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Summary of My Post-CPI Tweets (June 2023)

July 12, 2023 2 comments

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy, but subscribers to @InflGuyPlus get the tweets in real time and a conference call wrapping it all up by about the time the stock market opens. Subscribe 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. Individual and institutional investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments! Check out the Inflation Guy podcast!

  • Welcome to the #CPI #inflation walkup for July (June’s figure).
  • At 8:30ET, when the data drops, I will run a bunch of charts. Because Twitter has made auto-posting them difficult (still not sure it’s impossible), I’ll post those charts manually with commentary as I go. Then I’ll run some other charts.
  • After I’m tweeted out, I’ll have a conference call with my overall thoughts. This is usually around 9:30ish. Later, I will post a summary of these tweets at https://inflationguy.blog and then podcast a summary at inflationguy.podbean.com .
  • Thanks again for subscribing!
  • The forecasts this month are almost comically low. Keeping in mind that last month, core came in high at 0.44%, and hasn’t been close to 0.3% since October – my forecast is the highest except for Cleveland Fed.
  • The first forecasts out of major banks were low even though they had a bump higher from Used Cars. Such a bump seems unlikely, although last month I thought would drag and it did not. But the surveys are worse this month.
  • Later bank estimates penciled in declines in Used Cars that make more sense. For a while I thought I was doing something wrong.
  • I’m not TOTALLY sure Used Cars will be a LARGE drag. Black Book declined in June, but it also did LAST June, and the Used Cars CPI rose. So there may be a seasonal glitch here that’s not being picked up (or is over compensated for).
  • My arms-length calculation suggests an 8bp drag from a -2.4% decline in used car CPI, but I will not be surprised if it’s unchanged. I WILL be surprised at an increase.
  • On the other hand, used car CPI has been running ahead of Black Book for a couple of months so perhaps that effect already happened. Thus in classic economist fashion I split the difference and penciled in a 1.2% decline, a 4bp drag on core.
  • As you can see from this chart, once you make a minor volatility adjustment Black Book is a VERY good forecast of y/y used car CPI. There is volatility in the month/month (some due to seasonals) but it’s heroic to forecast a large miss.
  • Now, aside from Used Cars there must be other drags to give us the lowest core CPI in a long time. The large banks are looking for another decline in airfares and a retracement of the strength in lodging away from home.
  • (To be clear, I don’t usually spend much time looking at other forecasts until after I’m done with mine. But I peeked more this month because of the really low forecasts coming out).
  • Basically, the Covid categories, along with a sequential additional slowing in rents. I have rents a trifle softer too, but not a ton.
  • Traders on Kalshi though MUST have big declines in rents penciled in. The Kalshi forecast for core is among the lowest out there, AND it has been really steady. Decent volumes (compared to history) too. Never say never.
  • I think part of what is going on is that summer seasonals drag a lot from the NSA figure. By forecasting low month/month numbers, economists are basically saying the trends haven’t picked up like in a normal summer.
  • I am not so sure of that. A lot of those are broad trends, not just in Lodging Away from Home or rents. But I think that’s the source of some of these soft forecasts, implicitly.
  • A quick look at the month’s trading leading up to this. Pretty stable overall. Yields are significantly higher, but not in a sloppy way, and breakevens/CPI swaps only marginally wider. Slow summer trading for the most part it seems!
  • One final note here. I said last month that we want to see the numbers not only head lower but also BROADLY lower, not just pulled lower by a few outliers. That means rents, it means services ex-rents. Not just health care services, not just Used Cars.
  • So we will look beyond the headline for that. Good luck!
  • Kalshi ftw I guess! 0.158% on Core and 0.180% on headline.
  • First glance, I see -8.11% on Airfares and -2.01% on Lodging AFH. I still don’t see any airfares declining but they have been for several months. This is a BIG one.
  • This clearly looks like a trend change, but I’d be a little careful.
  • Decline in Education/Communication. Everything else positive but very tame.
  • Core goods (+1.3% y/y) went back down, although I suspect that’s mostly base effects. Core Services turning down more in earnest (+6.2%). But again…
  • OER and Primary rents have clearly peaked, but no surprise there. OER was +0.45% m/m, down sequentially from +0.52% last month; Primary rents were +0.46%, down from +0.49%. No collapse here.
  • So this tells the story better. My estimate of Median is 0.365% m/m. Still better! But not the collapse that core is suggesting. Which tells you the core drop is a tail thing.
  • Sorry, make my estimate 0.359%. Energy Services looks like the median category.
  • So the “COVID Categories” are where the intrigue is. Airfares as I said, -8.1% m/m. Lodging Away from Home -2.01% m/m. Used Cars was -0.45%, not as low as I’d expected but not an add. Motor Vehicle Insurance was +1.41% m/m…and probably will continue to be. New cars -0.03% m/m.
  • Car/Truck Rental -1.43% m/m. Baby Food -1.29%. Health Insurance the usual (for this year; reversing some next year) -3.61% m/m. College tuition is interesting, flat on the month.
  • But look: Food Away from Home: +0.38% m/m. Remember, that’s wage-sensitive. So let’s look at the four pieces and see what is happening to core services ex rents.
  • Before we do though, here is a chart of (NSA) Airfares. According to the BLS, airfares are back down to where they were pre-Covid. I do not understand that one.
  • Piece 1: Food and Energy. Declining on a y/y basis. Now, Food overall was up this month, so was energy, but less than the normal seasonals would suggest and less than last year.
  • This was always going to happen – food and energy mean-revert. It was only a surprise in how long it took.
  • Core goods, shown before. This is partly due to better supply chains but also partly due to dollar strength. The question is whether it goes back to 0% or slightly negative. I think that’s unlikely, and it matters for whether inflation ultimately settles back where it started.
  • Core Services less Rent of Shelter – this looks great! The usual reminder that some of it is a function of the Health Insurance drag that will stop in a few months, and eventually reverse. This will make the Fed feel better though. Yeah, it’s probably not as good as it looks.
  • And piece 4, Rent of Shelter. Still way up there, but hooking lower. Is it going to 3% like some forecast? No.
  • Core ex-housing dropped to 2.80% y/y, the lowest since March 2021. Part and parcel of the overall nice tone to these numbers. But a lot of them still trace back to a few things, which we’ll see when we look at the distributions.
  • This chart won’t change your life but I just want to update it with today’s numbers. Again I wonder what the people calling for an uptick in Used Car prices were looking at. Very modelable.
  • Don’t think I said that my estimate of y/y Median is 6.45%, down from 6.74% last month and 7.20% in February.
  • Biggest declines (annualized m/m): Public Transport -57%, Lodging Away from Home -22%, Car/Truck Rental -16%. See any outliers? Biggest increases: Motor Vehicle Insurance +22%, Motor Vehicle Maintenance/Repair +17%. Striking the low and high outliers sort of balance except…
  • And yeah, most of “Public Transportation” is Airline Fares. Other intercity transportation and Intracity transportation are small weights (and both positive m/m btw). The NSA decline in Airline fares was -6.5%. So not a seasonal glitch: airline fares are plunging. (?)
  • Just speculating…there’s been a lot of talk about the improved fuel efficiency so passenger miles are running far ahead of jet fuel demand. So maybe some of this is passing the increased efficiency on to customers (through competition, not benevolence).
  • Congrats to anyone who saw that coming to that degree.
  • Getting into some of the diffusion stuff. This is the Enduring Investments Inflation Diffusion Index. Dropping all the way to 12 this month. Very good news.
  • So gasoline and public transportation go into the mental model of the consumer as one chip each, even though the average consumer buys FAR more gasoline than public transport. But those chips in “transportation” aren’t the same as those in “the food aisle.”
  • Anyway that’s the short version.
  • Just saw Wireless Telephone Services was -1.46% m/m NSA. That’s odd – ever since data became basically free, the steady deterioration in wireless telephony costs has stopped. This won’t be repeated. The category is 1.8% of core so that’s 2.6bps of drag.
  • Last chart. You can see that there is a big weight in 2%-and-under items, a secondary distribution/smattering around 5ish, the two big spikes for shelter, and some far-right-tail items. This is an unclear picture.The far-left items are mostly goods, and the rest mostly services.
  • We can all “know” that the airfares and wireless stuff won’t be repeated, and recognize that wage growth is still high (6% on the Wage Growth Tracker) so the important wood is yet to chop. But shelter is in slow retreat, and overall trends look good.
  • The data is not exacting any price for a Fed pause. And indeed, hiking into this presents the risk of looking like too much, later. I think the odds of a Fed hike just dropped a lot (I never thought the argument in favor of one was very good, though).
  • OK, let’s do a conference call in 5 minutes, at 9:45ET. Call in if you want! [REDACTED] Access Code [REDACTED]

