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Is Inflation Dead…Again?
I am not the first person to point out that the stock market, at outlandish multiples, is not behaving consistently with commodities markets that are flashing imminent depression. If we insist on anthropomorphizing the markets, it really makes no sense at all unless we posit that “the market” suffers from a split personality disorder of some kind. But that sort of thing happens all the time, in little ways.
But here is something that seems very weird to me. Prices of short-dated inflation swaps in the interbank market suggest that NSA headline inflation is going to rise less than 0.9% for the entire balance of 2023 (a 1.45% annualized rate). And actually, most of that rise will be in the next 2 months. The market is pricing that between June’s CPI print and December’s CPI print the overall price level will rise 0.23%…less than ½% annualized!
Now, eagle-eyed readers will notice that there was also a flat portion of 2022, covering roughly the same period. Headline inflation between June and December last year rose only 0.16%, leading to disappointing coupons on iBonds and producing proclamations that inflation was nearly beaten. Here’s the thing, though. The second half of 2022 it made perfect sense that headline inflation was mostly unchanged. Oil prices dropped from $120/bbl the first week of June, to $75 by mid-December. Nationwide, average unleaded gasoline prices dropped from $5 to $3.25 during that time period.
A comparable percentage decline would mean that gasoline would need to drop to $2.32 from the current $3.58 average price at the pump. To be sure, the gasoline futures market is in much steeper backwardation than normal, with about 44c in the curve from now until December compared with 28c from June to December 2024.[1] So that can’t be the whole source of this insouciance about inflation. If gasoline does decline that much, the inflation curve will be right…but there’s an easier way to trade that, and that’s to sell Nov or Dec RBOB gasoline futures.
So the flatness must be coming from elsewhere. It can’t be from piped gas, which has recently been a measurable lag, because Natural Gas prices have already crashed back to levels somewhat below the norm of the last 10 years. Prices of foodstuffs could fall back more, which would help food-at-home if it happened, but food-away-from-home tracks wages so it’s hard to get this huge of an effect from food.
Ergo…this really must be core. Except there, the only market where you can sort of trade core inflation rather than backing into it, the Kalshi exchange, has the current prices of m/m core at 0.35% in May, 0.32% in June, 0.57% in July, 0.45% in August, 0.35% in September, 0.18% in October, and 0.22% in November. (To be sure, those markets especially for later months are still fairly illiquid but getting better). That’s not drastically different from the 0.41% average over the last six months.
Markets, of course, trade where risk clears and not necessarily where “the market thinks” the price should be. I find it hard to understand though who it is who would have such an exposure to lower short-term prices that they would need to aggressively sell short-term inflation…unless it is large institutional owners of TIPS who are making a tactical view that near-term prints would be bad. Sure seems like a big punt, if so.
Naturally, it’s possible that inflation will suddenly flatline from here. I just don’t feel like that’s the ‘fair bet’. That is after all a key function of markets: offer attractive bets to people who don’t have a natural bias in the market in question, to offset the flows of those people who are willing to pay to reduce their risk in a particular direction. (This should not be taken to suggest that I don’t have a natural bias in the market; I do.)
There’s another reason that this matters right now. Recently, markets have also been starting to price the possibility that the Federal Reserve could continue to hike interest rates, despite fairly clear signals from the Chairman after the last meeting that a ‘pause’ was in the offing. That certainly makes sense to me, since 25bps or 50bps makes almost no difference and after one of the most-aggressive hiking cycles in history, putting rates at approximately long-term neutral at the short end, it would seem to be prudent to at least look around. If, in looking around, the Fed were to notice that the balance of the market is suggesting that inflation has a chance of going instantly and completely inert, it would seem to be even stranger to think that the FOMC is about to fire up the rate-hike machine again for another few hikes.
[1] N.b. – June to December on the futures curve isn’t the exact right comparison since prices at the pump lag wholesale futures prices, but it gives you an idea.
Social Security Solvency, Solved
I’m going to depart temporarily from my usual inflation-focused column to write about something that affects all Americans, and propose a simple solution to a bedeviling problem – a solution that is guaranteed to work.
