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Fair is Fair, and TIPS are There (Almost)

September 30, 2022 6 comments

For a very long time, I have been writing in our Quarterly Inflation Outlook that TIPS were “relatively cheap, but absolutely expensive.” By that I meant that TIPS real yields at -1%, -2%, etc were not exciting (implying as they did that a buyer would have long-term real wealth destruction), but that compared with nominal Treasury yields of 1%, 1.5%, or 2% any investor in fixed income should have vastly preferred TIPS.

I have repeatedly said – as far back as 2016 – that with breakevens below 1.5% there wasn’t even a decent strategic case to own nominal bonds rather than inflation-linked bonds (ILBs) except to defease specific nominal liabilities and that at times those low breakevens meant that owning nominals instead of ILB amounted to a really big bet (as I said in this article from March 2020). Those are relative concepts.

But 10-year real yields were below zero, and as low as -1.2%, for most of 2020, 2021, and the first half of 2022. And 10-year real yields have been below +1% almost continuously since 2011. When real yields were below zero or just fractionally positive, it meant that TIPS were absolutely expensive. That wasn’t just a TIPS problem of course: low real yields were the most obvious in TIPS, but you couldn’t avoid them by trafficking in other asset classes because they were a characteristic of the environment we were in. Everything was absolutely expensive, but TIPS were at least relatively cheap.

More recently, our models indicated TIPS getting quantitatively fair on a relative basis, which is historically unusual (see chart, source Enduring Investments); they even got somewhat rich a couple of months ago and that’s historically unheard of.[1] Real and nominal yields were still low, but at least it was a fair horse race between which ones to hold. And if you’d bought TIPS when I said there was “a big bet” being made against them, and sold them when we said they were fair, you crushed a nominal portfolio’s return. (As an aside, the rich/cheap chart and value is available every day on my private Twitter feed. Sign up for that private feed here: https://inflationguy.blog/shop/ I keep adding more charts etc, in addition to the main event, my live CPI report coverage each month).

As of today, 10-year TIPS yields are all the way up to 1.67%, the highest they’ve been since 2010. I explained back in June why the equilibrium risk-free real interest rate is approximately 2.25%, so TIPS are getting to the neighborhood of long-term fair values in an absolute sense. TIPS have no risk in real space, when held to maturity, so if you can get an annual 2%ish real increase in wealth with no risk, that’s a good deal. And inflation-linked bond yields in developed markets basically never yield more than 4% or 4.5%, so the higher the yield goes the less your potential mark-to-market downside. A 5-yr or 10-yr TIPS yield of 4% is back-up-the-truck stuff if you see it. At those real yields, with no risk, other asset classes simply can’t compete. At 1% breakevens there was no reason to own nominal bonds rather than TIPS; at 4% real yield there would be no reason to own stocks rather than TIPS.

But that sort of yield is of course very rare and we won’t see it unless nominal yields get up to double-digit land. At the current level, with TIPS at fair or slightly-cheap relative value and approaching fair absolute value, it is worth accumulating TIPS as a long-term hold.

It has been an astonishingly long time since I could make that statement. And TIPS may well get cheaper from here. I hope they do! But in the meantime, you can do a lot worse than guarantee yourself that your wealth will increase 18% more over the next decade than the price level rises.[2]


[1] I have written previously though about the value of long inflation tails, and how that value is NOT reflected in TIPS so that even when our model says TIPS are fair, they’re still very cheap if that tail option is reasonably valued. But that isn’t included here.

[2] (1+1.67%)^10 – 1 = 18%.

Categories: Bond Market, CPI, TIPS Tags:

Corn Prices – Has the Correction Run its Course?

September 21, 2022 1 comment

Recently there has understandably been a lot of focus on the extremely high prices of agricultural products. The front Corn futures contract hit an all-time month-end high back in April, at over $8/bu (see chart, source Bloomberg). Over the last decade-plus, in fact, grain prices have been generally higher and more-volatile than in the 40 or so years prior to the GFC.

It is always good to remember, though, that because the overall value of the currency is in more or less perpetual decline, it is expected that the price of any good or service should be expected to rise over time. The more important question is, what has the real price of grains done over the decades? And here, the picture is starkly different and looks like the chart of many, many goods. It’s the way that the real price of consumer goods should look over time, given that the arrow of productivity points mostly in one direction. This one chart shows the price of corn, in 2022 dollars. Back in the 1970s, corn only cost $3/bu, but the dollar was worth more then. It would have taken more than $20 of today’s dollars to buy a bushel of corn in mid-1974.

The chart also has an orange line on it, which shows the US Cereal Crop Yield each year according to the World Bank.[1] I’ve inverted that series, so that when we are able to get more crops from each hectare, the line declines. It’s also on a logarithmic axis.

The point of this chart is merely to illustrate that real corn prices have declined over a long period of time because contrary to Mathus’s fears the production of cereal grains has been able to keep up and in fact exceed the increase in the demand for them over time. The chart is necessarily imprecise, since we’re not considering how the number of hectares producing corn changes each year, and we’re not looking at specific corn yields. Nevertheless, you will notice that many of the spikes in prices are associated with spikes (that is, dips, since it’s inverted) in crop yields. Which makes sense, of course.

What causes changes in crop yields? Different planting and harvesting techniques are obvious improvements that are pretty much one-way. Also, improved fertilizers and pest control, and better use of the proper mix of fertilizers. But then why do crop yields sometimes decrease, if all of these things tend to get better over time?

One obvious answer to that is the weather. Less obvious is that the use of fertilizers isn’t constant. When fertilizer prices are high, farmers try to use less and that reduces crop yields. Also – and this is directly relevant to today – when there is a shortage of fertilizer then less of it is used and the price of fertilizer goes up. With the conflict in Ukraine and the cutting off of natural gas supplies to Europe (natty is an important input into the manufacture of some fertilizers), we are in that sort of situation. If we overlay real corn prices with real fertilizer prices[2] you can tell that these are closely related series.

So in the long run, the general level of corn prices is driven by the purchasing power of the dollar (aka the overall price level) and the steady improvement in agricultural productivity. In the short run, corn prices are driven by fertilizer prices.

Fertilizer prices have come down somewhat. The continued embargo of natural gas into Europe has only a small effect on fertilizer supply, and Russia only directly provides about 10% of the global supply of fertilizers.[3] But the overall level of commodity inputs into the manufacture of various sorts of fertilizer obviously impacts the output price. I suspect it will be a while before fertilizer prices even in real terms get back to their pre-COVID levels. And the overall CPI is not about to decline any time soon. Does that mean that corn (and wheat, etc etc) prices can’t decline from here? Of course not – but my guess is that we’ve seen most of the good news on the agricultural commodity front for a while.


[1] https://data.worldbank.org/indicator/AG.YLD.CREL.KG?locations=US Annual data through 2020.

[2] US Cornbelt Urea Granular Spot Price, source Bloomberg. The 1:1 congruence of scales and amplitudes is mostly coincidental – one is cents per bushel and one is dollars per short ton.

[3] https://www.fas.usda.gov/data/impacts-and-repercussions-price-increases-global-fertilizer-market

Summary of My Post-CPI Tweets (August 2022)

September 13, 2022 7 comments

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy, but to get these tweets in real time on CPI morning you need to subscribe to @InflGuyPlus by going to the shop at https://inflationguy.blog/shop/ , where you can also subscribe to the Enduring Investments Quarterly Inflation Outlook. Sign up for email updates to my occasional articles here. Investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments! Get the Inflation Guy app in your app store! Check out the Inflation Guy podcast!

The tweets below may have some deletions and redactions from what actually appeared on the private feed. Also, I’ve rearranged the comments on the charts to be right below the charts themselves, for readability without repeating charts, although in real time they appeared in comments associated with a retweeted chart.