There is no doubting that this was a good number for the market, for the Fed, and for consumers. Yes, core inflation is still 4.8% y/y and Median is still well above 6%. But they’re declining, and that decline will continue.

It’s important to recognize, though, that there has been little debate that there is a deceleration coming in the y/y, partly because of base effects but partly because the Fed has stopped squirting liquidity everywhere. The question is whether inflation is headed back to 2% any time soon. Note that core goods is still well above zero, even with a very strong dollar. If Core Goods doesn’t get negative, there’s not much chance at getting core inflation back to 2% (and note that home prices are rising again, which puts paid to the argument that rents are going to imminently collapse because home prices are going to decline).

What we didn’t see in this figure was the broad deceleration that we really need to see. It is broadening, I suppose, which is why median CPI is slowly declining. We saw huge drops in a few categories that won’t be repeated. Airfares. Cell phones. What we didn’t see were huge jumps in any categories, and that’s encouraging.

The most interesting (and non-repeatable) part of the CPI data was airfares, which was a 5bp drag on core CPI. Amazingly airfares in the CPI are back to the level (not inflation rate, but the price level) seen prior to COVID. Part is lower jet fuel prices, as the regression above showed. But there’s more to it.

I find it plausible that some of the decline in airfares is due to less fuel intensity: more passenger miles with less jet fuel, which is a trend we’ve seen in the weekly energy data. But…have you really seen air fares going down? I haven’t. But I wouldn’t discard this data or expect it to reverse on that basis. Here’s one possible explanation, which is potentially a good reminder not to rely too much on anecdotal evidence without remembering to put the accent on “anecdotal” more than “evidence”: I don’t fly business class, and I don’t buy business tickets. If I were an airline, that’s where I’d be cutting prices – for the non-leisure traveler. Business travel is down, for sure, and is far more discretionary than it used to be. So if you cut the price to the business traveler, overall fares can decline…even if you and I aren’t seeing them. By the way, that’s not the BLS explanation but my supposition.

We need to remember that prior to this figure, there was strong stasis at about 0.4% for core CPI. It’s difficult for me to believe that we jumped from ~5% annualized to ~2% annualized on core, without a stop in between. That being said…this sort of number is great for stocks, and great for bonds, compared to just about any other print. I don’t necessarily think it’s a sign of a sea change, because the big slow-moving parts of CPI aren’t decelerating very quickly. But I can understand the enthusiasm in the markets among those who ignore value and ‘just trade the number’.

This figure also puts the Fed in a bind…or it would, if you really believe the Fed earnestly wants to yank rates up another 50-100bps. I don’t believe that, and think the Fed speakers are mostly burnishing their hawkish credentials to keep markets from getting ahead of themselves. Indeed, they might speak more hawkishly after this, making clear that further hikes are still on the table even though the odds of taking a pass this month just went up a lot.

So enjoy the number! But don’t necessarily get used to it. (That said…Kalshi traders right now have Core CPI for next month at 0.16% m/m. And they were right this month! But repeating this figure without airfares and cell phones will be a serious trick.)

Categories: CPI, Tweet Summary Tags: , , ,

Enough with Interest Rates Already

June 21, 2023 17 comments

One of the things which alternately frustrates me and fascinates me is the mythology surrounding the idea that the central bank can address inflation by manipulating the price of money, even if it ignores the quantity of money.

I say “mythology” because there is virtually no empirical support for this notion, and the theoretical support for it depends on a model of flows in the economy that seem contrary to how the economy actually works. The idea, coarsely, is that by making money more dear the central bank will make it harder for businesses to borrow and invest, and for consumers to borrow and spend; therefore growth will slow. This seems to be a reasonable description of how the world works. But this then gets tied into inflation by appealing to the idea that lower aggregate demand should lower price pressures, leading to lower inflation. The models are very clear on this point: lower growth causes less inflation and more growth causes more inflation. The fact that this doesn’t appear to be the case in practice seems not to have lessened the fervor of policymakers for this framework. This is the frustrating part – especially since there is a viable alternative framework which seems to actually describe how the world works in practice, and that is monetarism.

The fascinating part are the incredibly short memories that policymakers enjoy when it comes to pursuing new policy using their preferred framework. Here’s the simplest of examples: from December 2008 until December 2019, the Fed Funds target rate spent 65% of the time pinned at 0.25%. The average Fed funds rate over that period was 0.69%. During that period, core inflation ranged from a low of 0.6% in 2010 to a high of 2.4%, hitting either 2.3% or 2.4% in 2012, 2016, 2017, 2018, and 2019. That 0.6% was an aberration – fully 86% of the time over that 11 years, core inflation was between 1.5% and 2.4%. Ergo, it seems reasonable to point out that ultra–low interest rates did not seem to cause higher inflation. If that is our most-recent experience, then why would the Fed now be aggressively pursuing a theory that depends on the idea that high interest rates will cause lower inflation? The most-recent evidence we have is that interest rates do not seem to affect inflation.

This isn’t just a recent phenomenon. But the nice thing about the post-GFC period is that for a good part of it, the Fed was ignoring bank reserves and the money supply and effecting policy entirely through interest rates (well, occasionally squirting some QE around, but if anything that should have increased inflation – it certainly didn’t dampen the effect of low interest rates). This became explicit in 2014 when Joseph Gagnon and Brian Sack, shortly after leaving the Fed themselves, published “Monetary Policy with Abundant Liquidity: A New Operating Framework for the Federal Reserve.” In this piece, they argued that the Fed should ignore the quantity of reserves in the system, and simply change interest rates that it pays on reserves generated by its open market operations. The fundamental idea is that interest rates matter, and money does not, and the Fed dutifully has followed that framework ever since. As I just noted, though, the results of that experiment would seem to indicate that low interest rates, anyway, don’t seem to have the effect that would be predicted (and which effect is necessary if the policy is to be meaningful).

