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 September (August’s figure).
• At 8:30ET, when the data drops, I will pull down the data and then run a bunch of charts. I think I’ve figured out how to autopost these again, fingers crossed. Then I’ll comment and post some more charts.
• Later, I will post a summary of these tweets at https://inflationguy.blog and then podcast a summary at inflationguy.podbean.com . Thanks again for subscribing!
• This month, after some low prints recently, we’re going to get some higher ones. Not terrible like last year, mind you, but higher. The economist consensus…which I’m again closer to than the swap market estimate…is for a high 0.2% on core and a low 0.6% on headline.

• That will raise y/y headline and drop y/y core (all the way to 4.3%!). Core should also fall again next month due to a harsh comp from Sep 2022. After that, progress will be slower. If there’s progress.
• The last couple of prints have been very low: core of +0.16% in both June and July. These were due to non-repeatable things, and I’ll talk about some of them in a bit.
• But the point is that we’ve gotten most of the positive surprises for a while I think (although I guess that’s the nature of surprises!)
• A positive (drag) today, and ongoing for a while, will be the deceleration in rents. Last month Primary Rents were +0.42% and OER was +0.49%. I am penciling the combined ‘rent of shelter’ in for +0.41% this month. That might be aggressive. But it will  keep slowing for a while.
• But there are a few things that are going to be reversing soon. One is health insurance. I wrote about this recently https://shorturl.at/agtCX . It will still drag today but that will reverse in October.
• Used Cars is a little indeterminate. I would have thought it was overdone on the downside but am less sure of that now. Here’s why:
• Black book implies continued downward pressure on used car prices. This is partly because auto finance companies have really jerked back on lending, sharply raising rates along with their cost of funding and actually checking credit occasionally.
• The rates make sense but the rationing not so much – delinquency rates have risen from the 2021 covid-funding inspired lows but are still at normal rates. Anyway the result has been downard pressure on used car prices.

• The rate effect is what people had been expecting from housing – the difference between a 5% car loan and a 0% car loan for 7 years is about 13% higher cost for the non-cash buyer so a budget-conscious buyer lowers his price somewhat as a result. Hasn’t happened in housing.
• But in housing the seller also has a loan with value and so is reluctant to sell at a lower price AND lose the low rate. That symmetry doesn’t exist in autos. I suspect that’s why used car prices have fallen farther than I expected (and I should have seen that).
• The Fed though is done (at worse, ALMOST done), and rates will level off for car loans. So this downward pressure will eventually ebb. And they should end up adjusting to a higher overall price level.
• Used cars will still be a drag today (I have a -3.5% fall in used cars penciled in), but that too should ebb soon.
• The real mystery from last month was airfares. That has been down >8% two months in a row, and the current level is about 15% too low for the level of jet fuel (which is rising).

• Do airfares recover 3%? 8%? 15%? I’m wild-guessing 6% but every 1% is worth 3/4 of 1bp on the core m/m. So I’m projecting it to add 4bps, basically. This is a big source of uncertainty, but mostly on the upside, this month.
• Now, we should also recognize that last month’s CPI was also pretty BROADLY low, which meant that median CPI also printed low.
• That would be wonderful if it happened again (but it’s unlikely). Indeed, between higher headline, core, and median, it will be very easy for some people to get carried away with negativity.
• But still, we’re talk ing about 0.23% on core, maybe rounding up to 0.3% if we get stuff a little high. That’s settling in towards the high-3s, low-4s, which is where I think we are going. But watch the breadth, and median.
• The markets, on net, have done almost nothing this last month. Real yields and nominal yields went up a touch, but longer breakevens and swaps are almost exactly unchanged. Shorter breakevens are wider on the strength in gasoline.

• I think markets recognize that the narrative is turning, from “we are in an inflationary spiral” to “inflation is coming down” to “okay now it gets harder.” And that leaves breakevens a bit aimless for now.
• I do think breakevens are too low!
• Energy is back rising, and this time there’s nothing left in the SPR to hold down gasoline prices. Government deficits are ballooning again, partly because interest costs are skyrocketing.
• Navigation from here, both macroeconomically and in a trading sense, starts to get difficult again. Good luck out there today!