  • Back to CPI Day – my favorite day of the month. Yours too? I’m glad.
  • A reminder to subscribers of the path we take today: First the walkup; then at 8:30ET, when the data drops, I’ll be pulling that in and will post a number of charts and numbers, in fairly rapid-fire succession.
  • I will put replies to those charts as necessary. Then I’ll run some other charts. What I will NOT be doing this month is the live commentary. Last month, that actually slowed everything down because of the multitasking.
  • So instead, afterwards (hopefully 9 or 9:10ish) I will have a private conference call for subscribers where I’ll quickly summarize the numbers. Not sure if that’s valuable, but we’ll try it.
  • After my comments on the number, I will post a partial summary at https://inflationguy.blog and later will podcast a summary at http://inflationguy.podbean.com . And all of that also will be linked on the Inflation Guy mobile app.
  • Thanks again for subscribing! And now for the walkup.
  • There was a talking head this morning saying “we should only care about the sequential number, not the y/y number. Those usually say the same things but not recently. And the sequential number is fresher” (I’m paraphrasing).
  • Couple of things wrong with this statement but I will focus on the main one: there is no planet on which one economic data point should matter overmuch to your view.
  • Can one number refute your null hypothesis? These are experiment results, samples from a distribution we can’t know. One data point would have to be wildly different than your null, and if it was then you’d suspect there is some quirk in the data.
  • For example, that’s what happened last month: median CPI printed again a little above 0.5%, but there was a very low headline number (because of gasoline) and a very low core because of large movements in small categories.
  • Large moves in small categories aren’t likely to be repeated, and they don’t tell you a lot about the overall distribution. They are more likely to be mean-reverting than trending. They shouldn’t change your view much, especially since Median is still rising at >6% pace.
  • The other issue with what he said is: the real question isn’t whether inflation is accelerating or decelerating. It is decelerating, and so the y/y number will decline. Most of the deceleration is in core goods. That has been expected for some time. Partly ports, partly dollar.
  • The real question is: will we recede on core/median to 2.5%, or 5%? I think it’s closer to the latter than the former, and not until next year, but there is no way that ONE NUMBER could really answer that.
  • So I care about sticky, I care about whether we are seeing a new uptrend in core services, I care about rents. I don’t care so much about lodging away from home.
  • Now, that doesn’t mean we should ignore this number. Indeed, to me it seems that expectations for this number have swung really to the low side. Both in economist land and in trading land.
  • Here is a chart of changes over the last month. Large declines in breaks at the short end – although to be fair a decent part of that is carry. But the optics influence the forecasts of those who don’t really dig into the guts, and that might be an opportunity.
  • Forecasts to me look low. Consensus is -0.1% on headline, +0.3% on core. The y/y forecast for core is 6.1% (which tells us that the real forecast is 0.32%-0.34%. Any higher and m/m rounds to 0.4%. Any lower and the y/y rounds down to 6.0%.)
  • That seems low. Last month’s 0.31% on core was infected by a lot of one-offs. Airfares -7.8%, Lodging away from home -2.7%, car/truck rental, etc. But primary rents were 0.7% m/m, and OER 0.63% m/m. So how do we get another 0.32% on core?
  • Well, you COULD get a retracement of some of the rents rise last month. That’s really the only thing I’d worry about. Some of the drops from last month may retrace (although core goods deceleration is real). But 0.3% seems sporty, especially with median still where it is.
  • The core/headline spread looks to me like it should be about -0.36%, so if we get 0.4% on core then we could print a small positive on headline. I think that’s where the risk is, unless rents are way off.
  • Used cars will drag a bit again this month, but it won’t be large.
  • I should say the interbank market is more in line with me than with economists. 295.71 NSA traded yesterday. That would be an NSA m/m decline, and a small positive SA.
  • The real question is the Fed’s reaction function. And I think their reaction to THIS number is basically nil. They’re going to go 75bps at the next meeting because the market has validated that level. The question is NEXT meeting; that will depend on how markets are behaving.
  • The Fed BELIEVES they are close to done, which is why Powell can make a vacuous “until the job is done” statement. The job (shrinking the balance sheet) has barely started, but they may be close to done on short rates.
  • Because if they’re ahead (and they think they are), at some point they need to pause to see the effect of their actions to date.
  • For today, there may be downside equity risk if the number is a little higher as I expect. But if it’s as-expected, there may be UPSIDE risk…probably fadeable, but I think the market reaction function and the Fed reaction function may be diverging.
  • So I know what I’m going to do when the number prints what the number prints, but I am less sure of what the market is going to do. Kinda feels there is still downside to equities. With real rates where they are, equities still look expensive (chart uses our equity return model).
  • OK, that’s all for the walkup. Number in 10 minutes. Good luck!

  • oooops
  • M/M, Y/Y, and prior Y/Y for 8 major subgroups
  • Food and beverages still rising. 0.77% m/m and 10.9% y/y! All other subindices contributed. “Other” was +0.73% m/m so that will be interesting. Medical Care +0.68% and that is also going to be interesting/disturbing.

  • Here is my early and automated guess at Median CPI for this month: 0.738%
  • Look at the median chart. This is just an estimate, and depending what the median category is it might not be precisely right…but if it is, then the 0.738% m/m is a new high for the m/m. OUCH.
  • Core Goods: 7.06% y/y Core Services: 6.07% y/y
  • Core goods actually went UP y/y, just a tiny bit, 7.06%. And core services continuing to rise, 6.07%. Convergence at 6.5% is not what people were hoping for.
  • Primary Rents: 6.74% y/y OER: 6.29% y/y
  • Further: Primary Rents 0.74% M/M, 6.74% Y/Y (6.31% last) OER 0.71% M/M, 6.29% Y/Y (5.83% last) Lodging Away From Home 0.1% M/M, 4% Y/Y (1% last)
  • Primary rents 0.74% m/m. OER 0.71% m/m. That’s the big ouch. I read this morning on Bloomberg I think that ‘rents are near a peak.’ Uh, sure. Lodging Away from Home was positive…didn’t retrace last month’s drop, but didn’t repeat it either.
  • I mean, this is a little scary, right? No sign of a peak yet.
  • Some ‘COVID’ Categories: Airfares -4.62% M/M (-7.83% Last) Lodging Away from Home 0.08% M/M (-2.74% Last) Used Cars/Trucks -0.1% M/M (-0.41% Last) New Cars/Trucks 0.84% M/M (0.62% Last)
  • Airfares keep sliding, but again a lot of this is jet fuel. As has been pointed out elsewhere, if you quality-adjust airfares then inflation is still soaring. Used cars was a small drag, as expected. But look at new cars!
  • The rise in new cars is probably the reason that core goods advanced. 0.8% m/m in new cars is impressive.
  • Piece 1: Food & Energy: 15.7% y/y
  • Only surprise here is that it isn’t retracing nearly as much as people expected. You know why? FOOD. When was the last time we really worried about food prices driving the CPI?
  • Piece 2: Core Commodities: 7.06% y/y
  • Piece 3: Core Services less Rent of Shelter: 5.75% y/y
  • This is even more concerning than the shelter numbers, in my mind. I’ll dig deeper into medical care, but this has been a well-behaved part of CPI for a long time. BUT IT’S WAGES. That’s what matters in this group. This is where your wage/price spiral would show up.
  • Piece 4: Rent of Shelter: 6.31% y/y
  • So 0.12% on headline (SA), 0.57% on core. Not exactly what the market was expecting.
  • Yeah, so I guess last month were one-offs. But those of us “in the know” knew that, right?
  • Last 12 core CPI figures
  • Stocks are NOT happy with this. And that’s no surprise! But it’s not because the Fed is going to go 100bps this month. They won’t. It’s because suddenly “maybe they’re not as close to done as we thought.” More on my thoughts about the Fed later.
  • I need to run some of my slower charts now but looking at markets the only quirky thing – I understand the market but it’s weird – is that energy prices are down. The theory is that more Fed hikes slow the economy more, but if you’re connecting growth and inflation then>>
  • …you’d have to also say that growth must be stronger than we think. Energy is confusing nominal and real prices again, too. Maybe it’s a dollar thing. Dollar is definitely stronger as Fed arc is perceived higher now.
  • …but it’s a weird idea that the more inflation you get, the more you want to sell commodities, isn’t it?
  • Core ex-shelter rose to 6.36% from 6.04%. Back to the level of May. Hard to tell on this chart. This will probably continue to decline, but…this is the really surprising part of the report. Going to get to the smaller stuff in a bit and see what’s up.
  • Car and Truck rental was -0.5% m/m (NSA)…it was a big drop last month as well. Interesting and not sure what that means.
  • No other interesting declines. On the upside was New cars…at 4% of the basket, that was 3-4bps of the surprise roughly. Not enough to explain it all!
  • Lots of other motor vehicle stuff. Maintenance and repair, insurance, parts and equipment…all rose at greater than a 10% annualized pace.
  • Also…south urban OER rose 0.9% m/m or so. So rents and prices are rising in the south, but not falling in the north. Some of that is migration. The median category was Rent of Primary Residence, which as noted was large.
  • With the median as Primary Rents, my 0.74% m/m median guess is probably pretty solid. That takes y/y median to 6.7% I believe. yowza.
  • Medical Care…Prescription Drugs +0.36% m/m (NSA). Dental Services +1.31%. Hospital Services +0.78%. YES. I’ve been wondering where this was for a long time. Still only up to 4% y/y, but it’s way overdue.
  • Similarly, prescription drugs…3.2% y/y, highest since 2018. I wonder if the determination that Medicare will ‘negotiate’ more drug prices is leading manufacturers to hike prices in advance?
  • OK…college tuition and fees, +1.3% m/m. That’s not unusual for the NSA to jump in this month; tuition jumps once a year basically. But that means the y/y change is going to move higher as the SA adjustment is smoothed in. Now it’s at 2.79% up from 2.35%.
  • Colleges have cost pressures too. And wage exposure. Over the last few years tuition inflation has been low because endowments and government support has been huge. This is all fading though, and costs are still climbing. Look out above.
  • Finally, in “Other”. We have cosmetics, perfume, bath, nail preparations (yes that’s a category) +2.3% m/m. Financial Services ex-Inflation Guy +0.87% m/m. Haircuts and other personal care services +0.66%. Notice something there? A lot of wages.
  • On the plus side, “Funeral expenses” was -0.5% m/m. So we got that going for us. Cigarettes +1.1% m/m.
  • While I wait for the diffusion stuff to calculate I’ll start the (brief) summary call. Dial the conference line at <<redacted>>. I’ll start in 3-4 minutes.
  • OK last chart. The red line here isn’t really going off the chart (yet) – it’s median at 6.99% (est). The EI Inflation Diffusion Index – no surprise – is not coming off the boil. Inflation remains high, but also broad. Some categories are slowing, but some are accelerating!