And really, this shouldn’t be a surprise because for the prior three decades, the level of the real policy rate (adjusting the nominal rate here by core CPI, not headline) has been completely unrelated to the subsequent change in core inflation.

So, to sum up: for at least 40 years, the level of real policy rates has had no discernable effect on changes in the level of inflation. And yet, current central bank dogma is that rates are the only thing that matters.

I stopped the chart in 2014 because that’s when the Gagnon/Sack experiment began, but it doesn’t really change anything to extend it to the current day. Actually, all you get is a massive acceleration and deceleration in core inflation that all happened before any interest rate changes affected growth (seeing as how we have not yet had a recession). So it’s a result-within-a-result, in fact.

Any observation about how the Fed manages the price of money rather than its quantity would not be complete without pointing out that the St. Louis Federal Reserve’s economist emeritus Daniel L Thorton, one of the last known monetarists at the Fed until his retirement, wrote a paper in 2012 entitled “Monetary Policy: Why Money Matters and Interest Rates Don’t” [emphasis in the original title]. In this well-argued, landmark, iconic, and totally ignored paper Dr. Thornton argued that the central bank should focus almost entirely on the quantity of money, and not its price. Naturally, this is concordant with my own view, plus more than a century of evidence around the world that the price level is closely tied to the quantity of money.

To be fair, the connection of changes in M2 to changes in the price level has also been weak since the mid-1990s, for reasons I’ve discussed at length elsewhere. But at least money has a history of being related to inflation, whereas interest rates do not (except as a result of inflation, rather than as a cause of them); moreover, we can rehabilitate money by separately modeling money velocity.

There does not appear to be any way to rehabilitate interest rate policy as a tool for addressing inflation. It hasn’t worked, it isn’t working, and it won’t work.

Categories: Causes of Inflation, Economics, Federal Reserve, Monetarism, Other Research Posts Tags: , , ,

Summary of My Post-CPI Tweets (May 2023)

June 13, 2023 3 comments

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy, but subscribers to @InflGuyPlus get the tweets in real time and a conference call wrapping it all up by about the time the stock market opens. Subscribe 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. Individual and institutional investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments! Check out the Inflation Guy podcast!

