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Inflation Guy’s CPI Summary (Apr 2024)
The CPI for April came in pretty close to expectations. CPI came in at 0.31% m/m, and 0.29% on core, versus a priori expectations for 0.37% and 0.30%. This relative accuracy does not necessarily mean that economists now know exactly what is going on in this index, only that all of the misses canceled out. But the misses are interesting, and worth looking at, and we will do that here. Ultimately, reports like this mostly create an opportunity for framing the debate on whichever side you are on. But to my mind, this report does not meaningfully move the ball towards ‘price stability’ and leaves the Fed – if they’re being honest – still in a bind between slowing growth and sticky inflation.
Not all parts of the CPI were sticky, and that’s the point here. Actually, that has been the point for quite a while, but it was very stark in today’s report. Here’s the distribution of y/y changes in bottom-level components in the CPI. Today, the left hand stuff got lefter, the right-hand stuff got a little righter, and the middle stuff stayed about the same.
I don’t usually lead with the distribution, but it is important to keep this in mind. Inflation is not, especially at lowish levels (say, less than 5-8%), a smooth process. I used to liken this to the process of popcorn popping in a bag; the bag inflates but not because all of the kernels popped at once. The good news is that the popping is slowing, as the Fed has removed some of the heat from the bag, but the pops are still happening.
Now, here’s the good news. Thanks to core CPI being on target, the 3-month, 6-month, 9-month (well, never mind that one), and 12-month averages all decelerated.
Median inflation won’t be out for a couple of hours, but my estimate this month is 0.348% m/m, essentially unchanged from last month. That’s sort of the bad news – the y/y median CPI should be stable this month at 4.5%.
So, I think the bold type for the top line is this: inflation is decelerating, but slowly, and in a sticky fashion. The markets loved that answer and stocks and bonds leapt on the report. But that’s all framing. The debate coming into today was never about whether inflation was declining – it has been, for a while, and is expected to (even by me, and I’m on the high side of Street expectations by a fair amount) until at least Q3 and probably into Q4. That wasn’t the question – we have known since the middle of last year that 2024 would see decelerating inflation. The question is whether the deceleration will continue after that, and whether it is decelerating to 3.75%-4.25% or 1.75%-2.25%. There is as yet no sign of the latter and all signs still point to the former, because the sticky stuff is not yet unstuck.
And that continues to boil down to this: deceleration is still being driven by core goods, and resistance to that deceleration by core services.
Core goods fell to -1.3% y/y this month. I have been saying that we’ve squeezed about all we can out of core goods, and then it drops from -0.7% to -1.3%, the lowest y/y figure in 20 years! This happened even though Apparel rose 1.2% m/m. As usual, the main culprits were autos with Used Cars -1.38% m/m after -1.11% last month, and New Cars -0.45% m/m. Ironically, I think the continued softness in autos is due partly to the continued rise in motor vehicle insurance costs (which were +1.4% m/m again). We hear a lot about the affordability of housing, but you gotta have housing. You don’t gotta update your car.
The softness in core goods is welcome, naturally, but that’s the volatile part of CPI. And such low levels are only sustainable if the dollar continues to strengthen.
On the other hand, core services only softened to 5.3% y/y from 5.4%. A lot of that is housing, with OER +0.42% m/m (was +0.44% last month) and Primary Rents slowing to 0.35% from 0.41%. But outside that, ‘super core’ (core services less rent of shelter) is actually still bouncing higher. It’s 4.91% y/y – below the 6.5% it got to in late 2022, but well above the lows from October (3.75%).
Some people will like the fact that the m/m Supercore was “only” 0.42% or so, which is down from recent months. But that’s a little deceiving. Airfares were -0.81% m/m, car/truck rental -4.6%, and the monthly health insurance bump has run its course and is back to a more normal m/m change (positive, but at a 3.5% annualized rate). Longer-term, we still have to worry about the continued acceleration in, say, hospital services, which is +7.7% y/y. I pointed this out last month, and the picture is no prettier this month.
