E-piphany

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy. 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 August (July’s figure).
• At 8:30ET, when the data drops, I will run a bunch of charts. Because Twitter has made auto-posting them difficult /impossible, I’ll post those charts manually with commentary as I go. Then I’ll run some other charts.
• Later, I will post a summary of these tweets at https://inflationguy.blog and then podcast a summary at https://inflationguy.podbean.com. Thanks again for subscribing!
• Get ready: today will be a low number, and good news. But it’s about as good as the news is going to get. Y/y core will decline again next month, but the monthlies won’t keep improving.

• This month, the forecasts get a large drag from Used Cars. And in fact, Used Cars creates downside risk to these numbers – it has surprised significantly on the high side for multiple months. If there’s payback, it could be a LARGE miss.
• The y/y figures for used cars have been in line with y/y figures from Black Book, so it’s possible that the recent misses have just been because of some odd seasonal quirk.
• If so, then no payback is necessary and we’ll get something like -2.5% (my forecast), plus or minus a couple of tenths. (That’s somewhat joking since this series is very volatile).
• I actually wrote a column (on the blog) about the volatility of these various series. While everyone thinks inflation is going to drop swiftly back to earth, the volatility of the numbers hasn’t done so. And that’s a tell.
• This is rolling 12-month volatility on used car CPI. The picture looks similar for lots of subcategories.

• The basic idea is that if everything was returning to normal in terms of the trend inflation level and the placid behavior of it…then we’d also see the VOLATILITY of inflation plunging back to normal. Not yet.
• Looking back at those forecasts, I should point out that I’m again (and annoyingly) right about where the consensus of economists is. Kalshi is lower, though it has been trending higher. Again, I do think there is downside risk to this figure.
• OER and Primary rents I have penciled in at +0.43%, sequentially slower from +0.45% last month. There is further slowdown coming, but we aren’t going to zero as NTRR and other models are predicting.
• I really like our new model, which is not just functionally a lag of property prices (which drives most models) or a straight lag of less-accurate (but current) rent figures. I write about the model in this quarter’s Quarterly Inflation Outlook (due out Monday).

• Because a lot of the drag this month is going to be from Used Cars, and we collectively feel pretty confident about that, it’s going to be critical to look at Median. Last month it was 0.36%, and the last several have been much better than those from the prior year.
• So again, all of this is good news. But we are using up a lot of the good news, and while everyone will extrapolate today’s CPI if it’s good news be careful about that.
• This month will also gets flattered on the headline from declines in piped gas, and the rise in gasoline won’t hit until next month. Oh, and gas is rebounding too.
• In the big picture, ‘supercore’ (core services less rents) is still the main category of interest, knowing though that it’s dampened by Health Insurance.
• Along those lines…the large rise in UPS compensation is emblematic of the new muscle of labor and a reminder that the wage-supercore feedback loop is still operating.
• Again, don’t get too excited by today’s good news! The big picture is: money stock contacting, but money velocity recovering (fastest 3q rise ever). Core goods down and dollar strong.
• But government deficits are rising again, partly because interest costs are skyrocketing. This federal dissaving isn’t seeing offsetting domestic (or international) saving. So expect more pressure on interest rates. And it sets up a future dilemma for the Fed.
• We aren’t out of the woods yet. I think inflation is going to ebb to the high 3s/low 4s on median CPI, but then get pretty sticky. And the next upthrust in inflation will start from a much higher level than before.
• But that’s all far away. In the meantime, inflation markets have been relatively calm with breakevens up a little bit over the last month and real yields hovering just below 2%.

• It would be a great place to have the market find balance, around long-term fair value on real yields. But…inflation volatility suggests it’s far too early to declare victory on inflation for all time.
• Good luck out there!

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• OK, 0.167% on core. Numbers still coming in, waiting to see how much was Used Cars. Rents were behaved.
• Sorry, that was 0.160% on core. 0.167% was SA headline.
• Used cars was -1.34% m/m, so about half of what I expected and the general consensus. So what dragged?
• Charts will follow in a few. OER was +0.49%, a bit higher than I expected; Primary rents +0.42%. Lodging Away from Home -0.34%.
• Wow, another huge drop from airfares. Remember last month’s -8.11% drop was almost unprecedented? Well, we got a second month of the same. That seems implausible. Not sure what’s happening there!
• Core goods, thanks to Used Cars mainly, dropped to +0.80% y/y. Core services is still high, but fell from +6.2% to +6.1% y/y.
• The diffusion things will look interesting. Of the 8 major subcategories, Housing was +0.35% m/m but no other category was higher than +0.23% m/m (and that was food). Next highest was recreation at +0.12%.
• Not my normal first chart but here is y/y CPI for  pharma. It was +0.58% m/m.

• OK folks –  here’s m/m core CPI. As I said, don’t get used to this low level. But it sure LOOKS like we’ve gone back exactly to 2% and stuck the landing!

• Here are the 8 major subgroups I mentioned. Very tame m/m.

• Now THIS is the big chart. This is Median CPI. I want to look at the subcomponents – Other Food at Home was the median category. This is the best news in the report.

• Here is the rent chart. Our model has them going to ~3% over the next year. Unless core goods keeps dropping (which means the dollar continues to rally) it’ll be hard to get inflation back to 2% if housing is at 3%. Only reason it happened before was core goods deflation.