  • Welcome to the #CPI #inflation walkup for June (May’s figure).
  • A reminder: At 8:30ET, when the data drops, I will post a number of charts and numbers, in fairly rapid-fire succession. Then I will retweet some of those charts with comments attached. Then I’ll run some other charts.
  • This month I have to skip the conference call because my daughter has an awards ceremony I need to make. But later in the morning, I will post a summary of these tweets at https://inflationguy.blog and then podcast a summary at http://inflationguy.podbean.com .
  • Thanks again for subscribing!
  • Although both nominal and real interest rates have risen across the board since last month, breakevens have been fairly stable except at the very short end.
  • That represents relative weakness in BEI, which at this level of yields should be moving about 67% as much as 10-year nominal ylds and 2x as much as real ylds. Expectations have been declining partly because of weak energy markets, but then why are short breakevens wider?
  • In short, market pricing of medium-term inflation seems very confused right now.
  • That’s perhaps not so surprising. In addition to energy market softness, you also can see plenty of talk about how ‘wages might not cause inflation’ and how rents are due to decline (“no, really this time!”).
  • Let’s tackle these. First, rents. Ongoing argument on this one. Here’s my take: the former surge in rents was partly a catch-up from the eviction moratorium. I highlighted this divergence back when it first happened.
  • Now asking rents are declining and effective rents are still rising, beginning to close this gap. But note that the BLS rents figure never did keep pace with the asking OR effective rents.
  • The top lines haven’t converged yet (to be sure, these are quarterly figures) and the bottom line is behind. I know that current rent indicators had looked softer – although they’ve been recovering lately – but I don’t see a good reason to expect a LOT of softness here.
  • But if you really think that housing and the rental market are going to collapse like in 2009-10, then you’re going to have a hard time buying breakevens very much higher than you were paying in 2010.
  • Except wait…in 2010, 10-year breakevens averaged 2.06%. And they’re at 2.19% now. And we don’t seem to be close to any calamity remotely like we saw in 2008-2010.
  • I think these days, investors avoid buying breakevens not because they don’t believe there aren’t long tails to the medium-term upside, but because they’re worried about the short-term spikes to the downside. It’s MTM fear, not value, I think.
  • So, rents have been a persistent source of strength to CPI. They are ebbing, but not nearly as fast as the consensus thinks. Last month primary rents were +0.54% m/m. This doesn’t seem wildly high to me. The prior month is the outlier so far.
  • The other persistent source of strength, ALSO a story I was on a long time ago, is the core-services-ex-rents or “supercore,” which is significant because that’s where wage inflation lives.
  • There was an Economic Letter from the FRB San Fran a couple of weeks ago called “How Much Do Labor Costs Drive Inflation.” https://shorturl.at/fsvEN The author concludes that “labor-cost growth has a small effect on nonhousing services inflation…”
  • Well, duh. Obviously, inflation causes more-rapid wage growth, not the other way around. Cost-push inflation isn’t real – if it was, every laborer would love inflation because they would be AHEAD of it. That’s clearly wrong.
  • So everyone says “wow, this means that supercore doesn’t matter and the Fed might ease.” Except that nothing changes in this argument. Anyone who said core services ex-rents was important because it CAUSED inflation missed the point anyway.
  • Core services ex rents matters because it causes inflation PERSISTENCE by feeding back inflation. It makes inflation sticky. It doesn’t cause it to spiral higher.
  • Core services ex-rents will remain firm. That’s a good reason the Fed will not ease any time soon.
  • Heading into today’s number, both mainstream economists and Kalshi’s markets are looking for core CPI to match or fall short of the lowest core CPI so far in 2023 (0.385%, in March). I am higher. More on that in a second.
  • One reason I think core will be a little higher is that used car prices were roughly unchanged, but the seasonal adjustment expects a decline. So I think that will add about 3.5bps to the SA number by itself.
  • Interestingly, the lag structure from Black Book to CPI-Used Cars seems to have changed from 1 month to 0 months. That’s why everyone has been off on used cars recently. No idea why this shifted. Maybe it hasn’t, just a weird recent coincidence. But I don’t think so.
  • Headline CPI forecasts are pretty close between economists/market/me. I think Food isn’t going to add very much, which is why I’m below the consensus for headline even though above the consensus for core (Deutsche Bank made a similar point in a note out yesterday).
  • Now, the interesting thing is that after this month and next month, the interbank market is projecting essentially zero headline inflation for the balance of the year. Ran this chart in my blog at the end of May. https://inflationguy.blog/2023/05/31/is-inflation-dead-again/
  • June to December headline inflation is in the market at 0.125%. Total. That seems unlikely, even though the seasonal adjustment factors would turn that into a +1.4% which isn’t terrible. Still, it is hard to fathom that prices are just going to freeze in place NSA.
  • Not today’s problem, however! One step at a time. Good luck. I’ll be up with charts and chats right after 8:30ET.
  • Core +0.44%…worse than expected.
  • Both stocks and bonds acting like this is good news, so we’ll have to see the breakdown…
  • It might take people a minute to figure out that this was a solid miss on core. Yes, it was 0.4% versus 0.4% expectations, but it was just barely rounded down to 0.4% while the forecasts (except for mine) were rounded up.
  • Still pulling down data…the BLS is working very hard to make sure people can’t get it quickly. I can see that Used Cars was +4.4% m/m, which was more than I expected. Core Services jumped to 6.8% y/y versus 6.6%. OER was steady at 0.52% m/m; Primary at 0.49%.
  • Lodging was +1.80% m/m; but airfares -2.95% m/m (weak again…I just don’t see it!).
  • Energy dragged about 9bps on the headline, which was in line with my forecast. Food was +0.21% NSA m/m, about same as last month, but that’s a higher SA contribution. Food at home was +0.05% SA; Food away from home (wages y’all) was +0.47% SA. m/m
  • m/m CPI: 0.124% m/m Core CPI: 0.436%
  • Consensus missed on core by almost 6bps. My forecast was 0.43%. Headline was soft relative to core.
  • Last 12 core CPI figures
  • There is absolutely nothing disinflationary about this chart recently. Haven’t even rounded down to 0.3% on core in 6 months.
  • M/M, Y/Y, and prior Y/Y for 8 major subgroups
  • “Other goods and services” bears some looking into. Otherwise no large surprises.
  • Core Goods: 2.03% y/y        Core Services: 6.57% y/y
  • Core goods maintained its prior y/y level but didn’t extend the bounce despite a nice rise in apparel. Core services is coming off but…not exactly dramatically!
  • Primary Rents: 8.66% y/y        OER: 8.05% y/y
  • Is this the top of the rollercoaster, and how steep is the drop? Yes is the first answer, but ‘not so steep’ is what I think we’ll conclude on the second. M/M annualized are running at 6% or so, and I think we’ll probably end up between 5-6%. Much better than now, but not great.
  • Further: Primary Rents 0.49% M/M, 8.66% Y/Y (8.8% last)        OER 0.52% M/M, 8.05% Y/Y (8.12% last)         Lodging Away From Home 1.8% M/M, 3.4% Y/Y (3.3% last)
  • …by the way, the reason is higher taxes, higher wages, short supply.
  • Some ‘COVID’ Categories: Airfares -2.95% M/M (-2.55% Last)        Lodging Away from Home 1.8% M/M (-2.96% Last)         Used Cars/Trucks 4.42% M/M (4.45% Last)       New Cars/Trucks -0.12% M/M (-0.22% Last)
  • I thought Used would contribute but it was heavier than I thought. New cars being down is surprising. Interesting that core goods was still flat even after this contribution and the contribution from apparel.
  • Here is my early and automated guess at Median CPI for this month: 0.427%
  • Median category by my calculation was West Urban OER, so the usual caveats apply about my seasonal adjustment. Might be a bit higher or a bit lower than this, couple of bps either way. However you look at it…no continued disinflation.
  • Piece 1: Food & Energy: -0.939% y/y
  • Piece 2: Core Commodities: 2.03% y/y
  • Piece 3: Core Services less Rent of Shelter: 4.38% y/y
  • “Supercore” was a little lower, but still at 4.4% y/y.
  • Piece 4: Rent of Shelter: 8.12% y/y
  • Probably the best news overall is that core ex-housing is down to 3.45% y/y.
  • Before I get to ‘other’, let’s look at Medical Care. 0.08% m/m. Pharma was +0.51%, and 3.99% y/y. Doctors’ Services was a drag at -0.50% m/m and -0.09% y/y. Medical Equipment and Supplies was +2.3% m/m (NSA), which is the reason this is positive. Health insurance the usual drag.
  • Keep in mind that when Health Insurance gets readjusted next year, Medical Care is going to turn on a dime and be a following wind pushing inflation up, not down. The Health Insurance curiosity is a major source of the apparent core inflation disinflation this year.
  • Other Goods and Services was +0.53% NSA M/M. And it was pretty broad. Cigarettes +0.6%, other tobacco products 0.44%, Personal care products +1%, Misc Personal Services +0.69%.
  • This is interesting. Really bipolar inflation distribution. Nothing in the middle. A lot of weight to the right, and then a big slug of things to the left. That’s why core is so much lower than median.
  • Only non-core things that declined more than 10% annualized in May were Car and Truck Rental (-33%) and Misc Personal Goods (-11.9%). Neither more than 0.15% of the consumption basket.
  • OVER 10% are Used Cars/Trucks (+68%), Motor Vehicle Insurance (+26%), Lodging Away from Home (+24%), and Personal Care Products (+12.8%).
  • Sort of reinforcing the distribution picture. The weight in “over 6% y/y” is declining but still heavy. Weight in <2% is about 25%, rising but still low.
  • Finally the EI Inflation Diffusion Index telling the same story. Upward pressures remain but are lessening. This reinforces the ‘inflation has peaked’ story but does not yet support the ‘inflation will crash to exactly 2%’ story.
  • Wrapping up: bonds like this because there is no reason in here for the Fed to reverse its promise of a pause, when they meet tomorrow. The Fed will stand pat. Stocks like this mainly because it removes that uncertainty.
  • There is nothing in here that supports the notion that the Fed will soon be able to stop worrying about inflation. M/M core inflation continues to run at a 5% ish level. Y/Y core will likely ease a little further on base effects through September and then level off.
  • My point forecast for 2023 Median Inflation has been around 5% since last May. It is starting to look like that might be slightly low but pretty decent I think.
  • Sort of the best-case for core CPI at year-end will be 4.25% y/y. Unless rents and wages suddenly (and inexplicably) drop, it’s going to be really hard to get it below that.
  • On the other hand, tightening further when inflation measures are gently declining will also be a hard argument. In short, I think the “Fed on hold for a long time” argument won the scorecard handily today.
  • We not only need lower inflation prints, but the distribution needs to get more uniform. Wages rising at 6% (Cleveland Fed WGT) is holding up services even as core commodities stop declining. Meeting in the middle still looks like 3-4%. Again, hard to ease, hard to tighten.
  • I think that’s about it for today. I’ll have a few more words in my blog and podcast summaries, but that’s the meat of it. I still think breakevens are too low for this environment!! Thanks for tuning in.

The chart of the day is the one of month/month core CPI figures. Here is another look at it, from Bloomberg. Tell me if you can spot the downtrend.

Nope, me neither. December’s was 0.40%, and the five core prints for this year were 0.41, 0.45, 0.38, 0.41, and 0.44. The six-month average is 0.42%. The 12-month average is 0.43%. The 24-month average is 0.46%. So, if there’s a downtrend, it’s a really gentle downtrend. Base effects from last year will cause the y/y number to glide down a little bit further, and base effects in headline inflation may cause that number to decline as well although that’s a lot less clear. We’re tracking towards something like 4-5% inflation. I’m a trifle more optimistic than that, thinking we will eventually settle in the 3-4% range, but my operating hypothesis for a while has been that we have entered a new distribution with a higher mean. I could still be wrong on that, of course, but so far there’s nothing to suggest that inflation is going back to 2%.

