CPI, and in Median CPI. The last three core CPI figures have been (after revisions) +0.60%, +0.52%, and +0.56% and the Street sees another 0.5% today.
• It’s hard to disagree too strongly with that forecast, because the recent numbers have been very broad and not just used cars or Covid categories. Rents have been accelerating, as expected (more on that later). But it’s the breadth that has changed the story.
• That said, I would not be terribly shocked with a somewhat softer used cars number this month, though I think New Cars will stay strong for a while, and we could get some weakness in airfares thanks to the brief Omicron scare.
• Also, it’s February which means we are looking at January data – January data always have a larger error bar, which is why last week’s Jobs figure wasn’t really “surprising” econometrically. We also have the annual adjustments in seasonal factors and in component weights.
• Those changes, despite some breathless analyses that circulated about how dramatic all of this will be and how profoundly it will affect CPI…won’t be the story. Sorry. The quick summary is that energy and vehicles gained 3% in weight and everything else lost a little.
• Weights on apparel, medical care, food and beverages, rents, education/communication, and “other” all declined. But there were lots of little changes camouflaged in there. The weight of elder care just about doubled, for example, even while medical care as a whole went down.
• But again – don’t stay up late worrying about it. It’s an effect that tends to dampen inflation slightly over time, since stuff that goes up gets a higher weight – and if it mean reverts, it has a higher weight when it goes down (and v.v.). But it happens every year.
• With more volatility in the figure, it will matter more than most years, but the absolute value of the whole darn number is much larger too. I don’t worry about the second and third-order effects right now. There’s enough to look at with first-order effects.
• OK back to the current market and today’s number. This chart shows the changes from 1 month ago for real rates, inflation expectations, and nominal rates. Some of the decline in infl expectations is carry, by the way.

• As I said up top, expectations are for a big number this month, and we’ll see an even higher y/y next month before we get to a peak thereafter. So right about the time the Fed starts to raise rates, y/y inflation will start coming down. Mostly b/c year ago comps get harder.
• Think that’s an accident of timing? It’s important to remember that the Fed is a political animal (ever since Greenspan), and it’s politically expedient to talk tough about inflation. It’s not politically expedient to crush markets, so they’ll try not to ACTUALLY be tough.
• If y/y headline inflation starts to decline when they start to tighten, it will make it much easier to take it easy. I think the extent of rate hikes embedded in the curve right now are very unlikely. But the Fed will still TALK a good game.
• Is the FOMC serious though? Well look at this chart of y/y changes in M2 in the US, Europe, and Japan. All are off the highs, but…in the US, money growth REMAINS very high; higher in fact than at just about any time other than the 1970s.

• That doesn’t look like a hawkish central bank to me. And if they are just going to slow-play it while waiting for inflation to go back to 2%, they’re going to be disappointed. “Normal” is more like 4% now. And I’m not sure we’ll get back there quickly the way things are going.
• A couple of items on rents, because that’s the big, slow moving piece with momentum. On the one hand, Owners’ Equivalent Rent has finally caught up with our model now that the eviction moratorium is over, but it has more to go. And parts of our model are less sanguine, actually.

• The gap between asking and effective rents is also still wide, though narrowing. It will take another 3-6 months for it to close, and that’s when we can say the eviction moratorium is out of the data. This chart is as of the most recent data, quarter ended December.

• Here’s something else fun. This chart is option-implied dividends on XHB, the SPDR Homebuilders ETF. It seems to have been leading rents by about 6mo. So again, we have at least 6 mo of further high prints in rents I think.

• Anyway, the bottom line is that even if today’s number surprises on the low side, there are still high numbers ahead. And if it surprises on the high side, the Fed isn’t doing 50bp in March (unless they really change their talk first, because they aren’t into surprises).
• Only market-clearing price if the market is free. With the eviction moratorium in place it wasn’t, and we’re still working through that.
• Replying to @MarketInterest
• Good luck! I will have a summary of all my tweets at mikeashton.wordpress.com sometime mid-morning and then I plan to put out an Inflation Guy podcast (inflationguy.podbean.com) sometime today.
• Podcast #18 discussed how inflation is the cost of the option to be long cash waiting for opportunities. It was a good one. Are you curious how my investors are sidestepping that cost while retaining liquidity? Ping me via the contact form at enduringinvestments.com
• Also look for the Inflation Guy app in your app store/play store (once we get enough users we will probably do livestreams to those users, rather than on Twitter).
• That’s all for the walk-up. And still time to grab a coffee. CPI is in 5 minutes.

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• Welp, 6% on core. Now that we have exceeded the early ’90s high we can say it: highest core in 40 years.
• Congratulations all around. Take a bow, fiscal spendthrifts. Curtain call, monetary firebugs. 0.58% on core CPI, 6.04% y/y.

• Primary Rents were +0.54% m/m, 3.77% y/y. Wow. Owners’ Equivalent Rent was 0.42% m/m, 4.09% y/y. But hey, Lodging Away from Home fell 3.92%. Thanks, Omicron!!!!
• Airfares, though, rose 2.3% m/m. There was some expectation of softness there thanks to the brief virus surge. But I guess it didn’t last long enough, since plans for flights have longer lead times.
• Cars befuddled me. I thought Used might be soft, but they were +1.47% m/m (+40.5% y/y). I thought New Cars would stay strong, but they were flat m/m.
• Food & Beverages +0.85% (not a core category obviously). Apparel +1.06%. Medical Care +0.66%. Recreation +0.88%. “Other” +0.76%. Criminy.
• Medicinal Drugs +0.86% m/m. That’s NSA, so the y/y rose but only up to 1.33%. Still, drug prices are on the rise.

