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Oil Be Home For Christmas

November 23, 2022 Leave a comment

As a general rule, don’t trade on pre-holiday thin-liquidity sessions. There can be amazing-seeming opportunities, but price can still get shoved in your face by whoever it is who feels like pushing markets around.

A prime example today is the energy market, where front-month oil prices are down nearly 4% at this writing. Recently, energy futures have been regularly jammed lower overnight in low-liquidity conditions and then have recovered during the day. There is a structural shortage of energy globally at the moment, and inventories are low…but sentiment is also very poor and as I’ve shown before, open interest has been in a downtrend for years – aggregate open interest in NYMEX Crude hasn’t been lower since 2012.

So, it’s a market ripe for pushing around and the day before Thanksgiving is probably not the day to take a stand by getting long even when the reasons given for the selloff are nonsense. Today, the story is again about the price cap on Russian oil that is being implemented soon by the US and EU. Market participants seem to struggle with Econ 101 here. A price cap has one of two effects in the market under consideration: if the price cap is set above the market-clearing price, it has no effect. If the price cap is set below the market-clearing price, it leads to shortages as suppliers – in this case, Russia – won’t supply as much oil (if any) to the capped market when there are other uncapped markets (say, China and India). There is probably an area near the price cap where the cost of switching to delivering oil in other markets is higher than the gain from switching deliveries, but that’s only in round 1 of the game theoretic outcome.[1]

In this case, since only the price from one supplier is capped, the result should be higher prices in the markets than otherwise since once price exceeds the cap, one supplier is lost. The chart below shows the classic outcome. Below the cap, the supply curve is normal. Above the cap, the supply curve is left-shifted.

This leads, at least in a frictionless market (which this isn’t), to prices being discontinuous around the cap. As demand shifts from left to right, prices behave normally and rise as they normally would, until abruptly jumping higher once the capped producer is removed. In any case, price is more volatile than it would otherwise be…but, and this is important, it is never lower in a market where some or all of the suppliers are capped, than it is in an uncapped market. At best, prices are the same if the caps aren’t in play. At worst, a combination of shortages and higher prices obtain.

Speaking of shortages…it seems that people are growing calmer about the chances of a bad energy outcome over the winter in Europe. This seems, to me, to be related to the fact that inventories of gas are reasonably flush thanks to conservation efforts and vigorous efforts to replace lost Russian pipeline supply (see Chart, source Gas Infrastructure Europe via Bloomberg).

That’s great, but the problem is that since the pipelines are not flowing Europe needs more gas going into the winter than they otherwise would have – because it’s not being replenished by pipeline during the winter, either. We certainly hope that Europe doesn’t run out of heat this winter, but the level of gas inventories is not exciting.

Putting downward pressure on both of these markets, but especially Crude, is the idea that the world will enter a global recession in 2023. As I’ve been saying since early this year, that’s virtually a sure thing: we’ve never seen interest rates and energy prices rise this much and not had a recession. But I have thought that the recession would be relatively mild, a ‘garden variety’ recession compared to the last three we’ve had (the tech bubble implosion, the global financial crisis, and the COVID recession). What worries me a bit is that the consensus is now moving to that conclusion. It seems that most forecasts are for a mild recession (although predictably, economists are all over the map on inflation depending on the degree to which they understand that inflation is a monetary phenomenon and not a growth phenomenon). I’m still in that camp, but that concerns me, because the consensus is usually wrong.


[1] In round 2, after oil delivery from Russia is switched to the uncapped markets, the available price in the capped market will need to be appreciably above the market clearing price in the uncapped market in order to cause the switch back.

Summary of My Post-CPI Tweets (October 2022)

November 10, 2022 Leave a comment

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy, but to get these tweets in real time on CPI morning you need to subscribe to @InflGuyPlus by going to the shop at https://inflationguy.blog/shop/ , where you can also subscribe to the Enduring Investments Quarterly Inflation Outlook. 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! Check out the Inflation Guy podcast! Note that this month and going forward, I will be delaying the drop of this tweet summary and the podcast until the afternoon rather than dropping it late morning. So subscribe if you want it live!