• To that point, core goods needs to go negative if you want to get back to 2%. And I think even then it’s difficult unless wages crash back down. No sign of that at the moment.

• Four pieces. The interesting bit is that core services ex-rents actually rose slightly y/y.

• More on Median. It clocks in at +0.19%. Amazingly, that’s despite all of the OER subcomponents being higher than that. Usually to get a low number you need at least one of the big-weight pieces to be there.
• But in this case, we had Recreation, Medical Care Services, New Vehicles, Housing Furnishings and Operations, all 4% or higher weights and all less than 1.5% annualized m/m.
• That starts to look a little quirky. If even one of the 1% categories had been higher then the median category would have been Fresh Fruits and Vegetables and the m/m would have been 0.29%. Still low but not the number we will see.
• I’ll have the diffusion charts in a minute and those are interesting. So, low core and median – you’d think a lot of really low categories right? But only ones below -10% annualized were Public Transportation (-54%, flag that!), Used Cars/Trucks (-15%), and Misc Pers Goods (-11%)
• On the high side we had Motor Vehicle Maint/Repair (+13%), Infants’/Toddlers’ Apparel (+17%), Motor Vehicle Insurance (+27%), plus a couple of non-core categories.
• But there were a LOT between -10% and +1.4% annualized.
• Core ex-shelter fell to 2.62% from 2.80%. It was lower in early 2021 but this is improvement obviously.
• as I said the airfares piece is really odd. Never have had 2 back to back months like that EXCEPT at start of pandemic and that was with jet fuel prices plunging. They’re not. This is…hard to believe. It’s a one-off last month I said we could be sure we wouldn’t get again! [First chart is m/m, second is y/y.]

• You really can go either way on this number. Here is the Enduring Investments Inflation Diffusion Index. The disinflation is continuing, and that’s good news. OTOH, we have some really crazy outliers like airfares.

• Here’s where CPI Airfare sits relative to jet fuel (seasonally adjusted). We are likely to see a catch-up in this next month. I am really curious which routes are getting lots cheaper. I haven’t seen it.

• Now, maybe airfares is a micro effect here that indicates a softening in travel and an early warning of decreased consumer spending. Maybe it’s a bullwhip – after “revenge travel” everyone is going back to normal travel demand. Still, betcha we don’t get another -8% next month.
• OK last chart. This is y/y but it looks similar m/m. The high bars on the right are shelter and they’re moving left. Few huge outliers on the right. Then lots of little categories strung out between 3 and 7%. Then about 22% less than 2% including 17% in outright deflation.

• The outright deflation ones are mostly core goods, and they’re not generally going to stay there. So what we are going to see over next year is all of these things starting to trend back towards the middle. Where’s the middle? I think it’s high 3s, low 4s. But that’s the question.
• Bottom line here. Overall number pretty close to expectations. There is nothing here that would argue that the Fed ought to keep raising rates – inflation is drifting lower, and nothing they can do will speed that up.
• Indeed, nothing the Fed has done so far has caused this, except inasmuch as higher rates helps the dollar which helps core goods to decline. Now…the Fed also oughtn’t ease any time soon. There’s no sign of deflation here or even stable sub-2% inflation.
• Ergo, I think we are going to see the Fed basically go to sleep here for a while, unless the bond market starts to get sloppy because of the huge demand from Treasury. If the Fed needs to intervene and buy bonds…that will be a very bad sign. But not going to happen today!
• Thanks for tuning in.

We knew going in that this would be a soft number, and that it also would likely be the softest in a while. We didn’t get as much of a drag from used cars as we expected, but we got some; the real culprit was the large drag from airfares. It’s hard to understand that one, but especially with jet fuel prices back on the rise we are going to get a give-back from that next month in all likelihood. Indeed, the August CPI is shaping up to be sobering. Core should be above 0.3% m/m again, and headline is currently tracking at 0.65% or so on a seasonally-adjusted basis. So store the party hats for now.

That said, it was encouraging to see so many categories with small changes on the month. There were enough changes that median inflation is going to print very low, 0.19% or so, this month. If that were to recur it would be a great sign. Alas, it’s very unlikely that we will see another median like that very soon. As it was, it was almost an 0.29% as the next category above the median one was that much stronger.

From a market perspective, this is positive. That’s partly because “the market” tends not to look ahead very much (yeah, I know you learned something different in school but “the market,” especially in a day dominated by mechanical trading based on parsing the news headlines, does not discount the future very well any more. That’s one reason why we keep having periodic mini crashes when reality abruptly intrudes). This inflation number gives no real reason for the Fed to hike rates again. As it was, the argument for another 25bps after 500bps have been done was always very weak, especially since there is no real evidence that interest rate hikes do very much to inflation. At some point, the beatings get to be gratuitous and sadistic.

The problem is that there is going to be pressure on longer-term interest rates given what’s happening with the budget. I’m watching that carefully. As I write this, 10-year interest rates are back above 4%. With data like this, that doesn’t make a lot of sense. But there’s a lot of paper out there and it may need higher rates to find its “forever home.”

So, enjoy this print. It’s legitimately positive news. Only the folks looking ahead to next month ought to be less cheerful but in the meantime eat, drink, be merry, and buy stonks.*

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* This is tongue-in-cheek naturally.