The issue is Social Security. According to the US debt clock, which keeps track of this sort of thing, the present value of the (off balance sheet) Social Security obligation is $22.8trillion. What has happened is that over the years since the Social Security program was created, people are living longer and benefits have increased; a secondary problem that will someday solve itself is that the population pyramid in the US is almost inverted as the baby boom generation ages. Consequently, current workers have to contribute quite a bit to support retired workers, and this will get worse in the near future (since Social Security is not a savings program but a transfer program, the current workers plus taxpayers pay for retirees).
The full retirement age has been raised occasionally in the past, each time to ‘fix’ the system, and each time under a firestorm of controversy. Raising the retirement age temporarily improves the fiscal position of the program, but ultimately fails because people are living longer. That’s a good thing, but it’s really bad as the ‘retired’ population gets bigger and bigger and the US population growth rate grows more and more slowly.
To demonstrate the problem and my solution, I ran some relatively simple simulations. I started with the current US population distribution by age.[1] For each subsequent year, I applied the 2020 period life table for the Social Security area population, as used in the 2023 Trustees Report.[2] For simplicity I used the females table. For new births, I took the prior year’s 25-year-old cohort and multiplied by 1.1, which resulted in an average population growth rate of 0.3% per year (which was roughly the low set in the pandemic, so very conservative). This takes the population of the US from 332mm in 2021 to 815mm, three centuries from now. (Bear with me; I know it’s ridiculous to project anything 300 years from now but this is for demonstration purposes).
I am also assuming that the current average benefit of $20,326.56 stays constant in real terms, and discount all future benefits using a 2% real interest rate. It’s important to realize that in what follows, I am showing 2021 dollars. Nominal dollars would be a lot higher. Another caveat is that I am implicitly assuming that people who are 1 year old, who have accrued zero Social Security benefits, can still be expected to cost the system in an economic sense even though in an accounting sense the government does not yet have a liability to those future-workers. I am also assuming that the entire population eventually works and earns a Social Security benefit. As a consequence of these last two assumptions, my number for “Present Value of Real Social Security Benefits” is about 2.65x higher than the official number.
However, it’s not important to get the accounting exactly right as long as we have the dynamics approximately right. If it makes you feel better, divide all of the numbers in the following charts by 2.65. It won’t change their shape.
I am also not assuming any increase in longevity over time, which is unrealistic but I think is what the SSA also assumes. My solution is still absolute, as long as longevity doesn’t advance very rapidly, forever.
So, under those assumptions and a fixed retirement age of 67, here’s what the PV in 2021 dollars looks like over the next 300 years.
It’s really not as bad as all that – in terms of dollars/population, it’s pretty stable. But this assumes no increase in longevity or benefits, which has historically been a bad assumption. This is probably not sustainable. So let’s change the retirement age. In 2025, we increase the retirement age to 70, ignoring for now the utter predictability of the firestorm that would erupt, and fairly so, if we did this.
That doesn’t really change the picture much. It lowers the overall number but the number still grows. And it would be really difficult to get even this change. Anyone remotely close to retirement age would be furious at having that brass ring snatched from them. And this small effect is from only a three year increase in the retirement age! It’s no wonder that everyone talks about Social Security’s solvency, but no one does anything about it. Nothing that you could actually accomplish, seems to have a big enough effect to be worth doing.
Here is my proposal. Starting in 10 years, raise the full retirement age by just 1 month. But do it every year after that. And, here’s the key word: forever.
Someone who is 57 today would still retire at the age of 67, so it doesn’t really affect them. Someone who is 45 today would retire at 68. They’re not really happy about the extra year, but that’s better than the prior example which was 3 years. Someone who is 33 today would retire at 69. That’s still better than the prior proposal, for them. Someone who is 21 today would retire at 70. They’re no worse off, and arguably lots better off because the 20-somethings all assume there won’t be a Social Security when they are old enough to claim it. With this proposal, there would be. And unlike the current spastic attempts to repair the system, this would be predictable. (The legislative trick would be to make it very hard to change, but once it’s understood as a solution it will have momentum of its own – just like the Fed, in theory, could be changed but in practice it’s really hard to mess with).