  • It’s CPI Day – and here we go again!         
  • A reminder to subscribers of the path here: At 8:30ET, when the data drops, I’ll be pulling that in and will post a number of charts and numbers, in fairly rapid-fire succession. Then I will retweet some of those charts with comments attached. Then I’ll run some other charts.      
  • Afterwards (hopefully 9:15ish) I will have a private conference call for subscribers where I’ll quickly summarize the numbers.    
  • Thanks again for subscribing! And now for the walkup.  
  • The chance of more-lasting inflation just went up a lot. With the much-narrower-than-expected margins for the Republicans in the House – and perhaps no margin at all in the Senate – this is “divided government” IN NAME ONLY.     
  • Republicans are notoriously bad at whipping their vote, and with a narrow margin it will be very easy to pick off a couple of votes with well-chosen pork to pass large stimulus measures if the Democrats want it. And they probably want it.             
  • And why shouldn’t they want it? The Republican message in the midterms was “Biden caused this inflation and we voted against the Inflation Redution Act.” The Democrat message was “Putin caused this inflation and we PASSED the Inflation Reduction Act.” Evidently, that resonated.          
  • Politicians will keep pushing MMT as long as the populace allows them to get away with it. And with such a narrow majority, Republicans can probably not ‘hold the line.’ Ergo, there will be more stimulus ahead.  
  • To say nothing of other continuing pressures, on resources & a need to shorten supply chains as the world fractures the post-Berlin-wall detente. To say nothing of demographic challenges. To say nothing of the fact that prices still have far to go to catch aggregate M2 growth.      
  • Those are not stories for the October CPI, but they are the backdrop.      
  • I was at a conference the last 2 days and several mainstream economists stated (it was barely phrased as an opinion) that core inflation will definitely be around 3% by middle of next year and low 2s by end of 2023.               
  • This seems ignorant of the composition of the CPI. EVEN IF you think inflation pressures in a macro sense are ebbing, we haven’t yet seen any signs of that in the data. Y/Y median CPI has accelerated 14 months in a row. Rents remain buoyant. 
  • Rents will eventually slow, but it will be a while before they slow very much. So far they are still accelerating! And core-services ex-rents is my recent focus. As a reminder, that’s where you find the wage-price feedback loops. And it has recently started spiking higher.
  • But there is a potential fly in the ointment in that group this month, and that’s the question about the CPI for health insurance. Here is the issue that some people are worried about.
  • Medical care is paid for by consumers directly, and indirectly for consumers by insurance companies. It is straightforward (if complex) to measure the part of medical care paid directly to providers – just ask doctors and hospitals.
  • The problem is that there is a difference between what insurance companies receive from consumers (which is part of consumers’ cost) and what they pay to doctors. That is, profit.
  • That’s still a cost to consumers but not captured if you just ask doctors. It shows up in the “Health Insurance” part of Medical Care CPI. So, periodically (because it’s not at all straightforward) the BLS tries to figure out this difference and adjust for it.
  • It tends to happen roughly this time of year, which is why people were looking for it last month and still looking for it this month. Here’s the problem – it isn’t always important.
  • You can see in the m/m changes in Health Insurance that sometimes there’s a discontinuity in the monthly figures, and sometimes not. Here’s the salient point, though – the adjustment doesn’t really matter.
  • If it’s done right, then the overall inflation in Medical Care will be about right. Could be seasonal issues, so any given month it could be wacky, but the REAL question is: is inflation in Medical Care overall accelerating/decelerating? Sure looks to me like it’s accelerating.
  • So I don’t pay a lot of attention to this nuance but be aware that it COULD have an impact potentially today.
  • Last month, big drivers were Rents again (primary=0.74%, OER=0.71%), Medical Care (0.68%, with Hospital Services 0.78% m/m and y/y Prescription Drugs at 3.2%, highest since 2018). Oh, and “Other” at +0.73%.
  • Inflation is of course very broad, and that means it is going to keep being pretty resilient. Until one day it starts narrowing and being less resilient. There’s no good way to say when rents will roll over. They will eventually. Probably not today.
  • But breakeven market is being very optimistic generally about this eventual occurrence! There’s almost no penalty to betting inflation will NOT go back to its old level. Or at least, a pretty small one.           
  • Used cars this month will again be heavy, but probably not as heavy as last month’s -1.1%. Used car prices have retreated (in the Black Book survey) about 12% from the highs but remain up about 35% since end of 2020. That’s about the same as M2, so it’s roughly “right”.       
  • Of course not everything will be up the same amount as the general price level, but that’s a decent touchstone. On average, once velocity finishes correcting back, the aggregate price level should be +30%-+35% (based on current M2) from 2020. Currently +15%. Long way to go.
  • Markets since last month: breakevens are up a bit, but real yields close to unchanged. Reals are pretty close to a long-term fair level. They’ll go higher if nominals go higher but they’re a pretty decent deal esp relative to nominals given the long term breakevens.
  • …and the nominal auction yesterday was pretty ugly, so I don’t know that the fixed-income bears are done. I suspect the Fed is getting close, though. My guess for terminal rate is currently 5%.          
  • Econ consensus for today’s CPI is 0.62% m/m on the headline and 0.47% m/m on core, bringing y/y core to 6.52%. With the medical insurance issue I’m reluctant to hazard a guess but 0.47% seems optimistic. Avg for last 6 months has been 0.56%. But interbank is LOWER than 0.47%.         
  • In any event, good luck! Auto charts will follow the print fairly quickly. I don’t know how many months I will be doing this before I stop being nervous about the automation. But I throttle those charts still to make sure that if something looks wrong it isn’t followed by 9 more.