---

• A bit on the high side. Core 0.278 to three decimals. Working on downloading data now.
• As I said, core was a little higher than expected, but still at the low end of what we’d seen for the prior year.

• CPI for Used Cars and Trucks was -1.23%, less than I expected. Airfares were +4.89% (I had +6%), so in the ballpark.
• M/M, Y/Y, and prior Y/Y for 8 major subgroups

• Core Goods: 0.234% y/y    Core Services: 5.9% y/y

• Primary Rents: 7.76% y/y    OER: 7.32% y/y

• Further: Primary Rents 0.48% M/M, 7.76% Y/Y (8.03% last)         OER 0.38% M/M, 7.32% Y/Y (7.66% last)         Lodging Away From Home -3% M/M, 3% Y/Y (6% last)
• Some ‘COVID’ Categories: Airfares  4.89% M/M (-8.09% Last)     Lodging Away from Home  -2.97% M/M (-0.34% Last)   Used Cars/Trucks  -1.23% M/M (-1.34% Last)    New Cars/Trucks  0.27% M/M (-0.08% Last)
• A little surprising that we aren’t seeing the same effect on New Cars (loan interest rate effect) that we are on used cars.
• Here is my early and automated guess at Median CPI for this month: 0.328%

• OK, this is what I expected. The broad everything-was-soft month was a one-off. Median is still slowwwwwly decelerating, but not collapsing like it appeared.
• Piece 1: Food & Energy: 1% y/y

• The energy story is known – OPEC is cutting supplies in anticipation of weak growth, but so far the main economic driver globally (the US) isn’t having the weak growth. And supplies are low. So headline was bubbly and will probably get more of that next month.
• Piece 2: Core Commodities: 0.234% y/y

• Core Commodities driven lower this month partly by Used Cars of course. But it’s going to be challenging to push it a lot lower. That said, the strength of the USD is putting constant pressure in the traditional way here – but nearshoring is still going to make this sticky.
• Piece 3: Core Services less Rent of Shelter: 3.88% y/y

• This is a little interesting…it’s just a little hook to the upside, but remember one of the big downward pressures here is Health Insurance and that’s due to reverse soon.
• But the other big input is wages, and labor’s recent muscularity along with increases in minimum wage in California is going to keep this from decelerating as much as it ‘needs’ to.
• Piece 4: Rent of Shelter: 7.33% y/y

• This is going to keep decelerating. But not back to zero!
• I had penciled in Rent of Shelter as +0.41%. OER slowed to +0.38% m/m, while Primary Rents (about 1/3 of the impact) was faster this month at +0.49%. But ‘Lodging Away from Home’ dropped about 3%, and that’s why Rent of Shelter was so soft. This should rebound next month.

• Interesting and important dichotomy continues: Food at Home was +0.09% (NSA); Food Away from Home was +0.34% (NSA). The latter is wages. Keep an eye on that.
• Medicinal Drugs was +0.61%m/m. Series obviously bounces around a lot but to my eye it’s creeping higher. I remember in 2020 and 2021 it was confounding that with COVID, there was downward pressure here. Looks like that’s ebbed.

• Doctors’ Services was +0.11% m/m, and remains sort of soft. But Hospital Services (2.3% of CPI) was +0.67% m/m. It had been one of the soft categories last month at -0.44%.
• Lodging Away from Home, as I’d mentioned, dragged down the overall Rent of Shelter. But it’s at the low end of its monthly range of wiggles and will probably add next month rather than subtract.

• Worth pointing out because it’s been in the news. Motor Vehicle Insurance, which is 1.7% of CPI – has been steadily increasing. Causes are higher car prices, and big increases in carjackings as well as some natural disaster losses. This doesn’t look like it’s going away. (charts show m/m and y/y)

• Core ex-housing is down to 2.36% y/y. This sounds low, but prior to COVID it hadn’t been over 2% since 2012. As noted earlier, core goods has squeezed out most good news already and core services – outside of housing – still faces wages growing faster than 5%.
• The biggest-losers list (annualized monthly figures) among core categories is led by Lodging Away from Home (-30%), Misc Personal Goods (-25%), Infants/Toddlers’ Apparel (-20%), and Used Cars/Trucks (-14%).
• Biggest gainers are Public Transportation (+58%), Motor Vehicle Insurance (+33%), Car/Truck Rental (+17%), Footwear (+15%), Car Maintenance/Repair (+14%), Misc Personal Services (+12%).
• The dispersion stuff is actually decent news. Broadly, things are slowing down. That doesn’t mean we are going back to 2% inflation; in fact there are very few signs of that yet. But it does mean that the broad upthrust in the price level is ebbing.