Honestly, I came into today thinking that this was a less-important CPI report than we had seen in a while. As I said in the walk-up, I thought the real question is whether this changes the Fed’s decision at the next meeting, not this month’s meeting. As it turns out, the answer to that is probably yes (but we have another CPI before that meeting). But the more important question that has re-surfaced is, “have we really seen the highs in inflation yet?”

That seems crazy to ask, if you believed that this was all one-offs caused by clogged ports and “supply constraints.” It hasn’t been about that in a long time – and really, never was, since those clogged ports were caused by artificially-induced demand – but if you’re still in that camp you’re utterly shocked here. But it still seems wild to ask from my perspective. My view has been that if the money supply has risen 42% since the beginning of the COVID crisis, and prices are only up 15%, then prices have a lot more to do before they are in line with money growth. But I thought that would happen more gradually, with a 5%ish inflation that stuck around longer than people expected.

That’s less clear now. If core services ex-shelter is really taking the baton from core goods, that’s really bad news. Because core services ex-shelter is where wage pressure really lives. We don’t import services; we pay people to provide them. If you want a wage-price spiral, look in core services ex-shelter to see if it’s happening. Honestly? That part of CPI was already looking a little spritely in recent reports. But it looks to have really broken out now. That’s very disturbing. It adds momentum to the CPI.

Ultimately, it’s still all about whether there’s too much money chasing too few goods. But if a wage-price spiral gets started, then that will manifest in higher money velocity over time so that even slower money growth will be associated with rising prices. That’s a bad thing.

By the way, it isn’t anything the Fed can break with interest rates. Decreasing the money supply has never really been the Fed’s focus, but that’s the lever they needed to be moving. And now? Doing that now would have less of an effect, if we have momentum in pricing again.

It’s still the right move, but the FOMC has made a terrible mess of this and is going to wear it.

That being said, there is another CPI due before the next Fed meeting. My thinking had been that the Fed figured they were close to done (otherwise, Powell beating his chest with the manly-but-vacuous ‘until the job is done’ thing…which by the way is going to become a meme just like ‘transitory’…just didn’t make any sense), so that if this number was as-expected they would be considering just how soon to pause their hikes. Maybe as soon as November. Now, that’s sort of out the window.

The market reaction makes eminent sense given this backdrop. But you didn’t need me to tell you that. Before this even printed, the fact that expected real equity returns were basically below long-term TIPS returns meant that being in equities didn’t make a lot of sense. It makes less now…at least, at this level. We may be about to see a different level.

Do Rents Really Actually Lead Home Prices?

The inflation thesis at this point has both a top-down and a bottom-up rationale (as all good theses do). The top-down rationale is that the extraordinary rise in the quantity of money over the last few years has yet to be fully reflected in the price level; ergo, inflation should continue for a while – even if money supply growth stops cold – because the price level has a lot of ‘catching up’ to do.

The bottom-up rationale depends a lot on what happens in the housing market. The first place that prices shot up was in the more flexible components of inflation, especially in goods. “Sticky” inflation followed, only turning north in 2021 and then accelerating in earnest especially as the eviction moratorium eventually ended and rents began to catch up. As the chart below (source: Atlanta Fed) illustrates, core “flexible” CPI (in white, right hand scale) is decelerating and is down to about 7% y/y…but core “sticky” CPI (red, left hand scale) is at 5.6% and shows no signs of even peaking.

An important part of the “sticky” basket is the weighting assigned to rents. Rents show up as both Rent of Primary Residence (you rent a place to live) and Owners’ Equivalent Rent of Residences (your opportunity cost is that you don’t have to pay for an apartment, so this is an imputed cost). Both rents move together, mostly because the Bureau of Labor Statistics reasons quite naturally that the best measure of the imputed rent a homeowner would pay is the market for rentals that he/she actually could pay. These two pieces of CPI are the biggest and the baddest, and they don’t even exercise. I always say that if you can forecast rents accurately, you will not be terribly wrong on overall inflation. Rents are the 800lb gorilla. Where they sit has a big influence on overall inflation.

Traditionally, observers of the inflation market have forecast rent based on a simple lag of home prices. There are reasons to suspect that’s not the whole story, but it has worked for a very long time. Here is a chart of the last 20 years or so, with the Case-Shiller index (lagged 18 months) in green and the Existing Home Sales Median Price y/y (lagged 15 months) in blue against Owners’ Equivalent Rent in red.

Even though inflation as a whole has been low and stable, home prices themselves have varied enough thanks to the housing implosion in the mid-2000s that you can see a reasonable outline of why inflation people tend to like this simple model. It’s at least suggestive.

Recently, that has been called into question by a researcher at the Mercatus Center at George Mason University. Kevin Erdmann wrote a paper published this year entitled “Rising Home Prices are Mostly from Rising Rents.” When the paper came out I tweeted it with the note “I need to read the whole paper.” If Erdmann is right, then the entire market is doing it wrong and (a) home price inflation should not be slowing down right now, since rents are not, and (b) the way the market models rents is just plain useless. So, this was definitely worth looking at from my perspective!

Well, I’ve read the paper. I am sorry to report that in my view, the author makes very strong claims but supports his argument with very weak statistics. That being said, I still think this is a paper worth reading – some might come to a different conclusion than I have.

It isn’t like I think the author is completely out of his gourd. It is absolutely reasonable to expect home prices and rents to be related since they are both ways to acquire shelter services. It isn’t as if Erdmann is saying that they aren’t related, and some of his cross-sectional data and findings are interesting. The problem is that he starts with a mental model of how things work, and then proceeds to show information which, given his assumptions, seem to support what he is saying. The mental model isn’t absurd: a home can be thought of as a way to purchase a whole stream of shelter services in one lump. When home prices rise, it could mean that buyers are evaluating this stream of services as being worth more than they previously were because they are observing rising rents, or because they were priced out of the rental market and chose to buy an asset with a shelter services component instead.

But it could also be the case that home buyers are reflecting rising expectations of long-term rent inflation, in which case spot rents needn’t change at all. It might be the case that home buyers are making totally stochastic decisions, and it just happens that when lots of people buy homes it pushes up home prices which then displaces people into the rental market.

All of these stories would result in time series that are highly correlated. And Erdmann has a number of illustrations and data points showing that there is a correlation. For example, he pointed out that in 2021, “the metropolitan areas with the highest rents also had the highest prices.” However, Erdmann’s real claim isn’t that home prices and rents are closely related, but that rents lead home prices. The point about the connection of rents and prices in various metropolitan areas is not evidence supporting his claim that rents cause prices, but it doesn’t refute it either. The problem is, he takes such data as support of his claim, when it isn’t. This turns out to be his modus operandi – start with a mental model of how it works, show data that demonstrates the two things are connected, and then assert causality.

In the paper, there is not a single test of causality. With time series, we can test whether one series statistically leads another in various ways; for example, with the Granger Causality Test (which doesn’t actually test causality but merely the lead-lag relationship). If the point of the paper is that (contrary to the usual assumption) movements in rents cause movements in home prices – which is a big claim – then at the very least I’d have expected to see a Granger test.

There is some evidence that statistical inference is not the author’s strong suit. He shows several clouds of data points where any reasonable person can see there is no clear trend, and then proceeds to run a regression line through them. The fact that we can calculate a regression slope – we can always calculate a regression slope – does not mean that it is statistically significant. And even if it is statistically significant, it may not be economically significant. Unfortunately, there are no such tests of significance in the paper and I suspect for several of the charts it would be impossible to reject the null hypothesis that there is no relationship at all between the variables despite a provocatively-drawn regression line.

He also has a figure (Figure 9 in the paper) which shows changes in prices and rents for a number of metro areas over time. Clearly, there is a positive relationship – but no one disputes that. The question is, does the relationship get better when you lag one of the variables? No such analysis is done.

In general, all the author “proves” is that there is a relationship between rents and home prices, which I think we already knew. The rest of it is storytelling, trying to persuade us that the causality makes sense his way. I don’t mean to suggest that the paper is a complete bust! The author does have some good ideas that I will borrow. He makes the point that discounting home prices by general inflation doesn’t really make sense because we don’t care about the general price level when we buy a home; we care about the price level of shelter. This is a simple point, but fairly profound in a way. It risks being somewhat circular if we aren’t careful, but it’s a good point.

And the funny thing is, despite the fact that I think the evidence is much stronger that the evidence for causality runs the other way, I agree with some of his policy conclusions. His main conclusion is that “…if rising rents are the more important factor [rather than temporary demand factors or monetary stimulus], then policies aimed at stimulating more construction may be more apt and may help increase real incomes for Americans in neighborhoods where rents have been rising.” I completely agree that, given the severe housing shortage that we seem to have in this country, that making it easier for builders to create homes and apartments would be good industrial policy.

But you don’t need to believe that rents lead home prices to think that is a good idea!

Summary of My Post-CPI Tweets (July 2022)

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy, but to get these tweets in real time on CPI morning you need to subscribe to @InflGuyPlus by going to the shop at https://inflationguy.blog/shop/ , where you can also subscribe to the Enduring Investments Quarterly Inflation Outlook. Sign up for email updates to my occasional articles here. Investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments! Get the Inflation Guy app in your app store! Check out the Inflation Guy podcast!

The tweets below have some deletions and redactions from what actually appeared on the private feed. But this is most of it.