The key word forever means that eventually, almost no one would get Social Security benefits and so the liability would dwindle to zero. But this would happen over generations. Would we leave our old folks penniless? Of course not – there are plenty of other safety nets to protect the truly needy. But we would remove the ‘entitlement’ part where everybody gets a slice because they paid into it.
Here’s what that picture looks like.
The problem goes away. It doesn’t go away immediately, and in fact over any one person’s life these nudges barely matter. But the liability is guaranteed to go away, unless lifespans start increasing faster than one month, every year. And frankly I’d still sign up for that! The fact that this doesn’t solve the problem immediately is a feature, not a bug: incremental change is digestible, and the trick is merely to make it repeatable.
This is how long-lived civilizations act. They operate on the scale of decades or centuries, instead of years or election cycles. We should use the power of time, and of compounding and discounting, wherever we can. We should use small nudges and behavioral tricks of forward commitment, for example, to make the solution tolerable. This is one way to do it – and a very simple way, at that.
[1] U.S. Census Bureau (2021). Sex by Age American Community Survey 1-year estimates. Retrieved from <https://censusreporter.org>
[2] Source: Social Security Administration
Summary of My Post-CPI Tweets (April 2023)
Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy, but subscribers to @InflGuyPlus get the tweets in real time and a conference call wrapping it all up by about the time the stock market opens. Subscribe 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. Individual and institutional investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments! Check out the Inflation Guy podcast!
- Welcome to the #CPI #inflation walkup for May (April’s figure).
- A reminder: At 8:30ET, when the data drops, I 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.
- After the tweeting dies down, I will have a private conference call for subscribers where I’ll quickly summarize the numbers. After my comments on the number, I will post a partial summary at https://inflationguy.blog and later will podcast a summary at http://inflationguy.podbean.com.
- Thanks again for subscribing!
- The market backdrop going into this one is very different from last month, when we were still dealing with panicky banking-collapse stuff. There are still some people selling that story, but there’s no real meat to it.
- But breakevens have come in, and real yields risen. And the Fed has tightened for what is likely the last time in the cycle. Some people are REALLY sold on the deflationary-depression scenario but right now shaping up to be a mildish recession with continued high inflation.
- That’s going to put the Fed in a classic bind, but with this Fed…maybe not really. I’ll say more about what I think about the Fed (big picture) in our Quarterly next week (subscribe at https://inflationguy.blog/shop/) but in sum I think O/N rates stay high all year.
- Next year, when inflation is still not coming down to their target (I think), they’ll have some decisions to make but for now, a mild recession won’t get them easing aggressively as they did under Greenspan/Bernanke/Yellen. It’ll be Silence of the Doves.
- The forecasts this month have amazing agreement in the headline figure, which is interesting because Kalshi and economists’ estimates have been rising meaningfully over the last week or so. I’ve been pretty consistent. I agree on headline. I’m significantly higher in core.
- Here’s why.
- Last month, core was a little soft, but not a ton. That in itself was remarkable, because rents decelerated a LOT m/m. And used cars was also a drag despite private surveys suggesting it should have been an add.
- So the fact that core was just a LITTLE soft was pretty amazing. Median (a better measure) dropped a lot because of rents, but the fact that core was resilient tells you there were some long-tail upsides. Diffusion indices are showing strongly that the peak is in, but…
- …but Core Goods having possibly bottomed (Used Cars should FINALLY deliver this month) means that the deceleration is going to be all rents and core services from here. So same stories but getting bigger going forward as the turn in Core Goods runs its course.
- And I do not believe in the sudden deceleration in rents – because nothing in rents happens suddenly. I think all the folks who have been looking for it for a while are succumbing to confirmation bias in thinking this is real.
- Maybe they’re right – another weak rents number will mean a lot to me. But I took note that the y/y rents figures still rose, which means that last year in the same month it was even weaker! That smacks to me of seasonal-adjustment issues.