  • m/m CPI: 0.438% m/m Core CPI: 0.272%       
  • OK now let’s look at these. Obviously the core figure was a disappointment but I can already see it’s not something I’m terribly worried about and not likely to signal that we’re done. That said, it should be a nice rally number.     
  • Last 12 core CPI figures        
  • Primary Rents: 7.52% y/y OER: 6.89% y/y     
  • Further: Primary Rents 0.69% M/M, 7.52% Y/Y (7.21% last) OER 0.62% M/M, 6.89% Y/Y (6.68% last) Lodging Away From Home 4.9% M/M, 5.9% Y/Y (2.9% last)
  • Well, 0.69% m/m is better than last month’s 0.84% on primary rents, but not exactly the deflation that people are expecting to happen ‘soon.’ Soon, it seems, is still a bit far away.
  • M/M, Y/Y, and prior Y/Y for 8 major subgroups          
  • Immediate observation – huge decline in Apparel (yes, a small weight) and in Medical Care (which I suspect is the technical adjustment). Housing, Food, Other, Recreation, all high.
  • Here is my early and automated guess at Median CPI for this month: 0.613%
  • Median: definitely better than recently! but a 7.6% compounded annual median rate isn’t GOOD news. And it suggests that most of the miss was in a few categories, not the main body of the distribution.
  • By the way, a little asterisk on my median calculation – I have the median category as West Urban OER. Since the individual components of OER are seasonally-adjusted (but we don’t know the seasonals), my estimate will be slightly off.
  • Core Goods: 5.08% y/y Core Services: 6.74% y/y        
  • And you can see the effect of Apparel (and Used Cars, which was down more than I expected it would be and more than Black Book suggested it would be) on core goods. This is partly a delayed dollar effect, and some supply-side relaxation, and not surprising in a macro sense.
  • Some ‘COVID’ Categories: Airfares -1.1% M/M (0.84% Last) Lodging Away from Home 4.85% M/M (-1.04% Last) Used Cars/Trucks -2.42% M/M (-1.07% Last) New Cars/Trucks 0.37% M/M (0.67% Last)           
  • So Used Car prices are coming down, and New Cars still going up. Remember in mid-2021 Used Car prices in some cases exceeded New Car prices b/c New weren’t available. They are now, so this is the convergence. Used is correcting, New is trending.
  • Used cars on top, New Cars on bottom, since day 1 of COVID. New have another 10% to go higher, Used another 15% lower, is my guess.
  • Piece 1: Food & Energy: 13.3% y/y   
  • Piece 2: Core Commodities: 5.08% y/y          
  • Piece 3: Core Services less Rent of Shelter: 6.42% y/y              
  • The y/y for health insurance went from 28.1% to 20.6%. Obviously, those numbers are way too high. But it caused the y/y for Medical Care to drop from 6% y/y to 5% y/y. This seems exaggerated.
  • Now, to be sure Medicare is dropping the amount that it is reimbursing health care providers. But Medicare is not in CPI and a squeeze on Medicare reimbursements may make the consumer part of health care more resilient. Got to pay health care providers somehow.
  • Piece 4: Rent of Shelter: 6.99% y/y  
  • No sign of any slowdown in rents yet. And without that, we’re not getting 2% inflation next year, period.
  • That really was an amazing adjustment to health insurance. I applaud those who decided it was going to be huge. Again, though, it’s just a question of how Medical Care inflation gets allocated. And it’s a one-off thing.          
  • Outside of food and energy, the biggest monthly decliners were Infants and Toddler’s Apparel (-32% annualized), Jewelry and Watches (-30%), Used Cars and Trucks (-25%), and Footwear (-13%). No services. OTOH…             
  • Biggest gainers were Lodging Away from Home (+77% annualized), Misc Personal Goods (+26%), Vehicle Insurance (+23%), and Food Away from Home (+11.8%). That last one is obviously Food & Energy but it’s also a wages indicator.
  • Looking at Median some more, probably the lowest it could be (if my West Urban OER seasonal is way off) is 0.55%. And could also be higher than my estimate. 
  • Core inflation ex-housing fell to 5.9% from 6.7%. That’s the lowest it has been since 11/2021. And it’s a good sign. A lot of that is goods.            
  • The deceleration in goods inflation is completely real. But that doesn’t mean goods prices are going to go DOWN, which is what consumers are expecting. Some places where there were overshoots like in Used Cars will go down, but in most cases we’re talking small.             
  • Here’s the challenge on the Fed question. I wouldn’t take a victory lap even though this is the lowest core m/m in more than a year. Median has still not obviously peaked! Next core comps are 0.52%, 0.56%, 0.58%, 0.50% before 0.32% in March.       
  • That means we are probably looking at core which will be steady to declining slowly, but not coming down rapidly. There aren’t 0.6s or 0.7s to roll off until May. So it will look like a peak but not a rapid drop. Unless of course rents roll over and drop like a stone.
  • OR, suddenly workers start getting wage cuts. Keep in mind that the Social Security adjustment for next year will flush a lot more money into the system. There’s just a lot of bad feedback loops that are in play.
  • By the way, Lodging Away from Home was high (+4.9% m/m) this month. That’s a volatile category but surprised me. Hospitality is having difficulty with finding workers though and so this is another one of those pass-throughs I suspect.      
  • Here’s the distribution of lower-level price changes y/y. It’s an interesting tale. The lower tail are mostly goods (insurance won’t be there for a long while), upper tail has some foods and some services. The middle part is still 7-9%.
  • Having said that, this is starting to look more like a disinflationary distribution where the mean is below the median because long tails start showing up to the lower side. I think we’ve likely seen the peak, although Median will take a bit yet.
  • I mean we still have 65% of the distribution above 6%…        
  • That health care insurance adjustment is odd. Normally the BLS smears the adjustment over 12 months roughly equally. I can’t imagine this is going to be 4% PER MONTH for a year. That would be really weird. Something to dive deeper on. For now I’m treating it as one-off.   
  • Last chart. I didn’t run this last month because of tech issues. The EI Inflation Diffusion Index remains high but dropped to 41. It’s not yet really signaling a peak in pressures but if we get down to 30 or 35 I’ll feel better that the peak is real.       
  • OK, let’s try the conference call for anyone who wants to hear this verbally. 🙂 [REDACTED] Access Code [REDACTED] Let’s say 9:35, 5 minutes from now.       