  • It’s #CPI Day again. I know we all get excited about #inflation day. Or maybe it’s just me.
  • This month is special because we’re taking the CPI ‘broadcast’ private. Non-subscribers will get many – but not all – of these tweets in a summarized form, a couple of hours from now. But you get the whole shebang.
  • Here’s how this will go: I will give my usual walk-up. Then at 8:30ET, when the data drops, I’ll be pulling that in and will post a number of charts and numbers, in fairly rapid-fire succession.
  • Then I will start putting ‘replies’ to the charts with some remarks where necessary. At the same time, I’ll be running a live commentary on Zoom. (That live feed will go live just before 8:30).
  • Here is the zoom link, for subscribers only: <<REDACTED>>   You’ll be muted and cameras will be blocked as well, assuming I remember to do that. 🙂 But you can put questions in the chat (or on Twitter) if you like.
  • If you prefer the phone, you can get to the conference line at (518) 992-1112, access code <<REDACTED>>. I’ll be on both. I’ll look better on the phone.
  • I’ll also be tweeting some of the charts that are slower to generate and giving you my impressions on the fly. I think the whole post-CPI bit will take about 30 minutes, and my Zoom only goes 40 so that’s a pretty solid estimate!
  • After my comments on the number, I will post a partially-redacted summary at https://inflationguy.blog and later will podcast a summary at https://inflationguy.podbean.com . And all of that also will be linked on the Inflation Guy mobile app.
  • But of course, you get it first, and you get some things others won’t. Starting with my thanks for subscribing!
  • With that, let’s start the walk-up. Going into last month, we’d seen a dramatic collapse of breakevens: -210bps on the 1y, -70bps on the 5y, -50bps on the 10y. Some of this was the decline in energy, but not all. Implied core inflation also fell.
  • This month has seen a bit of a rationalization, and stability returning. Short breakevens still contracted because of gasoline, but longer inflation swaps/breakevens actually rose a smidge.
  • Since gasoline ‘caught up’ in a way, core inflation implied by swaps increased a bit. Right now, the curve implies 3.7% core CPI over the next year, 3.2% the year after that, then 2.95%, and so on. Actually, NOT pricing in that core will get back to the Fed’s target.
  • As an aside, to me this still looks low. There should be asymmetry to outcomes (5% higher inflation is more likely than 5% lower inflation) that implies these should have some option value and trade above our raw expectations for inflation’s path. Still, it’s not horrible.
  • Although I think the 3.7% for the next 1y DOES look quite low. We’re at 6%-ish right now on both core and median. It isn’t just one thing that needs to revert to some mythical mean. It’s the whole dang distribution. That seems challenging.
  • Especially since rents, both primary and OER, continue to surge. I’ll be honest: when I first sat down to think about this month’s CPI, I thought there was a chance for a small deceleration in rents, which jumped from 0.6% to 0.7% m/m on OER and slightly more on Primary Rents.
  • That was a big part of the upside surprise in core last month. But when I look at it…I’m not convinced that was necessarily an outlier. Yes, rents will eventually decelerate. But not yet I think. The chart here is census for asking rents and Reis for effective.
  • The gap between them came about during the eviction moratorium. I thought it would close. But asking rents are moving higher, not converging back. (Some other private surveys suggest asking rents may sag, but it seems speculative at the moment).
  • There’s another reason I’m concerned about rents, and I’ll talk about it on Zoom after the number when I’m working through the charts.
  • For this number today, the consensus is for 0.5% on core and 0.2% on headline because of the decline in gasoline. The OTC market has core around 0.54% and economists are at 0.49%, basically; they both round to 0.5% but the market is more bullish.
  • I’ve mentioned why I don’t think the downside risks from rents will necessarily materialize. But there are a couple of other downside risks.
  • Airfares, which is essentially energy services because it tracks jet fuel (see chart), will very likely decline this month. Some of this is seasonal, though – I adjust for that in the chart – which means that raw airfares could fall and not bring down airfare CPI.
  • Used cars seems overextended too and I’ve been expecting a correction there. The Black Book index Jan-June was -2% vs CPI for Used Cars +3%. FWIW, the Black Book index was down this month. So that’s another potential drag.
  • But…all of that sort of seems to be ‘in the price’ as they say. The last 3 core CPIs were 0.57%, 0.63%, and 0.71%, and the consensus this month is around 0.5%. So some of that is in the pudding already. I don’t know that I’m short at 0.5%.
  • Reaction function? Well, a strong core…I think even an 0.6% may qualify…is going to be rough on stocks and bonds. Another 0.7% and you’ll hear talk about an intermeeting move (I don’t think that’s likely).
  • Softer core, 0.4% print, will be initially taken well by the market. But be careful about jumping in. If we get an 0.3% or lower and the market rallies, sell into it because most likely there is a one-off that is pushing it lower. Watch the real-time Median I produce, to tell.
  • The market’s currently pricing in lots of good news, which is why I’d be leery about riding a pop higher. After all, the next 2 core readings to roll out of the y/y will be 0.18% & 0.26%…core will keep rising, so Fed heads are safe to react hawkishly to a modest core surprise.
  • That’s all for the walkup. I have to go refresh my coffee and turn on the conference line and zoom. Good luck and thanks again for subscribing.

  • 0.313% on core…definitely a surprise and we have to see why.
  • m/m CPI: -0.0193%   m/m Core CPI: 0.313%
  • Last 12 core CPI figures
  • M/M, Y/Y, and prior Y/Y for 8 major subgroups
  • Here is my early and automated guess at Median CPI for this month: 0.53%
  • Core Goods: 6.98% y/y Core Services: 5.54% y/y
  • Primary Rents: 6.31% y/y OER: 5.83% y/y
  • Further: Primary Rents 0.7% M/M, 6.31% Y/Y (5.78% last) OER 0.63% M/M, 5.83% Y/Y (5.48% last) Lodging Away From Home -2.7% M/M, 1.2% Y/Y (10.1% last)
  • Primary rents were 0.78% m/m last month, so the 0.7% was a modest deceleration but not exciting. OER was 0.70% last month so also a deceleration.
  • Some ‘COVID’ Categories:
    • Airfares -7.83% M/M (-1.82% Last)
    • Lodging Away from Home -2.74% M/M (-2.82% Last)      
    • Used Cars/Trucks -0.41% M/M (1.61% Last)       
    • New Cars/Trucks 0.62% M/M (0.65% Last)
  • The big story for ‘why the tail’ in core comes mostly from here, and maybe a bit in apparel (down on the month). An 8% drop in airfares is a big deal. Lodging Away from Home. And Used Cars wasn’t really a surprise, as I mentioned in my walkup.
  • Used cars could have been down more. I expected a decline, but there was room for more underperformance than that.
  • Piece 1: Food & Energy: 18.5% y/y  
  • Piece 2: Core Commodities: 6.98% y/y
  • Core commodities is where we find Used Cars and Apparel. New cars was still strong. We knew that as supply chain constraints cleared, this would moderate.
  • Piece 3: Core Services less Rent of Shelter: 5.26% y/y
  • Medical care was +0.44% m/m after 0.95% last month. Pharma +0.58% (0.38% last month). Doctors’ Services +0.27%, hospital services +0.49%.
  • Piece 4: Rent of Shelter: 5.76% y/y
  • Core ex-housing 6.04%, which is down from 7.6% in Feb, and dragged down by the same stuff the overall core was. But still pretty high.
  • a little surprised stocks holding as much onto their gains…this was soft for some really obvious reasons. It’s good news for the Fed but not GREAT. I guess it does take 75bps off the table probably.
  • It’s not time for a victory lap but I guess it does help to remove the sense of panic.
  • We’re still going to get higher core over the next couple of comps are easy and since the central tendency of this distribution is still strong, there’s no reason to think we’re going to keep getting 0s on core.
  • Checking my Median CPI. The median category as I said was Midwest OER, and since I manually seasonally adjust the OERs I could be a bit off. But looks like it will still be somewhere between 0.52 and 0.57 m/m…so again, no crash in the broad distribution.
  • Car and truck rental was also really weak, although a very small weight. Public Transportation, Lodging AFH, Misc Personal Goods, and on the Apparel side Infants/Toddlers and Men’s/Boys were all negative m/m.
  • Communication was also -0.33% m/m. Internet Services and electronic information providers was -0.81% m/m. That’s 1% of CPI, so that’s about 1bp of the core miss right there.
  • Also weak were various furnishings categories. Major appliances were -1.8% NSA m/m. Indoor plants and flowers…which has about the same weight as major appliances – check your understanding by answering why…were -1.2% NSA m/m.
  • “Other Furniture” was -4.3%! Other linens -1.8%. These are all NSA m/m figures. And this is where the supply chain squeeze lessening is going to show.
  • Here is major appliances PRICE LEVEL. Yes, they’re down, but they’re not going all the way back. The price level is permanently higher. What remains to be seen is how much of this is permanent and how much is ‘transitory’ due to supply constraints.
  • Same message from apparel – seasonally we tend to get a decline in July but this was larger than the normal seasonal which is why apparel was down m/m. And we import almost all apparel.
  • The message from the people who say inflation will go back down with recession is that unintended inventory accumulation is going to cause retailers to cut prices. Apparel is where you expect to see that first, because the seasons change quickly.
  • Here is the distribution of the CPI weights. There is more weight in the left tail, and that’s why core declined. But it’s REALLY in many cases that the weight in the left tail moved further left.
  • And here’s why I make that statement: the weight of categories inflating above 5% y/y went down only a tiny bit. So this is a left-tail event…which again is what median inflation is telling us.
  • The ongoing question is, “have inflation pressures peaked?” and “are we now in a disinflationary mode?” On the former, it’s too early to say but median at 0.53% rather than 0.7% is at least hopeful.
  • On the latter question, also too early BUT one small positive sign is that core inflation moved below median. It’s just one month, but remember: inflationary environments tend to have long upper tails (core>median), and v.v.. So watch this.
  • Median is going to get to about 6.27% y/y this month. And when the Quarterly Inflation Outlook comes out in a couple of days, you’ll see (if you are a client, or subscribe to it) that the midpoint of our 2022 median CPI forecasts have been moved WAY up to 6.3%. And 5.2% for 2023.
  • I think this is the last chart. The Enduring Investments Inflation Diffusion Index remains very high, no real sign of retracement yet.
  • So wrapping up. Stocks at this hour remain ebullient, while bonds have retraced some of the initial spike. It makes sense to reduce the probability of 75bps at the next FOMC meeting, even though this was mostly a left-tail event. >>
  • To be sure, I think the Fed still needs to reduce its balance sheet an awful lot, but if it just levels off then the price level will eventually converge to the rise in money growth. There’s a lot more to go there, though, which is why we’re not going back to 2% core soon.
  • So, I understand why stocks are excited. But I would be loathe to jump aboard unless the S&P can get above 4200 decisively and/or stay there for a few days. There’s a lot of optimism priced in. And CPI was nice…but the IMPORTANT parts aren’t yet “good news.”
  • In any event, thanks very much for subscribing and if you have any feedback, please write me at <<REDACTED>> and let me know! Have a good day.