One other comment/update on rents. It is proceeding according to expectations, although I expect a slightly faster rate of deceleration for the next quarter or so. But then, all the signs are that rents are going to re-accelerate. Even those terrible indicators that inflation dummies (this includes Yellen and most of the Fed) relied on to forecast that rents would be in deflation this year…even those indicators are showing a bounce to come. Home prices are accelerating again. And none of this is surprising given that landlords are facing higher costs and increasing demand (6 million immigrants need roofs). And this is why the inflation dummies are inflation dummies – there was never, never, a good argument for why rents should be in free fall, if you just spent 10 minutes talking to an actual landlord. Get your heads out of your models and look around occasionally, dummies.
Okay, so that was a little strident but I am getting a little tired of asking potential clients how they are addressing inflation and hearing them tell me about their economist. Inflation hedging ≠ economists. Come on, people.
Let’s take this around to what we care about, and that’s policy. The Administration is trying to help the inflation figures by delaying the refilling of the Strategic Petroleum Reserve if prices go up, but is also implementing new tariffs on Chinese goods. That answers the first WWJD question (what will Joe do) – in an election year, actions which cause inflation next year are fine…just not anything which causes inflation this year. The other WWJD question (what will Jerome do) is still interesting. Growth is indeed slowing, and has been slowing for some time. Consumers are looking a bit tired, and unemployment is rising slowly. But inflation is not behaving. Median inflation won’t get below 4% until September at the earliest, and even optimistically won’t get to 3% before it starts to bounce. Before, the Fed could pretend that the new rent indicators showing widespread deflation gave it some latitude to move before the rent decreases actually arrived, but that isn’t a plausible argument any more.
However, the FOMC has started to lean more dovish. The significant decrease in the rate of taper that was announced at the last meeting clearly shows which way they are leaning. The case for a rate cut later in the summer (absent some financial crack-up that needs to be addressed) would be based on the Committee members’ sense that the current policy rate is above neutral and can be moved back towards neutral as the risks become ‘more balanced.’ Additionally, doves could argue that they don’t want to be seen easing right before the election so an ease at the end of July is a ‘down payment’ on looser policy later. The inflation data don’t support that, but the Fed doesn’t care only about inflation data. If I was on the Committee, I would not vote to loosen the taper or lower rates, but I would not be surprised to see a token ease at the end-of-July meeting. It would be cavalier, and possibly political, and not supported by the data we currently have in hand…but it wouldn’t surprise me.
One final administrative notice to those of you who subscribe to the Quarterly Inflation Outlook. The Q2 issue is expected to be published this Sunday, so look for it! (And subscribe, if you haven’t).
You Cannot Inflate the Debt Away
There is a popular meme that the government has an incentive to inflate, because the same debt is worth less in real terms at a higher price level. If inflation is high enough, then the government (it is said) can make the debt go away. Inflation is, after all, a tax; doesn’t it then follow that if the government increases that tax quite a bit then it can get itself out of hock in real terms?
It turns out that this is difficult to do, at least over a range of ‘normal’ inflation rates. The reason is that it is hard to get the debt to go away fast enough when the market adjusts interest rates to reflect the level of inflation. I want to try and illustrate the general idea here. I’ve looked at this before, so I know the answer, but I’ve never put this in a blog post before.
First, let’s start with the current distribution of debt for the US. The chart below is from Bloomberg, showing how many trillions of Treasury bill/note/bond maturities will happen every year. For a host of reasons, prime among them being incompetence, the US did not take advantage of the artificially ultra-low interest rate environment to extend maturities. That makes inflating the debt away even more difficult.
The average interest rate on US debt is 3.21%, about double what it was in early 2022 and the highest it has been since 2009 (and there is a lot more debt outstanding now than there was then, thanks to a decade and a half of massive deficits designed to save the world). Having a lot of debt mature every few years is a great way to increase the sensitivity of your interest expense, and therefore deficit, to short-term inflation and interest rate fluctuations. That’s not feature, it’s a bug!
