E-piphany

Below is a summary of my post-CPI tweets. You can follow me on X at @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 December (November’s figure). This is the last month I’ll be doing this live!
• Thanks to all of you who have subscribed, voting with your dollars that this was useful. I’ve suspended all renewals so you will no longer be charged after today. I’m deeply grateful that you participated in this experiment. Thank you!!
• As in the past, if you miss the live tweets, you can find a summary later at https://inflationguy.blog and I will podcast a summary at inflationguy.podbean.com . Those will continue in 2024 after the live tweeting stops.
• For this month, I’m on top of the consensus economists’ forecasts for core, but higher for headline. I left Cleveland Fed out because it’s routinely the worst.

• Here’s a rough sketch of where I get my core. Average of the last 3 core numbers is 0.28%; average of the last 6 is 0.26% but that includes a couple of outliers. Average of the last 6 median CPIs is 0.34%. Roughly, overall trend core is about 0.28%.
• But we have to add 1bp for Health Insurance; and I’m writing in -1% m/m for Used Cars which is a 3bp drag. That’s an abbreviated version of how I get 0.26%, but it’s pretty close.
• A quick word on Used Cars, which I have as a drag but some of the big shops have as a +. Black Book fell about 3.7%, seasonally adjusted, last month. The seasonals are an add back, but the add back is much less than the decline. I might be wrong on this, but I don’t see the add.
• That said, there were several months recently that SHOULD have been an add, and were a subtraction, so maybe some economists are expecting a correction. Or maybe my model is just bad.
• What I am NOT including is any drag from airfares. If you’ve followed these tweets in the past you know that airfares have been quite low for the level of jet fuel prices (see chart, red dot is end-of-Nov fuel and end-of-Oct SA fares)

• This month, jet fuel prices plunged, so I think some people have penciled in a decline in airfares. And it could happen. But all this really does is move fares back in line with the current jet fuel (yellow triangle, if NSA fares were unchanged).

• FWIW, there is no strong seasonal adjustment from Oct to Nov in airfares. They tend to drop in December, but that shouldn’t be in this report.
• Previously, I’d been assuming a boost from airfares moving back in the direction of the trendline. That hasn’t happened. If again the dots move just parallel to the line, the jet fuel drop implies about a -3.3% decline in airfares, which is worth 2.5bps on core.
• So if we get a low number like that, the first place I’m looking is shelter (just because it’s big); the second place is airfares.
• Obviously we’re still going to watch shelter. OER was +0.41% m/m and Primary Rents +0.50% last month. I expect both of those to be lower. On the other hand, Lodging Away from Home should swing in the other direction, so shelter overall should be similar to last month.
• Fair disclosure that my Primary Rents model starts to drop fairly rapidly now, so if I take the number naively then I’d be penciling in 0.32% m/m for Primary Rents. That would be much lower than anything we’ve seen m/m yet. And, anecdotally, I don’t see that yet.
• Finally – my headline ‘forecast’ is higher than others’. And that’s because of piped gas, and because I don’t get fired if I miss. Natural Gas spiked in October; given usual lags that SHOULD mean ‘Piped Gas’ is higher this month.
• That would add 7bps, while gasoline drags about 22bps. But subsequent to that, Nat Gas has dropped sharply. And I don’t think most people want to forecast HIGHER gas and try to catch the zig-zag. Safer to just forecast flat.
• If it’s flat, then my headline is exactly in line w/ CPI swaps: -0.21% m/m NSA, +0.10% SA headline. But if I’m taking the mechanical drag from gasoline then I’m taking the mechanical bump from Natty. (Although to be fair, gasoline passes into CPI directly and Natty doesn’t.)
• Turning to markets. Market movements this month are all lower, as the massive bond rally can be seen in real rates and in breakevens.

• Let’s not lose sight of the fact that the monetary metrics are continued good news. M2 is still negative y/y and q/q. And bank loan growth is also very soft (a lot of that is mortgages though).

• Now, you can kinda think of the ‘potential energy’ as the amount the line moved above some trend…say 5%, 6% money growth or loan growth…and it needs to ‘absorb’ that by being below by a certain amount (or the price level will be permanently higher, which is likely the case).
• How long can money growth be below 0? I’ve already been surprised! But if the market is right about the substantial Fed easing in 2024, then money growth will not stay low enough, for long enough, to get inflation back to where everyone wants it.
• OK, bottom line is that everyone is forecasting a SOFT 0.3% on core, meaning that it will round up and barely keep y/y rounding to 4.0%. If shelter comes in soft or airfares moves with jet fuel, it will be a downside surprise.
• But stocks are already on the roof and bonds are 75bps off the high yields. I am not sure an 0.23% or 0.24% on core will be greeted with a tremendous market rally. But 0.31%…or heaven forbid an 0.34% that turns Core CPI up a tick? That would be ugly.
• Ergo I think a downside surprise is the bigger chance, but the smaller effect. I’d sell the initial pop. An upside surprise: I wouldn’t try to catch the knife. Especially in illiquid year-end conditions.
• So that’s a wrap. Good luck today, and thanks again for your persistent support!