Stocks at this hour continue to celebrate, and not entirely without reason. The Fed is much less likely to tighten by 75bps this month than they were before the number. However, we have some doves scheduled to speak today (Evans and Kashkari) so be attentive and if they’re still talking about 75bps, and keeping in mind there’s one more CPI print before the next FOMC meeting – it’s a sign that they really are focused on the bigger picture.

And the bigger picture is this: the economy is headed into a recession, but the signs on that will be unclear and/or people will be able to explain the signs away for a while. Meanwhile, inflation remains high and sticky, despite today’s number. I’m pleased that median CPI, which  exploded to 0.7% m/m in June, was back down to “only” 0.53% or so in July. But that’s still a 6.4% rate, and looking over the last several months you certainly can’t say there are any signs that inflation pressure is lessening or narrowing. At best, leveling off…and it’s even too early to be sure about that, given the continued acceleration in rents.

A year ago, I would have said that the Fed will take advantage of the weaker inflation data to back off of tightening some. But the Fed has been far more hawkish than I expected, and if they really do want to “get ahead” of inflation then they need to do it sooner rather than later since once core inflation starts to drop because of base effects, and the employment situation starts to weaken, there will be much more resistance to 75bp hikes. If Unemployment is at 5% and rising, they will not be hiking 75bps per meeting, no matter where inflation is.

So I’d repeat my admonition above – be careful jumping on board this equity rally. If stocks can sustain above 4200, then I have to reluctantly go along with the momentum. But I’d be careful about being too excited about inflation just because airfares dropped 8% this month.

Categories: CPI, Tweet Summary

Restructuring the Inflation Guy Content Offering

August 2, 2022 2 comments

For many years, I’ve been producing a blog and pushing free content. Before that, I wrote Sales and Trading commentary for Natixis, and before that Barclays, and before that Deutsche Bank, and before that, Bankers Trust. I never charged for any of that and neither did the banks, at least directly.

Writing, at least with respect to the blog itself, was part of my process of thinking through the economic and investing environment. I had to do that anyway, so distributing those thoughts was easy and the feedback/pushback I got was important and useful as well. It still is.

But over the years, my content offering (which is congruent to the set of Enduring Investments’ content offering) has widened to different channels and even different media. There is now an Inflation Guy podcast, an Inflation Guy mobile app, and even an Inflation Guy album of ‘80s hits. (Okay, not that one.) I’ve written two books and am contemplating a third. And then there’s Twitter. And as the number of content outlets and offerings metastasized, it has also become clear that I have gone way beyond just the idle penning of my musings and that this takes a lot of time. Some other things I would like to do would take even more time. So there needs to be a business purpose!

The hope has always been that some people who find these thoughts useful would become investing or consulting clients of Enduring Investments. Some have! And more will, in the future. But others may want some content and be willing to pay for the value, but not be willing or able to become clients. Consequently, I’ve been discussing with a bunch of my advisors how to capture the value that people are willing to pay, but not in the single avenue we presently offer (that is, becoming a client).

So I took a survey, and many of you participated. I want to tell you that I really appreciate the answers you gave and the time you took to answer the survey. It was well worth the two Visa gift cards (which, incidentally, haven’t yet been claimed – check your spam folders, folks, as I have written to two of you who are winners!). There were some very thoughtful comments and some good ideas. There was also some humor: one person put my address in for the raffle (I didn’t win). And then there was a bot! All of a sudden, one day I received a deluge of hundreds of responses. Some of these responses indicated that Inflation Guy content was worth $50,000 per month. I am flattered, robot, but money means different things to humans I guess. Fortunately, it was easy enough to cleanse the data of bot responses, which were fairly obvious…and, in retrospect, there is probably a thriving business out there of people pouring bot responses into raffles to tilt the odds. Live and learn.

On the basis of the responses, this is what we have decided to do with “Inflation Guy/Enduring Investments” content going forward.

First of all, free stuff:

  • The E-piphany Blog, which was at https://mikeashton.wordpress.com and now can be reached at https://inflationguy.blog . It has always been free, and will remain free. You can subscribe to email alerts of the content. The monthly summary of my CPI-day tweets will continue to appear here, a couple of hours after the release.
  • Cents and Sensibility: the Inflation Guy podcast. Free wherever good podcasts are found. There may someday be advertisements but the podcast itself will remain free.
  • My weekly Investing.com column, which is unique to http://www.investing.com . They have subsidized it so that you don’t have to.
  • The Inflation Guy mobile app. While there may be “premium content” on the app, the app itself will remain free as well as will a goodly amount of its content.
  • @inflation_guy on Twitter will remain a free follow. My blog columns and podcasts and other free content will funnel through that channel. The monthly CPI tweets, though, will not (see below).

And now, the new offerings. These, and any others we add in the future, are available on the blog site at https://inflationguy.blog/shop/ . Please note that Enduring Investments clients pay nothing for these offerings.

  • Inflation Guy Plus on Twitter – Private Twitter account subscription. I am moving the real-time analysis of the CPI report to a private, subscription-only Twitter account. I will release my charts as soon as possible after the number, and will also have a private live audio broadcast as I comb through the charts and data. (I haven’t figured out whether this will be on Discord, Google meet, Zoom/Skype, but will probably start as a simple conference number). @InflGuyPlus will also have other daily/weekly charts and commentary not available on @Inflation_Guy. The cost of a monthly subscription will be $99/month with a discount for an annual subscription. This is in line with other private Twitter offerings. For example, Damped Spring offers a private Twitter feed for $80/mo with similar content though of course less concentrated on inflation. And the results of the survey we took suggested this price is not inappropriate for the people who require the real-time analysis to make trading decisions.

I do know that some people will be disappointed this isn’t cheaper. It’s an unfortunate characteristic of walls: unless there are people on both sides, you don’t need a wall. (Again, Enduring Investments clients are automatically catapulted over the wall. Although that is an unfortunate metaphor come to think of it.)

  • Quarterly Inflation Outlook – I have been writing the QIO for more than a decade now. It comes out on the ‘refunding’ cycle: February, May, August, and November, within a couple of days after the CPI reports in those months. I decided to make single-issue subscriptions available, at least for now, hoping that after trying an issue people will sign up for the discounted monthly subscription. The current issue is $80 (right now, you can buy the August issue, which will be delivered via email when it is published); the preceding issue is $70 (in this case, that is the May issue) for an immediate download; earlier issues may be made available once I have time to sort through them and find ones with staying power. To test whether there’s any demand, I listed the Feb 2022 issue for $50. I also listed the 2020Q4 QIO, in which I look prospectively at the incoming Biden/Harris Administration, for $40. A recurring subscription gets a discount to $75/issue, which seemed to be acceptable to most of the respondents to the survey.

We are going to start with those two paid offerings, and see how it goes. There seemed to be some interest in a $2.99 monthly subscription which would update your personally-weighted inflation index, and in a $20 monthly subscription to a collection of model portfolios, but we will see how the response is to these products before adding other options.

One other quick comment about the prices: being a markets person, I will be attentive to dynamics that suggest I should raise or lower the price. But for you, if the price is acceptable there is no reason to delay subscribing. That’s because if I raise the price, all existing subscribers will be grandfathered at the original price; if I lower the price, I will lower it for all existing subscribers as well. So there is no price risk to you in deciding to buy now.

Now, let me mention one final offering. This has a very narrow audience but which audience seemed, in the survey, to be enthusiastic about deeper access to Inflation Guy.

“You take the blue pill—the story ends, you wake up in your bed and believe whatever you want to believe. You take the red pill—you stay in Wonderland, and I show you how deep the rabbit hole goes. Remember: all I’m offering is the truth. Nothing more.”