• It would be nice to go back to worrying mainly about relative price changes instead of absolute price-level changes. We aren’t there yet. The volatility of prices, and some of the broad pressures like trade and wages, remind us that we are still in the inflation episode.
• This only FEELS like inflation is low, because we saw what high feels like. But 4% core/median inflation is no picnic. And it will keep correlations elevated.
• Last chart. Here is the weight of categories inflating faster than 4%. Obviously we are getting close to 4% being the median. Now, about a third of the basket is housing so that third is in the >4% category. But if we flip and look at <2%, it’s still not back to the old normal.

• …implication being the same as with the diffusion index, volatility, and correlations – we are on the right path, but not there yet.
• NOW – that does NOT mean that the Fed needs to keep raising rates. That’s fairly ineffective anyway although it looks meaningful in used cars. That’s not the issue though. What the Fed should, and probably will do, is just keep rates steady here. And I think they will.
• The real problem comes later: with burgeoning deficits and upward pressure on long rates (I worried about this here: https://inflationguy.blog/2023/08/02/three-colliding-macro-trends/ ), at some point the Fed is going to be under pressure to start buying Treasuries again.
• That’s a bad path, but it’s going to be hard to resist.
• That’s all for today. Thanks for tuning in! I’ll have the summary posted to the blog in an hour or two, and then the podcast later today. Have a good day.

The CPI number this month delivered broadly as expected (and, as expected, broadly). Used Cars continued to slide, and airfares did not repeat the -8% again. The surprise drop in Lodging Away from Home will likely reverse next month, and airfares will be another add. While Used Cars will remain soggy, we only have one more month of Health Insurance drag of 4bps/month before that reverses.

The upshot is that the balance of this year will likely see more 0.3s for the most part, with some high 0.2s (meaning that it rounds down). The easy lifting on core has been done. Due to base effects core will still drop next month, but after that…it is going to get difficult. Decelerating housing inflation will be a persistent following wind, but all of the other things that were rowing in one direction while housing was rising…are about to be rowing in the other direction. And housing’s drag is already reversing. (If you were looking 12 months ahead at the possible future declines in rents, to be fair you should be looking now at 12 months ahead when we’re going to start to see percolating through the re-acceleration that we’re seeing in spot rents and home prices.

There is no need for the Fed to tighten further. Rate hikes don’t really help very much (except in some categories like used cars!) to restrain inflation, and short rates are a bit above normal. But as noted in the tweet stream, we are converging on what will be a more difficult path to navigate. The Fed made a mistake and overdid the COVID response, and then held it too long. It deserves credit, on the other hand, for pivoting and throwing off the dovish history of the last two decades to begin shrinking the balance sheet and for being steady on that path even as the rate hikes cease. But those were, or should have been, easy decisions from the monetary policy standpoint as the central bank was leaning into the prevailing wind by pursuing restraint when the economy was robust.

Before too long, the Fed is going to face a circumstance where restraint remains necessary because inflation is sticky at too high a level, but longer-term interest rates begin to tick higher. This will put pressure on economic growth, and on the budget deficit, so that their restraint will be seen as wrong-headed. That’s the danger zone, and I think it probably is a 2024 problem. My fear is that it will be very difficult for the Fed to not give in, arguing to itself that “hey, slower growth means lower inflation” even though there’s no evidence for that, outside of energy, and start to temper its hawkish stance.

That would be a big mistake. But it’s probably next year’s mistake. For now, we can sit back and watch the core and median inflation numbers come down. Not as fast as people will be expecting, but the direction is right.