Unless, of course, you think rents are about to flop. There has been some recent research on that, and as a result there is near-unanimity of the view that rents are going to be flat to declining “soon.” I’ve read the research, and it’s not convincing. Error bars for the forecast period are very wide right up until we get actual data, and the period over which the relationship is purported to exist is not similar to the period we are in.

Remember, people also thought that home prices would collapse under the weight of higher interest rates. They dropped a couple of percent, and are rising again already. Not only that, but mortgage delinquencies just dropped to the lowest level in 20 years: not what you’d expect if higher rates are crushing homeowners. What higher rates are doing is hurting builders, who will build less as a result, and landlords, who will raise rents as a result. The fact that economists want monetary policy and inflation to work this way isn’t sufficient. It just doesn’t.

This is not to say that there aren’t some good trends in the data. Our diffusion index clearly signals that the pressures towards higher prices are slackening. Some products and services that had seen extreme spikes are retracing. But wage growth is still 6%, and there are still a lot of goods and services which haven’t yet fully adjusted to the new price level. So: there will continue to be volatility in prices for a while, with some good news and some bad news and a gentle trend towards less inflation.

Sounds like “Fed on hold” to me.

Categories: CPI, Federal Reserve, Tweet Summary Tags: , , , ,

CPI Swaps Improving? Not as Significant as You Think

June 7, 2023 6 comments

Today we are going to geek out on inflation derivatives a little more.

Since early 2022, just after the Russian invasion of Ukraine, 10y US CPI swaps have fallen from about 3.15% to around 2.50% (see chart, source Bloomberg).

This is, on its face, pretty remarkable since median inflation during this time has risen from 4.76% in February 2022 to 7.20% in February 2023, and has now ebbed all the way to 6.98%. Core inflation has fallen farther, largely because of the drag from Health Insurance, but is still at 5.5%. Headline inflation has plummeted to 4.9% y/y. There are clearly some base effects that will pull those numbers lower from here, but 10y CPI swaps at 2.50% still looks pretty sporty. After all, you can pay fixed and receive inflation on CPI swaps (aka ‘buying’ the swap) and enjoy positive carry as long as the monthlies are consistently above 0.20% NSA, and six of the last nine have been.

Unfortunately, what you also get when you buy the swap is the negative mark-to-market as 10-year expectations decline. A cursory glance at the market would suggest that the Fed has successfully stuffed the inflation expectations cat back in the bag. Back in 2018, the rolling-10-year-compounded realized inflation rate got as low as 1.37% (granted, this measured from just before the GFC), and even a few years ago it was around 1.60%. If the Fed is putting the inflation genie back in the bottle (I’m working on getting my metaphor count up), then gosh – maybe there’s more downside to inflation swaps.

Or maybe not. Look at the following chart, which breaks down the 10-year CPI swap into the 5-year CPI swap and a 5-year swap, starting in 5 years. We call the former a 5-year “spot” CPI swap; the latter is a 5y5y forward CPI swap. The 5y5y shows us the rate you could lock in today, paying fixed for 5 years and receiving actual realized inflation from June 2028-June 2033.

These two rates have the relationship that

sqrt[(1+5y rate)(1+5y5y)] – 1 = 10y CPI rate

In other words, you can pay fixed and receive inflation in one of two ways: you can pay the 10y rate and receive inflation, or you can pay the 5y rate and receive inflation for 5 years, and simultaneously lock in the rate where you would do the same transaction in 5 years.  

Notice that almost all of the improvement in the 10-year rate since early 2022 is in the spot 5-year rate. Now, the spot rate is always more volatile than the forward, because energy is very volatile in the short term but mean-reverting in the long term. For this reason, policymakers often obsess on the 5y5y, which is perceived to be long enough for the energy volatility to wash out.[1] But in this case, pretty much all of the improvement in inflation quotes is coming from the front of the curve. In other words, if inflation expectations were “unanchored” (at least judging from the market, which as we know is a terrible measure of expectations) back in 2022 then they still are, 500bps of tightening later.

That being said, it’s hard to get terribly concerned about this supposed unmooring because if you back up a little farther it’s obvious that market pricing of longer-term inflation is still damaged from way before COVID. The chart below shows 5y5y CPI going back basically to the beginning of the inflation derivatives market.

From 2003 to 2014, 5y5y was never far from 2.75%-3.00%. There were occasional forays down to 2.5%, and occasional jaunts up to 3.25%, but other than the volatility around the GFC it never varied far from that. Today’s level of 2.58% would be at the lower end of the historical range prior to 2015, and at the upper end of the historical range from 2015 to present.

What happened in late 2014? Well, the dollar soared and oil prices crashed from 100 to 50 in a short period of time. Somehow, this led to a structural change in the shape of the inflation curve. In the old language we used to use, the “risk premium” of 5y5y over spot 5y got squeezed out. I suspect it was because of the structural change to lower volatilities, which lessened the value of the ‘tail’ option in long-dated inflation. But…I may be attributing too much sophistication to the market.

Whatever the reason, long-dated inflation quotes appear to me to still be very low. If the Fed achieves a 2% target for PCE, that’s 2.25% or so on CPI and you lose 33bps versus the 2.58% forward. If the Fed moves the inflation target to 3%, as some people are advocating, then you’re ahead by 67bps.[2] And if the Fed just plain misses, you’re to the good by even more. The only way you lose big is if we slip into a pernicious deflation that lasts a decade – and, since all the Fed needs to do is repeat the recent Bernanke-inspired helicopter-money experiment to avert deflation, this would seem to be an unlikely outcome.

Markets trade where risk clears, not at ‘fair value’ or at ‘market expectations.’ What the current level tells you is that not enough people are demanding inflation protection. If you’re one of the people who needs inflation protection, it is still a very good time to get it at a very affordable price.

If you’re an institutional investor or OCIO who needs help on that topic – visit https://www.EnduringInvestments.com and reach out!

[1] N.B. the level of the 5y5y is still positively correlated to the price of gasoline, which is obviously absurd and another example of exploitable error in inflation markets.

[2] (But listen to my latest podcast, Ep. 67 Three-point Goal? Or go for Two? (Percent), where I point out that the Fed currently pursues Average Inflation Targeting in which the official goal is just not terribly important).

Categories: Uncategorized Tags: , , , ,

Is Inflation Dead…Again?

May 31, 2023 3 comments

I am not the first person to point out that the stock market, at outlandish multiples, is not behaving consistently with commodities markets that are flashing imminent depression. If we insist on anthropomorphizing the markets, it really makes no sense at all unless we posit that “the market” suffers from a split personality disorder of some kind. But that sort of thing happens all the time, in little ways.

But here is something that seems very weird to me. Prices of short-dated inflation swaps in the interbank market suggest that NSA headline inflation is going to rise less than 0.9% for the entire balance of 2023 (a 1.45% annualized rate). And actually, most of that rise will be in the next 2 months. The market is pricing that between June’s CPI print and December’s CPI print the overall price level will rise 0.23%…less than ½% annualized!