Morpheus, The Matrix

Let’s call this “Inflation Guy Prime.” It is really for the institutional investors and traders who want regular forecast updates and detail, some relative-value metrics and possibly trading signals, subcomponent forecasts/curves, and two-way communication with the Inflation Guy. Because of the two-way communication bit, this offering is capacity-constrained and so will be capped at a yet-to-be determined number of subscribers; the price will increase as we get more subscribers who want to be “Prime.” The current price is shown on the shop.

And so now…we see what happens. Thanks again to everyone who participated in the survey and offered independent, helpful suggestions. The offering will change and hopefully improve over time. We will add other offerings for readers/investors who have different needs. And we will figure out the right price points, eventually…but we had to start somewhere. Please let me know of any questions and/or suggestions you may have!

Summary of My Post-CPI Tweets (June 2022)

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy. Or, sign up for email updates to my occasional articles here. Investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments! Get the Inflation Guy app in your app store! Check out the Inflation Guy podcast!

  • Here we go again. It’s #CPI Day. #inflation
  • Before I get started with the walkup: after my comments on the number, I will post a summary at https://mikeashton.wordpress.com and later it will be podcasted at https://inflationguy.podbean.com . And all of that also will be linked on the Inflation Guy mobile app.
  • What sets apart this month from many over the last couple of years are two things.
  • First, economists are now fully in the inflation-liftoff camp, with forecasts that are starting to look more like the actual data. The consensus for Core CPI is 0.54%. The average core CPI for the last 8 months is…0.54%! Who says that Econ PhD isn’t worth the money.
  • Second, and more significantly: the market has completely erased the possibility of sticky inflation and reflects 100% confidence that the Fed will be immediately and dramatically successful in restraining inflation.
  • The interbank market is pricing in 1.2% headline CPI for this month, but a SUM of 0.3% for the next 3 months. Even if gasoline, which has recently plunged from $5/gallon to $4.66/gallon, goes to $3.50 and stays there, this implies core CPI immediately decelerating.
  • The decline in the inflation markets has been unprecedented. 1y CPI swaps have fallen more than 200bps over the last month. The real yield on the July-2023 TIPS as risen 220bps during that time. 10y breakevens are narrower by 47bps.
  • The 1y inflation swap of 3.75%, considering that core and median inflation – which move slowly – are currently rising at a 6%-7% rate, implies a massive collapse in core prices and/or gasoline.
  • And this is important to note: there is as yet almost zero sign of that. Could it happen? Sure. But the Fed just made a massive 7% screw-up on inflation. My confidence that they know exactly how to get it back to 2% is…low. And to do so quickly? Very low.
  • I mentioned earlier the consensus for core CPI is +0.54%, which would put y/y at 5.7%. The consensus for headline is +1.1% (interbank market is at 1.2%), putting y/y headline at 8.8% or 8.9%.
  • I don’t do monthly forecasts because I want you to respect me in the morning. But I will say that the SPREAD between core and headline this month seems very wide to me. Typically core vs headline is a function of gasoline prices in a pretty simple way (see chart).
  • Given where the monthlies have been trending, I think core could be a little higher than consensus and headline a little lower. But if headline surprises to the upside, I suspect that will be because core did also.
  • Rents will continue to be strong. Last month, primary rents and OER rose at >7% annualized pace, and that didn’t seem too out-of-whack. Used Cars will likely be close to flat, and we could get a drag from airfares (?). So I would shade the core forecast on the high side.
  • But unless core is a lot higher than that, 1.1% or 1.2% m/m seems a stretch.
  • Used Cars will likely be close to flat, and we could get a drag from airfares (?). So I would shade the core forecast on the high side, but I’m not hugely confident in that.
  • Later you will see a lot of headlines about that new high in y/y CPI, but core CPI will continue to slide from its recent high at 6.47% in March. But after this month, Core CPI has easy comps for the next 3 months. If we keep printing 0.5%, we’ll get a new high in September.
  • Like I said, that’s contrary to the market’s pricing at the moment.
  • As a reminder, I tend to focus on Median CPI partly for this reason – outliers in core can pollute interpretation. And the Median CPI y/y chart is unambiguous at this point: still accelerating. In fact, the m/m Median CPI is looking even more disturbing than this y/y version.
  • Which brings me to an announcement of sorts. I do all of these charts more or less manually from big spreadsheets. But this month I am trying something new with my Median estimate (the Cleveland Fed reports Median CPI around lunchtime).
  • This month I’m trying an experiment with that figure. It’s going to be produced automatically when the CPI data drops, within about 1 minute (fingers crossed). And tweeted automatically. Does that make me a bot??! If it works, I may do others of my charts.
  • The actual core and headline m/m changes will also be bot-tweeted. I hope.
  • Anyway – market reaction to this number will be very interesting. If CPI is higher than expected, I would anticipate a very negative reaction to stocks and bonds, and v.v. People will start talking about 100bps of tightening this month (I doubt we will get that though).
  • And if CPI is soft, we should get a positive reaction from nominal stocks and bonds…naturally.
  • But what of inflation markets? Traditionally, an upside surprise would be met by a rally in breakevens. However, if investors really believe the Fed is going to respond aggressively and sucessfully, with a chance of overdoing it, then breakevens may FALL with a high surprise.
  • I don’t think that would make sense, but it also doesn’t make sense for 5y breakevens to be at 2.52% with median CPI at 5.5% and rising, wages at 6.1% and rising, and rents at 5.1% and rising.
  • However, markets clear risk; they don’t forecast. The inflation markets are telling us that people believe they have far more exposure to declining prices than to rising prices, and so need to sell it. That seems nonsensical to me, but ::shrug::.
  • So it will be interesting to look at the reaction in breakevens, especially if it seems nonobvious with the number.
  • That’s all for now. Number coming up. Good luck.

  • well…the consensus got the spread right, if not the level!
  • m/m CPI: 1.32% m/m Core CPI: 0.706%
  • Here is my early and automated guess at Median CPI for this month: 0.731%
  • Hey, that worked.
  • So, Owners’ Equivalent Rent was +0.7% m/m; Primary Rents +0.78% m/m. Rents will eventually decelerate, although not decline, but this will take a while.
  • Largely as a result of rents, core services rose to 5.5% y/y; core goods fell to 7.2% y/y. Not actually good news, since services are stickier.
  • So airfares fell, -1.82% m/m after a 12.5% surge last month. Lodging away from home -2.82% m/m. Car and truck rental -2.2% m/m. But Used Cars and Trucks +1.6%; New cars and trucks +0.7%.
  • Baby food +1.1% (NSA), and 12.6% y/y. But the main plant that had been shutdown is reopening. So, we got that going for us.
  • With y/y core falling to only 5.9%, it makes it even clearer that we will hit new highs in September if not before. Especially with core services continuing to rise, the m/m figures just aren’t going to drop that fast. And the comps for the next 3 months are +0.31, +0.18, +0.26.
  • I kinda buried the lede that headline CPI rose to 9.06% y/y. However, that is going to be the high for a little while unless energy sharply and quickly reverses.
  • Babysitting the bot got me off my game a little. Forgot to post this chart of the last 12 core CPIs.
  • So, this was not the highest core CPI we have seen. We had bigger ones back in 2021. But those were driven by outliers – you know that because median CPI did NOT have those spikes. This 0.7% is much worse…it’s not from outliers.
  • In the major groups, Apparel was +0.79% m/m. medical Care was +0.67% m/m. “Other” was +0.47%. The rise in medical was broad, with Pharma (+0.38% m/m), Doctors’ Services (+0.12%), and Hospital Services (+0.26%) all contributing. Still lower than core CPI, but trending higher.
  • Core CPI ex-shelter did decline, though, to 6.1% from 6.4%. That’s good I guess?
  • 10y BEI +7bps. So remember I was concerned that an upside surprise could be met with LOWER breaks if investors really believe the Fed is in charge and is gonna go large. Well, they may go large (stocks getting killed), but inflation folks less sure they are “in charge.”
  • The median category looks to be Medical Care Services. And that bot chart actually matches my spreadsheet. It was just truncated until I clicked on it. Man, this looks ugly.
  • That would put median CPI at 5.952%, rounding up to 6%, y/y. Another record high.
  • Biggest increases in core categories were Motor Vehicle Maintenance and Repair (+27% annualized) and Motor Vehicle Insurance (+26%), both a function of rising parts and replacement costs. Used Cars/Trucks +21%. Footwear +21%. Jewelry +19%. Infants’ apparel +16%.
  • In median, the Cleveland Fed splits OER into four geographic categories. This month, “South Urban” OER was up at roughly 12.5% annualized (roughly, because I seasonally adjusted it differently than the Cleveland Fed does).
  • Biggest monthly decliners were lodging away from home -29% annualized; -23% car and truck rental. Public Transp -5%, Misc Personal Goods -4%.
  • OER at 5.5% is well above my combo model. But it’s actually a little below one component of the model, which is based on incomes. 6.1% annualized income growth means the REAL rent growth isn’t as big as it looks.
  • This is a disturbing chart. It shows Atl Fed wages minus median CPI. I’ve estimated the last point (Wages could still accelerate this month, but won’t as much as Median). For a while, the median wage was steadily ahead of inflation. No longer. That’s why cons confidence is weak.
  • Let’s do four-pieces. Piece 1. Food & energy up more than 20% over the last year. That’s the highest in many, many years. And it’s why Powell is suddenly interested in headline.
  • Piece 2: Core goods. Yay! This is the story they were all sellin’ back when we first started spiking. “Once the ports clear, inflation will collapse back.” Actually, they told ya that PRICES would collapse. That is not ever going to happen. But inflation in core goods will slow.
  • Part of the reason core goods inflation will slow is because of the persistent strength in the dollar. I don’t know that will last forever, but while it happens it will tend to pressure core goods inflation lower.
  • Piece 3, core services less rent of shelter. This is the scariest one IMO, because it has been in secular disinflation for a long long time.
  • Piece 4, rent of shelter. This is also a candidate for scariest. People keep telling me home prices and rents will collapse but there’s a massive shortage of housing and building is difficult. Real prices could fall and nominal prices still rise, and that’s what I expect. Later.
  • So, this is fun. I have run this in the past but had to shift the whole thing because most of the distribution was off the right side. So the left bar shows the sum of categories inflating less than the Fed’s 2% target. The right bar is the weight of categories inflating >10%.
  • The sum of the weights of categories inflating faster than 5% is now over 70%. This was essentially zero pre-Covid.
  • Well, I guess we can wrap this up with a look at the markets. S&P futures -60 just before the open. 10y yields +5bps. 2y yields +12bps. 10y breakevens +5bps. Actually less-severe than I’d have expected. This is an ugly number.
  • So, we keep being told tales that inflation is peaking. And it will. Surely it will. It’s just that there are things that are still going up.
  • Our problem is that we have trained our perception on a low-inflation world. When prices go up 10%, we expect them to fall back. That isn’t automatic in an inflationary world. Prices going up too fast are followed by prices still going up, but a little slower.
  • There is most definitely a wage-price feedback loop going on. The black line below is going to get to about 6% today. The red line – which is a better measure than avg hourly earnings – is not likely to fall under that pressure.
  • We are still in an inflationary world. We are still in an accelerating-inflation world. It won’t last forever. But it isn’t over yet.
  • That’s all for now. Remember to visit https://mikeashton.wordpress.com to get the tweet summary later. Try the free Inflation Guy mobile app to get lots of inflation content. Check out the Inflation Guy podcast. https://inflationguy.podbean.com Like, click, retweet, etc. Thanks for tuning in!