- That doesn’t explain the full deceleration from 0.7 to 0.5 in rents, but it would explain some. I think we’re going to bounce back, but if we get another 0.48% on primary and OER, I’ll take notice.
- I also want to look at Food Away from Home. I wrote about this last week https://inflationguy.blog/2023/05/04/food-inflation-served-hot-and-cold/ – Food At Home and Food Away from Home have now diverged, and the FafH is tied more closely to wages.
- So: Core ex-rents, but also rents. And Food Away from Home as part of the Core ex-rents-imbued-with-momentum-from-wages meme.
- Do note that y/y core will decline even if we get my number (0.46%), and likely median also. It will help cement the idea the Fed is going to wait for a while.
- (Then again, last month I said I didn’t think they’d do 25bps because 25bps just doesn’t matter. But now we also have them signaling as much. It’ll take a lot to get them to move either direction soon.)
- Honestly, I need to step back and watch for a while myself. So far, the last few years have been relatively easy to call. But now we have a rapid rebound in velocity (which I expected) and declining M2 (which I did not).
- For the trajectory of inflation beyond this summer, we need to know which of these is going to win. I have trouble believing M2 will keep declining, especially as money demand gets adjusted to the new interest rate regime. But it’s an open question.
- And a very important question! And one that will not be resolved today! But it will be an interesting report I think – I’ll be back with more at 8:31ET. Good luck.
- okay. 0.409 on core…pretty darn good work by economists and Kalshi!
- Very nice jump from Used Cars…+4.5% m/m. So that’s an overdue catchup.
- OER 0.54 and Primary Rents +0.56 m/m. That’s a jump compared to the prior month, but quite a bit lower than trend. Some deceleration is probably happening, but last month was an illusion as to how much, probably from seasonal quirks.
- Core goods rose to 2.0% y/y (largely on the strength of the aforementioned Used Cars) and Core services fell to 6.8% y/y.
- Here is Core. This month right in trend. 0.4% is still almost 5% per year!
- Median retained most of its deceleration…but didn’t decelerate further m/m. Oddly, also 0.41% as with core. Normal warning: looks like one of the regional OERsis the median category – ergo, my estimate might be off since I have to guess at seasonals.
- Medical Care was the usual drag, but everything else was positive. There were some drags, but mainly the story here is rent deceleration.
- I noted the acceleration in core goods, which is mostly used cars this month. But I think the macro trend that we’ve seen most of the core goods deceleration is in place. Will it bounce to 5%? Probably not. But it’s no longer going to drag overall inflation lower.
- Primary Rents have officially peaked. OER, not yet. Soon. As with the overall inflation numbers, which peaked but won’t be declining as much as people were expecting, so it will be with rents.
- So in the so-called COVID categories, Airfares were -2.5% m/m; Lodging Away from Home -3.0%; Food @ Home -0.17%(sa) and Food Away from Home +0.37%(sa). This latter is a noticeable slowdown.
- Piece 1: As-expected look. I thought Food would add 0.03% to CPI but it actually added about 0.02% it appears. Nothing surprising in this.
- Piece 2 is Core Commodities – already commented on this.
- Core Services less ROS – this is starting to look less-horrible. Still, 5% isn’t lovely but this is the wage-driven piece. Taken together with the Food-Away-from-Home improvement, there seems to be some signs that the wage-price feedback is slowing some. And that’s good news.
- And rents are still high. While the Core Services piece is showing decent signs that it may have peaked, a deceleration in rents is still an article of faith. It will happen, but I don’t see it falling to 2% or lower, which is where some people think it’s going.
- (Some people still think housing is going to collapse. It’s not going to. Prices are already starting to rise again.)
- Core ex-housing went from 3.81% y/y to 3.75% y/y. Still pretty high even with the drag from core goods. Overall, the picture is IMPROVING but not good yet.
- …and that story, actually, supports the idea of a Fed pause. “We finally turned back the attackers from the walls. Now let’s wait and see if they regroup or if the battle is over.” That’s the wise course.