Now, eagle-eyed readers will notice that there was also a flat portion of 2022, covering roughly the same period. Headline inflation between June and December last year rose only 0.16%, leading to disappointing coupons on iBonds and producing proclamations that inflation was nearly beaten. Here’s the thing, though. The second half of 2022 it made perfect sense that headline inflation was mostly unchanged. Oil prices dropped from $120/bbl the first week of June, to $75 by mid-December. Nationwide, average unleaded gasoline prices dropped from $5 to $3.25 during that time period.

A comparable percentage decline would mean that gasoline would need to drop to $2.32 from the current $3.58 average price at the pump. To be sure, the gasoline futures market is in much steeper backwardation than normal, with about 44c in the curve from now until December compared with 28c from June to December 2024.[1] So that can’t be the whole source of this insouciance about inflation. If gasoline does decline that much, the inflation curve will be right…but there’s an easier way to trade that, and that’s to sell Nov or Dec RBOB gasoline futures.

So the flatness must be coming from elsewhere. It can’t be from piped gas, which has recently been a measurable lag, because Natural Gas prices have already crashed back to levels somewhat below the norm of the last 10 years. Prices of foodstuffs could fall back more, which would help food-at-home if it happened, but food-away-from-home tracks wages so it’s hard to get this huge of an effect from food.

Ergo…this really must be core. Except there, the only market where you can sort of trade core inflation rather than backing into it, the Kalshi exchange, has the current prices of m/m core at 0.35% in May, 0.32% in June, 0.57% in July, 0.45% in August, 0.35% in September, 0.18% in October, and 0.22% in November. (To be sure, those markets especially for later months are still fairly illiquid but getting better). That’s not drastically different from the 0.41% average over the last six months.

Markets, of course, trade where risk clears and not necessarily where “the market thinks” the price should be. I find it hard to understand though who it is who would have such an exposure to lower short-term prices that they would need to aggressively sell short-term inflation…unless it is large institutional owners of TIPS who are making a tactical view that near-term prints would be bad. Sure seems like a big punt, if so.

Naturally, it’s possible that inflation will suddenly flatline from here. I just don’t feel like that’s the ‘fair bet’. That is after all a key function of markets: offer attractive bets to people who don’t have a natural bias in the market in question, to offset the flows of those people who are willing to pay to reduce their risk in a particular direction. (This should not be taken to suggest that I don’t have a natural bias in the market; I do.)

There’s another reason that this matters right now. Recently, markets have also been starting to price the possibility that the Federal Reserve could continue to hike interest rates, despite fairly clear signals from the Chairman after the last meeting that a ‘pause’ was in the offing. That certainly makes sense to me, since 25bps or 50bps makes almost no difference and after one of the most-aggressive hiking cycles in history, putting rates at approximately long-term neutral at the short end, it would seem to be prudent to at least look around. If, in looking around, the Fed were to notice that the balance of the market is suggesting that inflation has a chance of going instantly and completely inert, it would seem to be even stranger to think that the FOMC is about to fire up the rate-hike machine again for another few hikes.

[1] N.b. – June to December on the futures curve isn’t the exact right comparison since prices at the pump lag wholesale futures prices, but it gives you an idea.

Categories: Bond Market, Federal Reserve, Trading Tags: ,

Social Security Solvency, Solved

May 18, 2023 9 comments

I’m going to depart temporarily from my usual inflation-focused column to write about something that affects all Americans, and propose a simple solution to a bedeviling problem – a solution that is guaranteed to work.

The issue is Social Security. According to the US debt clock, which keeps track of this sort of thing, the present value of the (off balance sheet) Social Security obligation is $22.8trillion. What has happened is that over the years since the Social Security program was created, people are living longer and benefits have increased; a secondary problem that will someday solve itself is that the population pyramid in the US is almost inverted as the baby boom generation ages. Consequently, current workers have to contribute quite a bit to support retired workers, and this will get worse in the near future (since Social Security is not a savings program but a transfer program, the current workers plus taxpayers pay for retirees).

The full retirement age has been raised occasionally in the past, each time to ‘fix’ the system, and each time under a firestorm of controversy. Raising the retirement age temporarily improves the fiscal position of the program, but ultimately fails because people are living longer. That’s a good thing, but it’s really bad as the ‘retired’ population gets bigger and bigger and the US population growth rate grows more and more slowly.

To demonstrate the problem and my solution, I ran some relatively simple simulations. I started with the current US population distribution by age.[1] For each subsequent year, I applied the 2020 period life table for the Social Security area population, as used in the 2023 Trustees Report.[2] For simplicity I used the females table. For new births, I took the prior year’s 25-year-old cohort and multiplied by 1.1, which resulted in an average population growth rate of 0.3% per year (which was roughly the low set in the pandemic, so very conservative). This takes the population of the US from 332mm in 2021 to 815mm, three centuries from now. (Bear with me; I know it’s ridiculous to project anything 300 years from now but this is for demonstration purposes).

I am also assuming that the current average benefit of $20,326.56 stays constant in real terms, and discount all future benefits using a 2% real interest rate. It’s important to realize that in what follows, I am showing 2021 dollars. Nominal dollars would be a lot higher. Another caveat is that I am implicitly assuming that people who are 1 year old, who have accrued zero Social Security benefits, can still be expected to cost the system in an economic sense even though in an accounting sense the government does not yet have a liability to those future-workers. I am also assuming that the entire population eventually works and earns a Social Security benefit. As a consequence of these last two assumptions, my number for “Present Value of Real Social Security Benefits” is about 2.65x higher than the official number.

However, it’s not important to get the accounting exactly right as long as we have the dynamics approximately right. If it makes you feel better, divide all of the numbers in the following charts by 2.65. It won’t change their shape.

I am also not assuming any increase in longevity over time, which is unrealistic but I think is what the SSA also assumes. My solution is still absolute, as long as longevity doesn’t advance very rapidly, forever.

So, under those assumptions and a fixed retirement age of 67, here’s what the PV in 2021 dollars looks like over the next 300 years.

It’s really not as bad as all that – in terms of dollars/population, it’s pretty stable. But this assumes no increase in longevity or benefits, which has historically been a bad assumption. This is probably not sustainable. So let’s change the retirement age. In 2025, we increase the retirement age to 70, ignoring for now the utter predictability of the firestorm that would erupt, and fairly so, if we did this.

That doesn’t really change the picture much. It lowers the overall number but the number still grows. And it would be really difficult to get even this change. Anyone remotely close to retirement age would be furious at having that brass ring snatched from them. And this small effect is from only a three year increase in the retirement age! It’s no wonder that everyone talks about Social Security’s solvency, but no one does anything about it. Nothing that you could actually accomplish, seems to have a big enough effect to be worth doing.

Here is my proposal. Starting in 10 years, raise the full retirement age by just 1 month. But do it every year after that. And, here’s the key word: forever.

