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Profiting From Zero Duration Inflation
One of the nice features of the USDi digital currency is that its path is known with certainty well in advance. The price of USDi is determined by the interpolated CPI index value compared with the value on the reference day (315.605). So, for example, we know that today’s[1] USDi value is 1.02681 because today’s CPI index value is 324.06614, and we know that because we know how to interpolate between the CPI prints from 3 months ago (324.122) and 2 months ago (324.054).
Importantly, those numbers we are interpolating between are the Non-seasonally-adjusted CPI figures from December (released in January) and January (released in February). And that interpolation methodology is exactly the methodology that TIPS use.[2]
You will notice that the CPI from 2 months ago is lower than the CPI from 3 months ago. That means that prices actually fell, before seasonal adjustment, which means that USDi actually declined slightly over the course of the month. It was even worse in January, because the November CPI was – as I have noted before – complete garbage due to the fact that BLS procedures led them to assume zero inflation for a lot of the missing October data. In the chart below, you can see the sharp correction during which USDi actually declined during January (and slightly further, in February).
Now, because we can ‘see the future’ due to the interpolation mechanism, we know exactly where USDi will trade each day in March. That’s also indicated on the chart. So we know that in March, USDi will rise at a 4.53% annualized pace. One-month t-bills are 3.6% right now. You do the math.
It gets better: the same BLS procedures that led to the terrible November number lead to self-correction, so the CPI Index will catch up over time. The biggest part of that catch-up is due to the rotation of the rent sample over 6 months, so while we do not know exactly what CPI will print at for February, March, April, and May, we have a good confidence that it will be above trend. We can see that from the CPI “fixings” market where those particular CPI prints trade. The market price is the market price, and sometimes wrong, but based on what trades in the market right now we can anticipate (orange line above) that USDi will climb at an annualized rate of 5.63% in April and 5.53% in May before slipping back to a still-better-than-bills 4.17% in June.
What does any of this have to do with duration?
Well, you may read this and say to yourself “I can get the same benefit if I just buy short TIPS bonds.” But no, you can’t. That’s because when you buy a TIPS bond, the principal amount rises with inflation but you still have to deal with price. It turns out that TIPS traders are very aware that their accretion (what we call the uplift in principal) is going to be higher than TBill rates over the next few months, and so the current price of TIPS bonds fully discount this. The July 2026 TIPS, which will mature at the CPI index value of July 15th (which is interpolated between April’s CPI and May’s CPI, so it includes all of those rebound months), trades at a price of 100-13…and remember, it matures at 100. So you’ll gain the accretion, but lose on price. I’ll save you the math: that price means the real yield of that bond is about -1%, which is convenient since the CPI between now and then is going to be something around 1% higher than the Tbill yield.
Every day that passes, as the principal value of the TIPS bond accretes, the price will decline. The only way you can profit versus fixed-rate Treasuries is if you are smarter than the market, and your forecast of CPI is better than what is already embedded in the price of the bond.
USDi has a price, but it is completely insensitive to yields which means you do not have to pay a premium to buy it now (nor did you get a discount back in December knowing the bad January numbers were coming). You can buy USDi today knowing that you will earn those exciting forthcoming CPI prints, without sacrificing principal.[3] You can buy USDi against USDC on Uniswap, or simply go to https://usdicoin.com/mint.
I’ve told you before how interesting USDi is since it’s the zero-duration instrument. Here is another concrete example.
[1] I say “today’s” because I am illustrating all of this with daily interpolation, but in practice USDi interpolates every block or “hash,” which is just a few seconds in length.
[2] …except for the fact that TIPS interpolate daily and USDi almost continuously.
[3] Of course, this is not investment advice. Although it sure sounds like it. Do your homework!
Inflation Guy’s CPI Summary (January 2026)
Let’s start by setting the context for today’s CPI number.