- You know, I gave economists a bit too much credit earlier. Their HEADLINE guesses were 0.41. Their core numbers were lower. We were about equally off. I was too high, because I thought rents would rebound more than they did. They were too low, for whatever reason.
- Sort of interesting that Recreation was +0.5% m/m. That’s a heterogenous category so it usually doesn’t do a lot. This month, Video and Audio was +0.45% (nsa) and Pets were +1.82%(nsa). Those are the two largest pieces of Recreation. Interesting bump from pets.
- Within Medical Care, Doctors’ Services was a drag and now is just +0.27% y/y! But Pharma added 0.42% m/m. The insurance drag continues to be what keeps that category inert (and, actually, it’s in core services ex rents so it’s also holding down “Supercore” some).
- Nothing really illuminating amongst the biggest gainers/decliners. Core categories Public Transportation was -46% (annualized monthly, which is what goes into median), Car/Truck rental -33%, Lodging Away from Home -30%.
- Gainers: Motor Vehicle Insurance +18%, Misc Pers Svcs +33%, Used Cares +69%. Actually some people say the insurance part is likely to continue for a bit. Lots of theft and higher car prices means that insurance rates need to rise too because cost-of-replacement is higher.
- Diffusion index down to 14!
- Okay, let’s try a conference call. Bottom line is I don’t think this figure is as good as stocks seem to think. But it DOES support the Fed-on-hold thesis. Still, it was a little higher than expected. Here is the conference number. I’ll start in 7 minutes.
Today’s number, while higher than expected on core by a little bit, was roughly in line with expectations. I was higher on my forecast than the consensus, because I thought rents would bounce back further and they didn’t; others were too high because they thought rents would keep dropping. I think that’s the main difference. Most of the rest of what is happening in the number was roughly what people expected. It was nice to see Used Cars bounce, since they were about 2 months behind what the private surveys were promising us – so not really a surprise.
While this is an expected number, that’s not saying it’s a wonderful figure. 0.4% monthly on core CPI…which is where we have been for the last 5 months…still gets you only to about 5% core for the year. That’s not where the Fed wants to see it.
On the other hand, it’s also clearly off the boil and most of the CPI is decelerating at least a little bit. It’s nice to see core services ex-rents (so-called “supercore”) decelerating, although we should remember that includes Health Insurance which is in the midst of a year-long mechanical adjustment that will swing the other way in about 6 months. But overall, the arrows are pointing in the right direction.
That’s distinctly unlike what was happening with the “transitory” nonsense, when the great bulk of the CPI was moving in the wrong direction – and not just the transitory pieces. So this is welcome.
And it supports the Fed’s decision to pause in rate hikes while continuing to slowly reduce its balance sheet. As long as the numbers continue to decline and nothing blows up that demands the Fed’s immediate attention, rates will stay on hold. I don’t think a minor recession, with inflation at 5%, will get the Fed to ease. Now, 6 months from now when it becomes obvious that inflation isn’t going back to the Fed’s target they’ll have some decisions to make, but that’s a story that will play out in slow motion. For now, we have a figure that supports ex-post-facto what the Fed chose to do this month.
Food Inflation Served Hot and Cold
Well, the Fed is done raising interest rates. They aren’t quite done tightening yet, because the Federal Reserve is going to continue to shrink its balance sheet slowly. That’s important. The fact that the Fed is no longer hiking rates, but is continuing to normalize its balance sheet, is quietly impressive to me. It makes me wonder whether someone at the Fed understands that saturating the economy with bank reserves means that today’s tightening is fundamentally different from the tightening of yesteryear, which was a money phenomenon and not a rates phenomenon.
We may never know, but I do have to admit that Chairman Powell impressed me a little in his post-FOMC presser. Not impressed me like ‘he’s the greatest’ but impressed me like ‘this is what I’d hoped we were getting.’ I wrote back in 2017 that the fact he is not an economics PhD was a positive…although the fact that he did not know anything about macroeconomics before joining the Fed suggested that he has learned economics in an echo chamber from some of the most blinkered non-monetarists on the planet, whose main claim to fame is that their forecasts have been consistently, and sometimes colossally, wrong for a long period of time. Still, he has a different background and that always offers hope.