Someone who is 57 today would still retire at the age of 67, so it doesn’t really affect them. Someone who is 45 today would retire at 68. They’re not really happy about the extra year, but that’s better than the prior example which was 3 years. Someone who is 33 today would retire at 69. That’s still better than the prior proposal, for them. Someone who is 21 today would retire at 70. They’re no worse off, and arguably lots better off because the 20-somethings all assume there won’t be a Social Security when they are old enough to claim it. With this proposal, there would be. And unlike the current spastic attempts to repair the system, this would be predictable. (The legislative trick would be to make it very hard to change, but once it’s understood as a solution it will have momentum of its own – just like the Fed, in theory, could be changed but in practice it’s really hard to mess with).

The key word forever means that eventually, almost no one would get Social Security benefits and so the liability would dwindle to zero. But this would happen over generations. Would we leave our old folks penniless? Of course not – there are plenty of other safety nets to protect the truly needy. But we would remove the ‘entitlement’ part where everybody gets a slice because they paid into it.

Here’s what that picture looks like.

The problem goes away. It doesn’t go away immediately, and in fact over any one person’s life these nudges barely matter. But the liability is guaranteed to go away, unless lifespans start increasing faster than one month, every year. And frankly I’d still sign up for that! The fact that this doesn’t solve the problem immediately is a feature, not a bug: incremental change is digestible, and the trick is merely to make it repeatable.

This is how long-lived civilizations act. They operate on the scale of decades or centuries, instead of years or election cycles. We should use the power of time, and of compounding and discounting, wherever we can. We should use small nudges and behavioral tricks of forward commitment, for example, to make the solution tolerable. This is one way to do it – and a very simple way, at that.

[1] U.S. Census Bureau (2021). Sex by Age American Community Survey 1-year estimates. Retrieved from <https://censusreporter.org&gt;

[2] Source: Social Security Administration

Categories: Uncategorized Tags: , ,

Summary of My Post-CPI Tweets (April 2023)

May 10, 2023 2 comments

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy, but subscribers to @InflGuyPlus get the tweets in real time and a conference call wrapping it all up by about the time the stock market opens. Subscribe 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. Individual and institutional investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments! Check out the Inflation Guy podcast!

  • Welcome to   the #CPI #inflation walkup for May (April’s figure).
  • A   reminder: At 8:30ET, when the data drops, I will post a number of charts and   numbers, in fairly rapid-fire succession. Then I will retweet some of those   charts with comments attached. Then I’ll run some other charts.
  • After the tweeting dies down, I will have a private conference call for subscribers where I’ll quickly summarize the numbers. 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.
  • Thanks again for subscribing!
  • The market backdrop going into this one is very different from last month, when we were still dealing with panicky banking-collapse stuff. There are still some people selling that story, but there’s no real meat to it.
  • But breakevens have come in, and real yields risen. And the Fed has tightened for what is likely the last time in the cycle. Some people are REALLY sold on the deflationary-depression scenario but right now shaping up to be a mildish recession with continued high inflation.
  • That’s going to put the Fed in a classic bind, but with this Fed…maybe not really. I’ll say more about what I think about the Fed (big picture) in our Quarterly next week (subscribe at https://inflationguy.blog/shop/) but in sum I think O/N rates stay high all year.
  • Next year, when inflation is still not coming down to their target (I think), they’ll have some decisions to make but for now, a mild recession won’t get them easing aggressively as they did under Greenspan/Bernanke/Yellen. It’ll be Silence of the Doves.
  • The forecasts this month have amazing agreement in the headline figure, which is interesting because Kalshi and economists’ estimates have been rising meaningfully over the last week or so. I’ve been pretty consistent. I agree on headline. I’m significantly higher in core.
  • Here’s why.
  • Last month, core was a little soft, but not a ton. That in itself was remarkable, because rents decelerated a LOT m/m. And used cars was also a drag despite private surveys suggesting it should have been an add.
  • So the fact that core was just a LITTLE soft was pretty amazing. Median (a better measure) dropped a lot because of rents, but the fact that core was resilient tells you there were some long-tail upsides. Diffusion indices are showing strongly that the peak is in, but…
  • …but Core Goods having possibly bottomed (Used Cars should FINALLY deliver this month) means that the deceleration is going to be all rents and core services from here. So same stories but getting bigger going forward as the turn in Core Goods runs its course.
  • And I do not believe in the sudden deceleration in rents – because nothing in rents happens suddenly. I think all the folks who have been looking for it for a while are succumbing to confirmation bias in thinking this is real.
  • Maybe they’re right – another weak rents number will mean a lot to me. But I took note that the y/y rents figures still rose, which means that last year in the same month it was even weaker! That smacks to me of seasonal-adjustment issues.
  • That doesn’t explain the full deceleration from 0.7 to 0.5 in rents, but it would explain some. I think we’re going to bounce back, but if we get another 0.48% on primary and OER, I’ll take notice.
  • I also want to look at Food Away from Home. I wrote about this last week https://inflationguy.blog/2023/05/04/food-inflation-served-hot-and-cold/ – Food At Home and Food Away from Home have now diverged, and the FafH is tied more closely to wages.
  • So: Core ex-rents, but also rents. And Food Away from Home as part of the Core ex-rents-imbued-with-momentum-from-wages meme.
  • Do note that y/y core will decline even if we get my number (0.46%), and likely median also. It will help cement the idea the Fed is going to wait for a while.
  • (Then again, last month I said I didn’t think they’d do 25bps because 25bps just doesn’t matter. But now we also have them signaling as much. It’ll take a lot to get them to move either direction soon.)
  • Honestly, I need to step back and watch for a while myself. So far, the last few years have been relatively easy to call. But now we have a rapid rebound in velocity (which I expected) and declining M2 (which I did not).
  • For the trajectory of inflation beyond this summer, we need to know which of these is going to win. I have trouble believing M2 will keep declining, especially as money demand gets adjusted to the new interest rate regime. But it’s an open question.
  • And a very important question! And one that will not be resolved today! But it will be an interesting report I think – I’ll be back with more at 8:31ET. Good luck.
  • okay. 0.409 on core…pretty darn good work by economists and Kalshi!
  • Very nice jump from Used Cars…+4.5% m/m. So that’s an overdue catchup.
  • OER 0.54 and Primary Rents +0.56 m/m. That’s a jump compared to the prior month, but quite a bit lower than trend. Some deceleration is probably happening, but last month was an illusion as to how much, probably from seasonal quirks.
  • Core goods rose to 2.0% y/y (largely on the strength of the aforementioned Used Cars) and Core services fell to 6.8% y/y.
  • Here is Core. This month right in trend. 0.4% is still almost 5% per year!
  • Median retained most of its deceleration…but didn’t decelerate further m/m. Oddly, also 0.41% as with core. Normal warning: looks like one of the regional OERsis the median category – ergo, my estimate might be off since I have to guess at seasonals.
  • Medical Care was the usual drag, but everything else was positive. There were some drags, but mainly the story here is rent deceleration.
  • I noted the acceleration in core goods, which is mostly used cars this month. But I think the macro trend that we’ve seen most of the core goods deceleration is in place. Will it bounce to 5%? Probably not. But it’s no longer going to drag overall inflation lower.
  • Primary Rents have officially peaked. OER, not yet. Soon. As with the overall inflation numbers, which peaked but won’t be declining as much as people were expecting, so it will be with rents.
  • So in the so-called COVID categories, Airfares were -2.5% m/m; Lodging Away from Home -3.0%; Food @ Home -0.17%(sa) and Food Away from Home +0.37%(sa). This latter is a noticeable slowdown.
  • Piece 1: As-expected look. I thought Food would add 0.03% to CPI but it actually added about 0.02% it appears. Nothing surprising in this.
  • Piece 2 is Core Commodities – already commented on this.
  • Core Services less ROS – this is starting to look less-horrible. Still, 5% isn’t lovely but this is the wage-driven piece. Taken together with the Food-Away-from-Home improvement, there seems to be some signs that the wage-price feedback is slowing some. And that’s good news.
  • And rents are still high. While the Core Services piece is showing decent signs that it may have peaked, a deceleration in rents is still an article of faith. It will happen, but I don’t see it falling to 2% or lower, which is where some people think it’s going.
  • (Some people still think housing is going to collapse. It’s not going to. Prices are already starting to rise again.)
  • Core ex-housing went from 3.81% y/y to 3.75% y/y. Still pretty high even with the drag from core goods. Overall, the picture is IMPROVING but not good yet.
  • …and that story, actually, supports the idea of a Fed pause. “We finally turned back the attackers from the walls. Now let’s wait and see if they regroup or if the battle is over.” That’s the wise course.
  • You know, I gave economists a bit too much credit earlier. Their HEADLINE guesses were 0.41. Their core numbers were lower. We were about equally off. I was too high, because I thought rents would rebound more than they did. They were too low, for whatever reason.
  • Sort of interesting that Recreation was +0.5% m/m. That’s a heterogenous category so it usually doesn’t do a lot. This month, Video and Audio was +0.45% (nsa) and Pets were +1.82%(nsa). Those are the two largest pieces of Recreation. Interesting bump from pets.
  • Within Medical Care, Doctors’ Services was a drag and now is just +0.27% y/y! But Pharma added 0.42% m/m. The insurance drag continues to be what keeps that category inert (and, actually, it’s in core services ex rents so it’s also holding down “Supercore” some).
  • Nothing really illuminating amongst the biggest gainers/decliners. Core categories Public Transportation was -46% (annualized monthly, which is what goes into median), Car/Truck rental -33%, Lodging Away from Home -30%.
  • Gainers: Motor Vehicle Insurance +18%, Misc Pers Svcs +33%, Used Cares +69%. Actually some people say the insurance part is likely to continue for a bit. Lots of theft and higher car prices means that insurance rates need to rise too because cost-of-replacement is higher.
  • Diffusion index down to 14!
  • Okay, let’s try a conference call. Bottom line is I don’t think this figure is as good as stocks seem to think. But it DOES support the Fed-on-hold thesis. Still, it was a little higher than expected. Here is the conference number. I’ll start in 7 minutes.