Okay, to be sure I have long been in the camp that inflation would go higher, and remain stickier, than most people thought. The early spikes in inflation, due to used cars, were to me a harbinger and not a one-off. This is not, and never has been, primarily a supply-side problem. Today’s inflation did not start on the supply-side. The shortages were caused by a sudden resurgence in demand, and that demand was entirely artificial. It was that demand that created the shortages. To call this a ‘supply side problem’ is either ignorant or disingenuous. In some rare cases, supply was permanently impaired. Refinery capacity, for example. But in most cases, it wasn’t. Real GDP is back on trend.

So then surely we can get inflation back down by destroying demand? No – that’s not how it works. If you destroy demand you will also destroy supply…because that’s how you destroy demand, by getting people laid off. Hiking interest rates will eventually do that – hurt demand and production, but not necessarily do anything to inflation.

To get demand down without destroying supply, you need to run the movie in reverse. You’d need to suck away excess money from the system. That’s not going to happen, of course; it’s easier to do a helicopter-drop than a helicopter-suck. At best, we can hope that money supply flattens out, and recently it has started to look like that’s happening. That would mean that inflation would continue until a new price level consistent with the new quantity-of-money level had been achieved. This is what we can hope – that even though the Fed isn’t draining marginal reserves, somehow money growth slows because demand for loans evaporates even though banks remains eager to lend.  

It might happen, but since we’ve never tightened policy in this way – rates only, not reserve restraint – we don’t really know how, how much, or if it will work. In the meantime, inflation continues to surprise us in a bad way.

The topic for the next couple of weeks is going to be whether the Fed decides to hike 100bps, as the Bank of Canada just did in a surprise move. The market had priced in 75bps, and then a deceleration. I expect they will not, although we need to be defensive against the same leaks-to-the-big-guys that happened last meeting. While the inflation numbers continue to be ugly, and employment has not yet rolled over in a big way, inflation expectations have collapsed. To a Fed that depends very much on the idea of anchored inflation expectations, those markets are saying “okay Fed, you win. Inflation is dead. Your current plan is sufficient.”

That’s not my view, of course. In my view, if you keep using the paddles and the patient doesn’t respond you either need to code him, or you need to find a different treatment. I rather think, though, that the FOMC will say “inflation lags monetary policy by 12-18 months, so we just haven’t seen our effect yet.” Then again, so far I have been completely wrong about the Fed’s determination to hike rates (to be fair, they haven’t yet been tested by a sloppy market decline or a rise in unemployment, but I didn’t think they’d even do this much so I am willing to score that as -1 for the Inflation Guy.)

What to do? With inflation markets fully pricing a return to the old status quo, and that right quickly, it would seem to be fairly low-risk to be betting that we don’t get there so quickly. It would be hard to lose big by buying short breakevens in the 3s, when it’s currently printing in the 9s. Possible, but I like that bet especially since it carries well. And since real yields have risen so much, and the inflation-adjusted price of gold has fallen so much, I’m even starting to like gold for the first time in years. I’m not nutty about it, but it’s starting to look reasonable. It has been a rough couple of months for just about every investment out there (except real estate!), but opportunities are coming back.

“The Great Demographic Reversal”

July 6, 2022 4 comments

I don’t often write book reviews and, strictly speaking, this isn’t one. I am not going to go into great detail about The Great Demographic Reversal, by Charles Goodhart and Manoj Pradhan. And yet, if you are reading about inflation – and in particular, you’ve read what I’ve written about inflation – then I think this is a book that you should read. It is important.

One of the dilemmas that people who model inflation have is that any given model of inflation in the United States tends to have a state shift around 1992 or so. Any model that you design works at best on the pre-1992 period or the post-1992 period. I mention this a lot, because while modern-day economists and policymakers are very content with their models because they’ve worked well for nearly 30 years (until 2021-2022, when the Fed has been so befuddled that Chairman Powell last week admitted that “We’ve lived in that world where inflation was not a problem.  I think we understand better how little we understand about inflation”), in my view they don’t really understand the underlying dynamics of big inflation shifts unless they can explain the state shift in or around 1992.

The most popular explanation is that inflation expectations abruptly became anchored at that point, causing inflation to suddenly become mean-reverting in a way it never did before. There have been plenty of takedowns of this idea, most notably by the Fed’s own Jeremy Rudd. My theory for some time has been that the sudden globalization and expansion of Free Trade following the fall of the Berlin Wall and the disintegration of the Soviet sphere of influence in the late 1980s, most-aptly summed up in this chart from Deutsche Bank, gave us a better tradeoff of growth and inflation for a given amount of money supply growth, but that that game was coming to an end at about the time Donald Trump was elected.

Goodhart and Pradhan, in the book I’ve referenced above, provide some additional support for that view but also go much farther and highlight the massive demographic wave that was cresting over the last quarter-century. It isn’t just the Baby Boom generation in the United States, but also (and critically) the opening up of China and the movement of rural Chinese to the cities that caused a massive outward shift of the labor supply curve. Since the title of the book gives away the ending I don’t mind sharing the point they make that the China demographic is shifting into reverse (as a foreseeable consequence of the one-child policy) and many other demographics-related trends are also. One of their big conclusions is that “for the past few decades, central banks have given too much credit to their own inflation targeting regimes and too little to demography in accounting for the disinflation we have seen.” (p.189-190)

The authors discuss the changing demographic landscape, and how this leads to a resurgence of inflation. They address a number of counterarguments, including (thank heavens) the “Why Didn’t It Happen in Japan” argument, and examine whether there is likely to be sufficient contrary forces coming from (for example) automation and the continued growth of India and Africa. They tinker with various policy proposals. I should say that I disagree with many of their policy proposals, which are redolent of some of the redistributional schemes common on the left.

But while I don’t like their solutions, I agree that they’ve identified the right problems and supported those views with plenty of charts and data. The book was published in late 2020, before the current inflation spike makes them look prescient. It was written prior to the COVID crisis, and there is an addendum chapter where the authors discuss whether and how Coronavirus changes their views. However, I think the authors would admit that they weren’t writing about the inflation spike of 2021-202x. They are really looking farther out. In their view – which I share – the basic forces which made the disinflation of the last 40 years possible (and possibly even inevitable) are moving into reverse, and we will struggle for many years with the difficult choices an underlying inflationary dynamic forces upon us.

I highly recommend this book.

The Coming Rise in Money Velocity

June 28, 2022 2 comments

As M2 money growth soared throughout the COVID and post-COVID period of direct stimulus check-writing funded by massive quantitative easing (QE), monetarism novices thought that this would not result in inflation because money velocity simultaneously collapsed. Consequently, they argued, M*V was not growing at an outrageous rate.

There was precedence for such optimism. In the Global Financial Crisis of 2008-09, money supply grew rapidly with the onset of QE and money velocity declined, never to recover. The chart below shows in a normalized fashion the rise in M, the decline in V, and the relative quiescence of MV/Q, which is of course P by definition as long as you choose your Ms, Vs, and Qs right.

A similar thing happened in this episode, so why would this be any different?