A couple of months ago, we missed a CPI because of the shutdown. The BLS simply didn’t have any data to calculate the October 2025 CPI. That wasn’t the real problem. The real problem was that the BLS’s handbook of methods more or less forced it, in calculating the November CPI index, to assume unchanged prices for October for some large categories – in particular, rents. This caused a large, illusory decline in y/y inflation figures. Importantly, this was also temporary – there has been some catch-up but the big one comes in a few months when the OER rent survey rotation will cause a large offsetting jump in that category, exactly six months after the illusory dip. Until then, inflation numbers will be more difficult to interpret and the year-over-year numbers will be simply wrong. So when you read that today’s figure resulted in the “smallest y/y change in core inflation since 2021, and consistent with the Fed reaching its target” – that’s just wrong. The true core y/y number is roughly 0.25%-0.3% higher than what printed today. The CPI ‘fixings’ market is currently pricing headline CPI y/y to rise to 2.82% four months from now, and that isn’t because of a coming rebound in energy prices.
I guess what I am saying is this:
Ladies and gentlemen, please take your seats. We will be experiencing some mild turbulence.
January, in general, is already a difficult month in CPI land because of the tendency for vendors of products and services to offer discounts in December and then implement annual price increases in January. But those price increases are not systematic, which means they are difficult to seasonally-adjust for. Ergo, January misses are rather the norm.
So with that context, the consensus estimates for today’s number were for +0.27% m/m on the headline CPI, and +0.31% on core. Some prognosticators were quite a bit higher than that – I think Barclays expected +0.39% on core CPI. The question was basically whether there is still any tariff increase that needs to be passed through; if so then January is a good time to do it. That didn’t really happen. The actual print was +0.17% on headline and +0.30% on core.
The miss on headline happened because while gasoline prices actually rose in January, the average price in January was lower than the average price in December – because in December, gasoline prices dropped sharply. While Jan 31 gas versus Dec 31 gas was $2.87 vs $2.833 (source AAA), January 1 vs December 1 was $2.83 vs $2.998. So, even though gasoline prices rose over the course of January compared to the end of December, that’s now how the BLS samples prices.
Be that as it may, core inflation was pretty close to target. One way to look at it is that y/y Core CPI, at 2.5%, is the lowest since March 2021. Another way to look at it is that the m/m Core was the third highest in the last year, and annualizes to 3.6%. So is it ‘mission accomplished’ for the Fed? Erm, nothing in the chart below tells me inflation is trending gently back to 2%. You?
The core number was actually flattered by a large drop in used car prices, -1.84% m/m. Used car prices actually rose in January, but less than the seasonal norm so that resulted in the large drop and that caused a meaningful drag. (Let’s not get in the habit of just dropping everything that doesn’t fit the narrative, though.) Anyway, core goods as a whole dropped to 1.1% y/y from 1.4%, while core services eased to 2.9% y/y from 3.0%.
While core goods fell more than expected because of that Used Cars number, it’s not surprising that it is moderating some. The question isn’t whether core goods prices will keep accelerating to 3% or 4%; the question is whether it stays positive, or slips back to the negative range it inhabited for many years. That’s an important story even though core goods is only 20% of the CPI. Until now it has been a ‘tariffs’ story, but going forward it’s an ‘onshoring’ story. My contention is that we should not expect a return to the persistent goods deflation that flattered CPI for a generation thanks to offshoring of manufacturing to low-labor-cost countries, because the flow is reversing. That is the story to watch, but it isn’t January 2026’s story.
While we are talking about autos, I’ll note that New Cars showed a small increase. I wonder (and I don’t have a strong forecast here) what the changes in car sales composition now that electric vehicles are no longer being pushed by the executive branch. Obviously non-electric cars are cheaper, so if we had a real-time measure of the average sales price of a car it would probably fall as consumers go back to buying cars they want instead of cars that look cheaper because of tax breaks. I don’t know though how much actual sales will change (auto production will certainly change as carmakers no longer have to check the box by making a certain number of cars that were hard to sell), and I don’t know how detailed the BLS survey is and whether it takes into account fleet composition. I guess we know that if there’s any effect, the sign should be negative. I suspect it is a small effect.