Starting from the distribution above, let’s model how the debt would grow over time using a couple of simple assumptions and then tweaking those assumptions. We will start with this: assume that the maturing debt, plus the annual Treasury deficit, is rolled into new debt distributed 1/30th to each year. We will assume a 4% inflation rate, and an interest rate of 1% over the inflation rate. Because we are spreading out the maturities, we are explicitly extending the maturity of the debt. The more rapidly the average interest rate reacts to the current interest rate, the harder it is to inflate the debt away. If we started with that 3.22% interest rate and rolled the debt as I have just described, here is how the average nominal interest rate evolves over the next 25 years.
I should note that I am also assuming that the deficit is initially $1 Trillion, and grows by the rate of inflation every year. So, in year 0 it is $1T; in year 1 it is 1.04T, which is the same amount in real terms. Note that this implies that discretionary spending is decreasing rapidly. In year 0, the Treasury would pay interest of about $876 billion ($27.2 trillion in debt * 3.22% interest rate). In year 1, the average interest rate rises to 3.80% and the deficit is $1T larger, so the interest paid rises to $1072 billion. Since we assumed that the overall deficit increased by only $40bln, the implication is that discretionary spending fell $156bln ($1072 – $876 – $40). So, the notion that the deficit grows only equally with inflation is not realistic. But even using such magical thinking, the total debt rises from $27.2T to $72.5T over 25 years. The real debt (remember, we’re inflating it away!) stays basically steady at $27.2T in today’s dollars.
So constant inflation actually doesn’t do it. It’s even worse than the picture suggests, as I said. If we instead assume the nominal debt increases by the change in the interest outlays – which means discretionary spending still decreases, but only in real terms – then that chart looks distinctly uglier. The nominal debt in 25 years with these assumptions gets to $294T, and the real debt steadily climbs over $100T.
We can see that this is just not going to work unless we decrease discretionary spending. Again, we’re just trying to figure out if there is some way to inflate ourselves out of this mess. So let’s go back to the assumption that the deficit only rises pari passu with inflation, but now let’s get rocking on inflation and increase it 1% every year, from 4% to 30% over the next quarter-century. Assuming that investors still demand a positive 1% real rate on all new debt, we get this picture.
We finally make some headway on the debt! Because so much of it is short-term, though, it takes a good 6-7 years before we see a lot of progress on the real debt because we’re just rolling it over at higher rates too quickly.
By the way, I neglected to mention that Medicare is an off-balance-sheet ‘debt’ that we can’t outgrow in this fashion. And it’s a big item. It is impossible to inflate away Medicare.
Now, most people who suggest that we can inflate our way out of debt do not imagine a steadily-accelerating inflation rate forever. That’s not what we would call a ‘re-electable outcome’. So let’s instead assume that we spike inflation for two years to 10%, and then drop it back to 4%. You can look at the chart below and see that once again this doesn’t work because the debt is turning over too quickly. There is a quick, small benefit to the real debt, but then it levels off again.
Unless you can spike inflation to, say, 100% for a year or two and then put it right back down to the prior level, you really need accelerating inflation because you need the principal amount of the outstanding debt to fall in real terms more than the interest payments are accumulating. If you can have inflation a bit above the average interest rate on the debt, then you’ll make headway but since the interest rate responds you have to keep doing this for a while. And remember, we are assuming that the government outside of interest payments is steadily shrinking in real terms.
What about if we balanced the budget? Well, then obviously the real debt will tend to decline over time, although more and more of the budget becomes interest payments.
So far, we can find no realistic way to inflate our way out of debt, other than moving toward hyperinflation (and the faster, the better). And even with these simulations, I am making a very unrealistic assumption about how the deficit evolves when the interest costs of the debt blow up. Hyperinflation, with a balanced budget, is what you need. Good luck with that. The only way that happens is if the dollar collapses and no one will lend us any more money anyway. And there is no one in government today, I feel confident in asserting, who thinks that outcome is a decent tradeoff in order to get out from under the mountainous debt. At least…let’s hope not.
Have a better idea? Let’s hear it!