The conduct of monetary policy under Powell has certainly been different than it was under his predecessors. We have to give him that! In any event, he said several things that impressed me because they surprised me. I’ll have more details and specifics in our Quarterly Inflation Outlook released a few days after CPI this month (you can subscribe at https://inflationguy.blog/shop/ ).
But today, I’m here to talk about food inflation. Normally, food inflation along with energy is deducted from the CPI to produce Core CPI, which is more stable and therefore should give better signals with less noise as long as food and energy inflation are mostly mean-reverting. And normally, they are. Energy is famously mean-reverting; the nationwide average price of a gallon of gasoline right now is $3.574, which is down 5 cents from…April 2008. There is a lot of noise and not much signal, so it makes sense to deduct.
Similarly, food inflation has a large commodity component and is also very volatile. It is not as volatile as is energy, partly because we don’t consume most of the foods that we buy in pure commodity form but rather in a packaged form; also foodstuffs are much more heterogeneous than gasoline and so branding matters a lot. Still, the food component of CPI is pretty volatile and normally fairly mean reverting although unlike energy it definitely has an upward tilt over time.
For some time now, though, food prices have been consistently adding to overall inflation. In mid-2021, trailing 12-month CPI for the “Food” subindex was about 2%; by late 2022 that was up to 11%! Recently, though, Food has started to come back to earth a little bit. The reason why is interesting and illuminating.
“Food,” which is 13.5% of the CPI, has two primary subgroups. “Food at home” is 8.7% of the CPI (about 2/3 of “Food”) and “Food away from home” is 4.8% of the CPI. The recent deceleration in the Food category has come entirely from “Food at home” (see chart, source BLS). That group got to about 14% y/y inflation, but most recently has fallen to a mere 8%. The steadier “Food away from home” is still plugging away, last at 8.8% y/y…a new high, actually.
As you might expect, while “Food at home” does not directly track, say, wholesale cattle or wheat prices, persistent changes in commodities prices does eventually percolate into pricing. The following chart shows a very simple relationship between “Food at home” and the Bloomberg Commodity Index “Agriculture” subindex (which tracks the performance of coffee, corn, wheat, beans, bean oil, cattle, hogs, cotton, and sugar. Aside from cotton, that list comprises a good part of what Americans buy to eat at home. So it isn’t terribly surprising that, at least for large movements in prices, these things eventually show up in the prices of things we buy. In this chart, the commodity index is lagged 12 months and shown on the right-hand scale. As an aside, consider how little of the price of what we buy must represent the actual commodity cost, if a 60% rise in commodities prices only results in a 14% increase in the price of Food at home, a full year later!
That chart says that “Food at home” should continue to decelerate and be a gentle drag for another year. On the other hand, “Food away from home” has completely different drivers that aren’t related to commodities prices hardly at all.
In contrast to the prior observation, consider how much of “Food away from home” must be labor, if the correlation between labor inflation and “Food away from home” is so high and of such a similar scale. Of course, we know that to be the case: the labor shortage hit the restaurant industry very hard and those effects are still being felt. There is not yet any sign of a decline in wage growth among these workers, and consequently there is not any sign of a deceleration in inflation of “Food away from home.” It should continue to be additive to CPI for a while.
The dichotomy between these two parts of the “Food” category is, of course, exactly what concerns the Federal Reserve and other economists who examine inflation. I’ve written about it here (and spoken about it on my podcast) a bunch of times: core services ex housing is where the wage-price feedback loop lives. It’s where the persistence of inflation comes from, and that is why it is the Fed’s main focus. Although I was writing about this before the Fed ever mentioned it, I have to give them credit – I thought they would seize on the fact that energy prices are pulling down overall inflation, or that rents may be decelerating soon, and use that as an excuse to take their usual dovish turn. They have not. The Fed actually seems to be focused on the right thing.
Maybe Powell is different, after all.