The number today made a lot of folks very happy, but it is a trifle early to declare victory over inflation yet. Core goods remains in deceleration mode. This is no surprise; the extended strength of the dollar helps depress core goods prices with a lag. The sharp drop in apparel prices is sort of the poster child for this effect. But the dollar will not be strong forever, and when it goes back to something like fair value – when the Fed stops hiking aggressively relative to the rest of the world – then there will be a little payback in this category. That doesn’t mean 10% core goods inflation but neither does it mean that we’re going back to the old normal of -1% inflation in core goods year after year. Given the re-onshoring trend and the general unsettled nature of geopolitics, I suspect core goods will end up oscillating around low-positive numbers. Think 1-2%, not -1% to -2%.

Rents remain strong, and there is no sign that they’ve rolled over yet. They will eventually, but it takes a long time for rents to reflect changes in home prices and even longer for asking rents to be fully reflected in rent CPI and OER. Rents will decelerate from here, but not for a while. And they’re also not going back to 2%.

Core services ex-rents is in a continued uptrend. There was a small correction this month, but the feedback loop has been triggered. Next year’s Social Security adjustment will throw more fuel on the fire, and even if unemployment rises so that real median wages decelerate nominal wages are going to keep climbing faster than they have historically. Core services ex-rents…and we saw similar effects in Lodging Away from Home and Food Away from Home, both of which have a big wage component…is going to stay strong for a while.

By the way, on Medical Insurance…that 4% per month drag over the next year is going to add up to 0.3% on headline and a bit more than that on core. But only if this isn’t offset elsewhere in the medical care category. This is bean-counting: insurance in the CPI doesn’t really measure the cost of insurance premiums but insurance company profits. If our estimate of profits declines it’s either because people are paying less for insurance (not likely) or because insurance companies are paying more out to doctors, which means the inflation should just show up there instead. So it will be a consistent drag that is mostly irrelevant in a practical sense.

All of which is to say that while core CPI has likely peaked, and median inflation will probably peak in a few months, the folks who are looking for it to drop to 2% next year are going to be terribly disappointed. I’m sticking with my view that we will be at high-4%, low-5% for 2023.

The Fed, though, will take the peak in Core as a reason to step down to 50bps at the next meeting, then probably 25bps, and ending at around 5%. If rates are at 5% and median inflation is around the same level late next year, it isn’t clear that much higher rates would be called for especially in a recession. But neither will much lower rates. So I think overnight rates get to 5% and then stay stuck there for a while. If you found this useful, and would like to get it in real time during next month’s CPI report, go to https://inflationguy.blog/shop/ and subscribe to my private Twitter feed. You can also subscribe to my quarterly, or purchase a single issue of the Quarterly Inflation Outlook (either current or historical). Thanks a lot for your support.

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