Turning to rents, as we do: Owners Equivalent Rent was +0.22% versus +0.31% last month. Rent of Primary Residence was +0.25% vs +0.27% last month. The chart below shows the m/m changes in OER… except that it does not show the 0 for October. There’s clearly a deceleration here, but my model says it should be flattening out right about at this level. Also not January 2026’s story, but it will be 2026’s story.
There was a small decline, -0.15% m/m, in Medicinal Drugs. Some folks had been eagerly waiting for that to show a large drop, thanks partly to the Trump Administration’s efforts to force drug manufacturers to align prices in the US market with prices in the ex-US market. There is not yet any discernable trend. Potentially more impactful is the Trump RX initiative, which by bringing transparency and cutting out the middleman in the really-effed-up consumer pharmaceuticals pipeline (dominated by three big wholesalers and three big pharmacy benefit managers, each of which is highly opaque about pricing) could well cause a significant decline in consumer-paid drug prices. But…remember that when those drugs are paid for by the insurance company, it isn’t a consumer expense and only shows up indirectly in the CPI. Yeah, that makes my head spin also. Bottom line: pharmaceutical prices are likely to decline some for consumers, but we just aren’t really sure where that will show up in the CPI and how soon it will happen.
The best news in the report today is the continued deceleration in core-services-ex-rents (‘Supercore’), which decelerated even with Airfares being +6.5% m/m.
Psych! You fell victim to one of the classic blunders! This is again a y/y figure that is flattered by the lack of October data. On a m/m basis, supercore had the biggest jump in a year, +0.59% (SA). Still, I think this is decelerating along with median wages deceleration. Of course, all of that data is messy right now as well, but the spread of median wages over median inflation remains right around 1%.
There is some early evidence that the downward slide in wages might be leveling off; if it does, that will limit how fast supercore can moderate. There are also some cost pressures in insurance markets that are probably going to show up in the next 6 months or so. But that’s not January 2026’s story.
The story in January 2026 is that the waters remain muddied by the government-shutdown-induced gap. The current y/y figures are all flattered by that event, and exaggerate how good the inflation picture is. That’s how the Administration can trumpet victory while the reality on the ground is that inflation is not converging to trend.
I’m working on the assumption that the Fed knows this, and the combination of core inflation that seems steady around 3.5% (abstracting from the shutdown gap), better-than-expected labor market indicators, and a distinct animus among current Fed leadership towards the President means that there’s no reason to expect an adjustment in overnight rates any time soon. Frankly, I think the argument is better for a rate increase than a rate decrease. On the other hand, rents do appear to be continuing to decelerate even if we ignore the October gap. My model says that isn’t going to continue, and even if I’m wrong I’m likely to be closer than the folks calling for deflation in housing. And moderation in Supercore is encouraging, even if – again – I don’t think that continues to the point the Fed needs it to be. Core goods inflation appears to have peaked, and the question is whether we go back to core goods deflation or not.
In each of these cases, my modeling suggests that the current level of median inflation of around 3.5% (ex-gap) is likely to end up being an equilibrium-ish level. But it isn’t ridiculous to look at the current trends and see good news on inflation. Either way, there’s not a Fed ease coming imminently. But if those trends continue until Warsh is confirmed and becomes Fed Chairman, there could be a rate cut later in the year.
But that’s not January 2026’s story.
My Quick, Early Opinion About the Warsh Nomination
Before I tell you what I think about Trump’s nominee for Fed Chairman, Kevin Warsh, I should first confess to the fact that my opinion of Chairman Powell has changed several times since he was first nominated. That’s a user-beware warning about my thoughts below, but it’s not just about me. I’ve watched the Fed since about 1990 – I wrote a book leaning against the perception of Chairman Greenspan as some kind of “Maestro” – but what happens when individuals meet institutions is that both are changed. The classic example is that Presidents always govern closer to the middle than their campaign rhetoric, but it is a general rule.