There are many reasons why these episodes are different. To name a few:

  • The absolute scale of the rise in M2 was 2.5x the rise in 2007-2010, and that’s being generous since that measures the growth in 2007-2010 starting almost 2 years before the first QE in November 2008 compared to only 15 months in the second case.
  • As I’ve written previously, QE in the first case was directed at banks; at the same time that the Federal Reserve was adding reserves it was also paying banks interest on reserves – because the point was to strengthen banks, not consumers.
  • 5y interest rates came into 2008 at 3.44%; they came into 2020 at 1.69%. Since velocity is most highly correlated to interest rates, there was less room for this factor to be a lasting downward influence on velocity (after the crisis began in 2008, 5y Treasury rates never exceeded 3% again except for a few days in 2018).
  • Bank credit growth never stopped in the 2020 crisis, while it contracted at a 5% rate in the 2008 crisis (see chart, source Board of Governors of the Fed).

The monetarist novices (you can tell they’re novices because they say things like “Friedman said velocity was constant,” which is false, or “velocity is just a plug number [true] and has no independent meaning of its own [false]”) insisted that velocity was in a permanently declining state and that there was no reason at all to expect it to ever “bounce.” After all, it bounced only slightly after the GFC; why should it do so now?

But after 2008, as I noted, interest rates bounced only briefly before declining again…with the added phenomenon that some global debt came to bear negative yields, calling into fair question whether there was in fact any natural “bottom” to velocity if interest rates are the main driver! And velocity, obediently, dripped lower as well.

There is at least one other big driver to money velocity, although it is rarely important and almost never for very long. And that is economic uncertainty, which creates a demand to carry excess cash balances (implying lower money velocity). A model driven (mainly) by rates and a measure of uncertainty has done a pretty good job at explaining velocity over time (see chart, source Enduring Investments), including explaining the collapse in velocity during the COVID crisis out-of-sample.

Now, explaining velocity is a helluva lot easier than predicting it, because it isn’t easy to predict interest rates. Nor is it easy to predict the precautionary demand for money – but at least we can count on that being somewhat mean-reverting. The latest point from the model shown above uses current data, and suggests (largely because of the rise in interest rates, but also because precautionary balances are declining) that money velocity should bounce. Not that the model predicts it will happen this week, but it should not be surprising when it does.

A rise in velocity would be a really bad thing, because the money supply is very unlikely to decline very far especially while bank credit growth continues to grow. The only reason we have been able to sustain 6% or 8% money growth for a very long time has been because we could count on velocity to keep declining with interest rates. If money growth ticks up at, say, a mere 6% while money velocity rises 5%, then nominal GDP is going to rise 11%…and most of that will be in prices.

Now, this is a very slow-moving story. I mention it now for one specific reason, and that is that we are almost certain to see a rise in velocity in Q2 when the GDP figures come out in late July. That’s because money growth for the quarter has been very slow so far. So far, the Q2 average M2 is 0.06% higher than the Q1 average. My best wild guess is that we will end up with an 0.5% annualized q/q growth rate. The Atlanta Fed GDPNow model estimates 0.25% GDP growth in Q2 (the Blue Chip Consensus is still at 3%). And if the inflation market is right, Q/Q inflation in Q2 will be about 11.7%. That’s CPI, so let’s be generous and say 9%. We don’t know all of these numbers, but we know 2/3 of all of them. Let’s use the Blue Chip consensus for GDP and assume M2 doesn’t spike next month and the price level doesn’t collapse. Then:

If that happened, the increase would be the largest quarterly jump in money velocity – absent the reactionary bounce in 2020Q3 after the 20% plunge in 2020Q2 – since 1981. And here’s the rub: because of the mathematics of declines and recoveries, that would still leave us with velocity that prior to 2020 would have been an all-time record low.

Does this matter? Not if you believe the monetarism dabblers, who will say this is a mechanical adjustment that will soon be reversed as velocity continues its long slide to oblivion. Nor will it matter to the Fed, who at best will take executive notice of the fact before ignoring it since they aren’t monetarists any longer. But for those who think that inflation comes from too much money chasing too few goods? It’s scary.

One Experiment Ends and Another Begins

June 15, 2022 5 comments

Today the Federal Reserve hiked rates 75bps, the biggest single-meeting increase since 1994. Two days ago, the markets had incorporated an expectation for 50bps. After a well-placed Wall Street Journal article that somehow everyone on the Street knew was a warning from the Fed, the markets immediately priced 75bps. I’ve never seen anything so dramatic, nor as blatantly insider. Giving weight to a “Fed mouthpiece” journalist who is assumed to have great sources at the Fed is a time-honored tradition. But I have never seen the entire market re-price with a virtual 100% certainty overnight based on a news article (especially when the last thing the Chairman had said on the subject of 75bps was fairly dismissive, not long ago). Ergo, I’m fairly confident that the article was only the public whisper. We will never know, and they like it that way.

Cynicism aside, today marked an important moment when the central bank finally admitted that inflation is higher and likely will stay higher than they previously have assumed (gone from the statement was a note that “the Committee expects inflation to return to its 2 percent objective and the labor market to remain strong”), rates will have to go higher – although they still don’t anticipate raising rates above inflation, according to the ‘dot plot’ – and that they probably can’t make this omelette without breaking some eggs.

Powell still refused to cop to the fact that this was a total policy error, and completely identifiable in real time. It’s always amazing to me that when policymakers make massive errors they always seem to think that no one saw the mistake coming. Greenspan said that about the tech bust. Bernanke said that about the housing bust.

But this was more than just a mistake. This was an intentional policy decision that was driven by a seductive but completely idiotic theory: the idea, promulgated by Modern Monetary Theory acolytes, that if the economy is not at full employment the government can spend any amount of money and the central bank can print it, and it will not cause inflation. The last two years were an experiment, testing that proposition. Massive government spending, financed by bond sales that the Fed promptly bought, was nothing more than MMT and lots of people said so at the time, including this author. In January 2021, right after the first stimmy checks went out, I wrote this:

So I expect that as things go back to normal, inflation will rise – and probably a lot.

This is the test! Modern Monetary Theory holds you can print all you want, with no consequences, subject to certain not-really-binding constraints. The last person who offered me free wealth with no risk was a Nigerian prince, and I didn’t believe him either. I will say though that if MMT works, then we’ve been doing monetary policy wrong for a hundred years (but then, we also leached people to cure them, for hundreds of years) and all of our historical explanations are wrong – and someone will have to explain why in the past, the price level always followed the GDP-adjusted money supply.

…and I’d also said something like that in November 2020. And in March 2020. And I certainly wasn’t alone. The meme that “MMT” stood for “Magic Money Tree” was well-traveled.

So this is in no way unforeseen. The prediction in advance was that this behavior would provoke very high inflation. And the MMTers said “pshaw.” They were wrong, and that experiment is over. The next person who mentions MMT, you are entitled to run out of town on a rail.

That’s the good news. [I will say that I did not believe the Fed would get religion this quickly, but then they also haven’t been punished by asset markets yet for turning hawkish. Still, I didn’t really think the Fed would get to 1% before they’d start reversing course, and I was definitely wrong on that!]

But now the bad news. We are starting a new experiment, and unlike the last one this experiment isn’t as obvious. The Federal Reserve is now, for the first time, trying to control high inflation by changing only the price of money, with no pressure at all on the quantity of money. Always before, the Fed changed interest rates by putting pressure on reserves. Banks that wanted to continue to lend had to bid up those scarce reserves, and so interest rates rose. As I’ve written frequently (and even talked about in my book “What’s Wrong With Money?” six years ago!), that isn’t how it’s done today. Banks live in a world where lending is not reserve-constrained at all, and only capital-constrained.

Changing interest rates, without putting pressure on reserves to drag down money growth, is an experiment just like MMT was an experiment. The Fed has models. Oh yes, they have models. Gobs of models. Given what we’ve just gone through, how much confidence do you have in their models? Here’s the thing. Raising interest rates, if banks have unlimited lending power, probably[1] means more money and not less. That’s because banks are very elastic when it comes to making profitable loans. Give them more spread, or a higher yield over funding, and they will lend a bunch of money. On the other hand, borrowers tend to be less elastic. If you’re a consumer who has an 11% consumer loan, and it goes up to 12%, is that really going to make you borrow less? Mortgage origination is one place where you’d expect to see an elastic demand response to higher rates, but less than you might think when home prices are rising 15% per year. In short, if you don’t restrain banks by pressuring reserves, I suspect it’s very likely that you get more lending, not less, with higher interest rates.

But we don’t really know one way or the other.

What concerns me now is that at least with MMT, we knew it was an experiment. It may have been a stupid experiment, or merely an excuse to do ‘transformational’ things in response to the COVID recession, but we knew we were doing things we had never done before. When we talk about interest rate policy, though, there aren’t a lot of people who think the Fed is doing anything new. People think that the Fed always operates by raising interest rates, because we “know” that “tightening policy” is synonymous with rate hikes. The problem is, that’s a mental shorthand. That isn’t, in fact, the way the Fed has historically operated. When the Fed was doinking around with inflation between 1% and 3%, the precise mechanism didn’t really matter – the Fed’s actions probably didn’t have any meaningful effect one way or the other. Now, however, we are in a dreadfully important time. There’s a reason that NASA tests rockets without anyone aboard, before they strap anybody to it. We, though, are all involuntary participants in this experiment.

Hope it ends better than the last one.


[1] Fine, fine, this is speculation on my part too because I haven’t done it either. But my forecasting record is better than the Fed’s.

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