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• Humorously, it looks like Twitter changed its authorization hooks again. So the auto chart will be manual again. Wish it could have been smooth for this last month! I’ll do it pretty quickly though.
• Well, +0.097% on SA headline, and +0.285% on SA Core. Higher than expectations, but not by much.
• Immediately jumping out is OER at +0.50%, higher than last month’s +0.41%. Primary Rents +0.48%, down slightly from last month but still wayy above my model. And my model is higher than what the Street has, which has been projecting deflation next year in rents.
• Used Cars was in fact an add. +1.58%, despite a 4% fall in (NSA) retail prices. The BLS seasonals just don’t have that much of a drop off, so it must be that some other survey was showing higher retail used car prices.

Some charts in a minute. BLS blocked everything for a bit.

• Airfares was -0.39%; recall I’d assumed flat despite a large decline in jet fuel. Feel good about that one. But Lodging Away from Home was -0.9% m/m.
• Last 12 Core CPI. The downside momentum is less evident now.

• Major subgroups. I will come back to this. Medical Care was an outlier compared to recent trends. Doctors’ Services rose more than 1% m/m. As I said I’ll come back to that.

• Core goods inflation got to 0, but core services inflation stayed at 5.1% y/y. I continue to think core goods inflation is just about done declining, but Used Cars keeps pulling it slowly lower.

• OER and Primary rents. Yes, they’re decelerating. But wayyyyyyyy less than people expected. 0.50% on OER m/m, and 0.48% on Primary Rents. Lodging Away from Home was the only drag on shelter.

• Some ‘COVID’ Categories:

Airfares  -0.39% M/M (-0.91% Last)

Lodging Away from Home  -0.93% M/M (-2.45% Last)

Used Cars/Trucks  1.58% M/M (-0.8% Last)

New Cars/Trucks  -0.06% M/M (-0.09% Last)

• My early guess on Median CPI is a rise to +0.434%, above 0.4%. As with core, the downside momentum here isn’t clear any more. Leveling out in the mid 0.3s gets us 4.25% or so y/y. Not good enough.

• Piece 1: Food and energy was a bit of a drag. HOWEVER, Piped Gas was +4.05% m/m, which added 0.04% to headline inflation – that’s the main source of the headline miss. I should note, I pointed this out…overall, Energy was a -0.23% drag.

• Piece 2: core goods, back to flat.

• Piece 3: the most disturbing piece, because it’s ‘supercore’ and now hooking higher. This is medical and I’ll come back to it.

• Piece 4 rent of shelter. A loooooooong way to go before deflation!

• Food was +0.22% m/m (SA), after +0.30% last month. Food at home was softer thanks to declining shipping, packaging, and commodities costs: +0.11% SA m/m vs 0.26% last. Food Away from Home remains bubbly thanks to wages: +0.43% SA m/m vs +0.37% last.
• Doctors’ services jumped 0.55% m/m. Y/y, it’s still -0.7%, but this jump contributed to the surprise in core and in ‘supercore’. It’s mostly a payback for the -1% surprise plunge last month.

• Medicinal Drugs was +0.45% m/m vs 0.6% prior. But Prescription Drugs jumped to 3.77% y/y. Have no fear: the Biden Administration just threatened to seize patents for any drug increasing prices too much. https://inflationguy.blog/2023/12/07/beware-the-price-controller/

• Core inflation ex-housing rose to 2.13% y/y, the first sequential acceleration since March. Not alarming at 2.13%, but prior to COVID this was in the low 1s.
• Biggest m/m declines were Mens/Boys Apparel (-26% annualized), Car/Truck Rental (-24%), Infants/Toddlers Apparel (-15%), Womens/Girls Apparel (-13%), Motor Vehicle Fees (-13%), and Lodging Away from Home (-11%). The Apparel decline is seasonal holiday discounting.
• Biggest annualized m/m core increases: Used Cars & Trucks (+21%), Tobacco & Smoking Products (+15%), Public Transportation (+13%), and Motor Vehicle Insurance (+12%).
• I love it when a plan comes together.