• Hospital services +0.5% m/m, +3.6% y/y. But this has been more trendless around that figure. Doctors’ Services fell another -0.08%, down to 2.63%/yr. Why do people not want to pay doctors?
• Overall, core goods rose to +11.7% y/y. Core services rose to +4.1% y/y. To review, the HOPE is that overall inflation settles down to…which one? Happy with 4.1% are we?

• Lots of household services rose. Water/sewer/trash collection +1% m/m. Window/floor coverings +1.6%. Furniture/bedding +2.4%. Appliances +2.6%. Housekeeping supplies +1.6%. Tools/hardware +1.8%. These are NSA but still.
• Core inflation ex-housing: 7.22%. I only have this series back to 1983. Fun chart.

• Only two categories fell more than 10% annualized on the month: Car/Truck rental (-58% annualized), Lodging Away from Home (-38%). There were 20 that rose more than 10% annualized. To be fair, 6 of those were food and energy.
• My first guess at median CPI is that it will be 0.54%, which would be the highest so far.
• OK, four pieces charts. Piece 1, food and energy. We feel this but it almost seems like it isn’t a big story any more! At least it mean reverts…but the period of mean reversion might be longer this time because of knock-on effects (energy affecting fertilizer, e.g.)

• Piece 2. No commentary needed.

• Piece 3, Core services less rent of shelter. This is starting to be disturbing. For a long time this was steady to lower. Not clear it is any longer. It’s still pulling DOWN on core, but not as much.

• [Piece 4] Rent of Shelter was SLIGHTLY higher in 2001, but otherwise you have to go back to the very early 1990s. And this is still going to go a bit higher at least.

• Here is a plot of the distribution of price changes. About 80% of all categories are now inflating faster than 3%. About 65% of them are faster than 4%.

• So, this is a record high for the Enduring Investments Inflation Diffusion Index. Not that any actual consumer needs to be told that inflation is hitting everything.

• At this hour, 10y inflation swaps are up about 0.5bp. That’s less than you would expect just from 1y swaps are +20bps. It’s incredible how committed people are, mentally, to the idea that inflation will return to the neighborhood of 2%.
• But look at this chart again. Four core prints in a row in a nice tight spread around a 6% or so annualized rate. The central point of the inflation distribution HAS SHIFTED. I don’t think it’s actually at 6%, probably more like 4%. But ain’t 2%.

• What will the Fed do? 25bps. Remember, when forecasters started saying 50bps was possible there was firm pushback from policymakers. Equity markets don’t believe that either. They will go slower than expected and stop earlier than expected, IMO.
• A dove doesn’t change his stripes.
• That’s all for today’s train wreck. I’ll have a summary up on mikeashton.wordpress.com a little later. And a podcast on inflationguy.podbean.com later today. And of course all of that will be linked on the Inflation Guy app. Thanks for tuning in!

I keep hearing talk about “the ongoing inflation debate.” This starts to be confusing. What exactly is this debate about? At one time, it was a debate about whether there would be inflation at all. “No way,” said the non-inflation camp, “there’s too much slack in the labor market.” That debate ended a long time ago, as inflation began to surge long before the employment gap closed. Then there was the debate about whether inflation was “transitory.” That debate, too, ended as it’s eminently clear that except in the trivial sense that all things are transitory, inflation right now is not. There was a debate about causes, as some people pointed to the clogged ports and said “see, that’s why we have inflation. It’ll decline once we get the ports moving!” Other people pointed to shortages of various things, like computer chips, that have knock-on effects in other products. At one time, the Biden Administration argued for spending another few trillion for infrastructure, because that would lower inflation by improving those bottlenecks. Seriously. And I think they believed it. But how does that explain rents? How does it explain core services inflation above 4%? It doesn’t.

I’ll tell you what does explain all of that, though: money supply growth still in the teens, and government still riotously spending as if we remain in a calamitous depression.

I mean, wouldn’t it be weird if the single clearest prediction of monetarism happened to be right but it was a total coincidence and not because monetarism is right?

Inflation is going to ebb in 2022, probably. It is at 6% on core, and that’s probably going to go a little higher before it comes down. But there’s nothing in the data to suggest that inflation is going to drop back to 2%. Or even 3%. There’s nothing in the data that suggests the culprit is clogged ports or other bottlenecks. I expect core inflation to slowly decelerate to the 4% neighborhood…but the last four months of Core CPI have averaged a 6.8% annual rate, and in a pretty tight spread of 0.52% m/m on the low side to 0.60% on the high side. You can make an argument that the new distribution is coalescing around 6%, and that is not at all inconsistent with 13% money growth.

If you want lower inflation, then the prescription is pretty plain: decelerate money growth to at or below the desired pace of nominal GDP growth (real GDP + desired inflation). And stop spending from the federal coffers as if there is no cost to doing so. You may end up with, and probably will, less real GDP and more inflation in the near-term than you’d like, but that’s the way you get back to reasonable inflation in the medium term.

Of course, that path would be disastrous for stock and bond markets, so I give it a very small chance of happening. Not zero, but it’s hard to do this when the Fed is now an overtly political creature. They give press conferences for goodness’ sake! How do you run difficult policy when you have to face the microphones every month? Ask the coach of any team that’s in a rebuilding year.

Monetarily-speaking, we need to be in a rebuilding year. But it’s so much easier to just extend and pretend…

Well, here is one positive thought anyway: I wonder if numbers like this will finally quiet the “BLS is cooking the CPI figures!” crowd. Because if they’re cooking the numbers, they’re doing a darn poor job of it.