In Powell’s case, I was initially very optimistic. Powell was a non-economist, the first such to have led the Fed since G. William Millers’ brief tenure prior to Volcker. “Maybe,” I thought, “Powell will be less likely to automatically buy into the assumptions of the poorly-performing models the Fed has used for the last few decades, and move away from them. My opinion fairly quickly shifted once he became Chairman and made it abundantly clear that he had basically learned everything he needed to know about monetary policy from the existing staff at the Fed. Total regulatory capture, in other words. And he moved too slowly when COVID hit and it was very obvious that inflation was going to spike given the government’s efforts to keep demand strong with lots of money, while supply had collapsed. He was totally Team Transitory, and totally wrong.
But then, the Fed actually started raising rates, and raised them far more than I thought that a traditionally-dovish institution was going to. My opinion of Powell rose again. Yes, it was exactly inverted to the right approach – instead of raising rates and letting the balance sheet stay large, he should have kept rates low and slashed the balance sheet – but he at least thought he was being hawkish. My opinion of him took a final turn lower, when his Fed made nakedly-political interest rate moves in the runup to the 2024 election.
In the end, I rank Powell well above the disastrous Yellen and the disconnected-from-the-real-world Bernanke, but below Greenspan. Indeed, while I don’t think Greenspan was any part of a “Maestro,” and he changed the Fed in some incredibly damaging ways (making it far too transparent)…I feel kind of bad in retrospect for my book since his three successors have all been worse.
Anyway, that is a long prologue but let’s face it, we have far more information about Powell than we do about Warsh. I want it to be a warning, though, about the fact that whatever I/we think today about Warsh, we should let his future actions inform our opinions!
So here’s what I think…and I am only telling you because some of you asked:
I think Trump could have done a lot worse than Warsh. While the President regularly confounds his critics by making solid decisions when they expect the ravings of a madman, this one surprised me too. For all his railing about how interest rates should be lower, and the Fed was moving too slowly, etcetera, he ended up choosing someone who is certainly on the hawkish side of the ledger…certainly with respect to the other people supposedly being considered.
Now, Trump isn’t wrong when he says the Fed did not manage the inflation spike or its aftermath very well. As I’ve said for a long, long time, managing inflation is about managing the money supply – and interest rates have nothing to do with inflation. I don’t think Trump is being this nuanced, but it’s the right answer: shrink the balance sheet, rein in money growth in other ways…and lower interest rates, because one thing we do know is that money velocity is influenced by interest rates. That’s how you get a non-inflationary boom, and it would be funny if Trump got there by accident. (Or…is it?)
But this is the way Warsh is supposedly leaning: near-term dovish, but hawkish on the balance sheet. Also important, as I alluded to earlier when talking about how the Fed has become more and more transparent: allegedly Warsh tends towards less communication about policy. If you want to de-lever the dangerously levered global financial system, a great place to start would be to decrease the predictability of monetary policy. More visibility = more risk taken, which increases systemic risk.
One of the things I hope for Warsh is that he ignores Bill Dudley’s advice, given today in a Bloomberg column. Dudley’s #1 piece of advice was “first, he has to win the confidence of his colleagues at the Fed. Although the chair directs the Fed’s staff and sets the agenda at each meeting of the policymaking Federal Open Market Committee, ultimately he has just one of 12 votes. To truly wield power, he’ll have to earn respect. He’s made this more difficult with his persistent criticism that the central bank needs “regime change” and that he might need to “break some heads.””
The incoming Chairman should completely ignore that. It’s nonsense and Dudley knows that. The power to set the agenda is the only power that matters – no Fed Chair has ever been even remotely close to being outvoted, and that’s partly because no Chair would ever call a vote he could lose. Dudley, and all Fed careerists, want to make sure the vast staff at the Eccles Building matters, and that the bureaucracy continues to be what actually sets policy. This is exactly what the President is complaining about, and he is not wrong!
The Fed doesn’t need to be “ended,” but it needs to be a lot more opaque and a lot more introspective about the historical incidence of Fed actions that caused harm versus those that caused good. It needs to be tighter on the balance sheet; overnight interest rates are roughly neutral but don’t really matter that much. At first blush, from my perspective, Warsh falls on the right side of those divides. Casting back to my earlier warning that I am willing and able to have my mind changed on this score as we learn more about the Warsh Fed, I will say at this point that I am pleasantly surprised.