• Glancing at the markets, I must say I haven’t the slightest idea why we rallied hard in both stocks and bonds on this data. This is not bullish data.
• Have to point out the inflation swap market nailed the headline figure. You can’t trade core in size, but the Kalshi market going in had it at +0.32%. That always seemed high to me.
• Overall, this was fairly close to expectations but the fact that it was shelter holding it up – which is why Median was high, also – is bad news. The entire mainstream thesis on inflation going back to target DEPENDS on something close to deflation in housing.
• …well, deflation in housing OR calamity elsewhere in services. Thanks to the lags in housing, core inflation is going to drip somewhat lower, but it won’t get below 3% before it is hooking higher UNLESS housing really does belly flop. No sign of that at all.
• I guess the counterargument is “but it’s ONLY housing holding it up.” That’s not really true, though. Actually the far left tail of goods in deflation is getting bigger – but that’s the short-cycle stuff (e.g. core goods) that will rotate back up. Services, housing still high.

• I shouldn’t obscure the good news, which is that the breadth of inflation is narrowing. And the decline in the monetary aggregates is promising. The problem is that we have just SO FAR TO GO and the market anyway is expecting the Fed to take its eye off the ball.

• In conclusion – yes, Virginia, this IS the hard part. Core and Median will drip lower thanks to shelter. That takes us from 4% to what, 3-3.25% in 2024 – before shelter’s disinflation is complete. Then what?
• I continue to expect inflation to settle in the high 3s, low 4s, although continued decline in the aggregates will have me push that a little lower. Maybe we’re mid-3s to high-3s in the medium term now, with cycle bottom around 3%. Is that good enough? Doesn’t feel like it.
• That’s all for today. And all for @InflGuyPlus! Thanks again for subscribing to this channel. Be sure to subscribe to the blog at https://inflationguy.blog and follow the podcast at https://inflationguy.podbean.com or your favorite podcast app – so we’ll stay in touch. Merry Christmas!

This number was a little bit above expectations, led by shelter, Used Cars, and Physicians’ Services. There weren’t a lot of large surprises (Physicians’ Services was an unexpected jump but last month it had an unexpected decline so this is best viewed as a give-back), which helps explain the relatively placid market response. Ultimately, how you feel about inflation these days comes mostly down to shelter although it is worth pointing out that ‘super core’ (core services ex-rent of shelter) hooked slightly higher too.

To get inflation back to target in 2024, we would need one or more of the following to happen:

• Shelter inflation indeed goes negative, as the mainstream forecast expects (but I do not – I believe rents will level off around 3% y/y and then likely rise from there); or
• Core goods goes into hard deflation, of -2%ish. With Used Cars already having given up 17% or so off its highs, it is unlikely to be the driver of that. Apparel? Medicinal Drugs? (chart below shows the striking relationship between the growth in M2 since the end of 2019 and the contour of Used Car prices – driving home again how important a continued decline in the money supply is, if we want inflation to get tame again); or

• Core Services ex-Shelter decelerates markedly. For that to happen, we’d probably need to see wages decelerate a lot more. The chart below shows the Atlanta Fed wages measure (y/y) in black, and ‘supercore’ as Bloomberg calculates it in blue. If you want Supercore down to 2%, then you probably need wages at 3-4%. We have a long ways to go there.

To repeat my recent theme: while the inflation numbers are better, and will keep getting better for a while in 2024 because of easy comps and positive trends, we are into ‘the hard part.’ The current trends do not point to inflation placidly returning to 2-2.25% in 2024, or in 2025 unless the money supply continues to shrink.

And that’s where we run into the issue. The market is pricing in something like 125bps of eases over the course of 2024. While it’s possible that the Fed could cut rates while continuing to shrink the balance sheet (since the Fed funds rate is now just stated, rather than being managed through pressure on reserve balances), it would be very odd for the Fed to do something that looks like easing with one hand and tightening with the other. They’d come under a tremendous amount of criticism for that. While that’s actually my recommended strategy for them, I don’t give it much chance of happening.

So, if that’s not going to happen, then one of two things is going to happen:

1. The Fed eases in 2024, and ceases shrinking the balance sheet. This is great for the bond market in the short term, but it would mean inflation probably wouldn’t even get back to 3% on core before re-accelerating. And no one will be able to blame the next increase (probably not a spike) on COVID.
2. The Fed does not ease in 2024, in which case at some point the bond and stock markets are going to have to stop pricing loose money. That would of course be very bad for stocks and bonds.

There aren’t any easy ways out. Yes, that’s what “this is the hard part” means!