Today’s number, while higher than expected on core by a little bit, was roughly in line with expectations. I was higher on my forecast than the consensus, because I thought rents would bounce back further and they didn’t; others were too high because they thought rents would keep dropping. I think that’s the main difference. Most of the rest of what is happening in the number was roughly what people expected. It was nice to see Used Cars bounce, since they were about 2 months behind what the private surveys were promising us – so not really a surprise.

While this is an expected number, that’s not saying it’s a wonderful figure. 0.4% monthly on core CPI…which is where we have been for the last 5 months…still gets you only to about 5% core for the year. That’s not where the Fed wants to see it.

On the other hand, it’s also clearly off the boil and most of the CPI is decelerating at least a little bit. It’s nice to see core services ex-rents (so-called “supercore”) decelerating, although we should remember that includes Health Insurance which is in the midst of a year-long mechanical adjustment that will swing the other way in about 6 months. But overall, the arrows are pointing in the right direction.

That’s distinctly unlike what was happening with the “transitory” nonsense, when the great bulk of the CPI was moving in the wrong direction – and not just the transitory pieces. So this is welcome.

And it supports the Fed’s decision to pause in rate hikes while continuing to slowly reduce its balance sheet. As long as the numbers continue to decline and nothing blows up that demands the Fed’s immediate attention, rates will stay on hold. I don’t think a minor recession, with inflation at 5%, will get the Fed to ease. Now, 6 months from now when it becomes obvious that inflation isn’t going back to the Fed’s target they’ll have some decisions to make, but that’s a story that will play out in slow motion. For now, we have a figure that supports ex-post-facto what the Fed chose to do this month.

Categories: CPI, Tweet Summary Tags: , , , ,

Food Inflation Served Hot and Cold

May 4, 2023 2 comments

Well, the Fed is done raising interest rates. They aren’t quite done tightening yet, because the Federal Reserve is going to continue to shrink its balance sheet slowly. That’s important. The fact that the Fed is no longer hiking rates, but is continuing to normalize its balance sheet, is quietly impressive to me. It makes me wonder whether someone at the Fed understands that saturating the economy with bank reserves means that today’s tightening is fundamentally different from the tightening of yesteryear, which was a money phenomenon and not a rates phenomenon.

We may never know, but I do have to admit that Chairman Powell impressed me a little in his post-FOMC presser. Not impressed me like ‘he’s the greatest’ but impressed me like ‘this is what I’d hoped we were getting.’ I wrote back in 2017 that the fact he is not an economics PhD was a positive…although the fact that he did not know anything about macroeconomics before joining the Fed suggested that he has learned economics in an echo chamber from some of the most blinkered non-monetarists on the planet, whose main claim to fame is that their forecasts have been consistently, and sometimes colossally, wrong for a long period of time. Still, he has a different background and that always offers hope.

The conduct of monetary policy under Powell has certainly been different than it was under his predecessors. We have to give him that! In any event, he said several things that impressed me because they surprised me. I’ll have more details and specifics in our Quarterly Inflation Outlook released a few days after CPI this month (you can subscribe at https://inflationguy.blog/shop/ ).

But today, I’m here to talk about food inflation. Normally, food inflation along with energy is deducted from the CPI to produce Core CPI, which is more stable and therefore should give better signals with less noise as long as food and energy inflation are mostly mean-reverting. And normally, they are. Energy is famously mean-reverting; the nationwide average price of a gallon of gasoline right now is $3.574, which is down 5 cents from…April 2008. There is a lot of noise and not much signal, so it makes sense to deduct.

Similarly, food inflation has a large commodity component and is also very volatile. It is not as volatile as is energy, partly because we don’t consume most of the foods that we buy in pure commodity form but rather in a packaged form; also foodstuffs are much more heterogeneous than gasoline and so branding matters a lot. Still, the food component of CPI is pretty volatile and normally fairly mean reverting although unlike energy it definitely has an upward tilt over time.

For some time now, though, food prices have been consistently adding to overall inflation. In mid-2021, trailing 12-month CPI for the “Food” subindex was about 2%; by late 2022 that was up to 11%! Recently, though, Food has started to come back to earth a little bit. The reason why is interesting and illuminating.

“Food,” which is 13.5% of the CPI, has two primary subgroups. “Food at home” is 8.7% of the CPI (about 2/3 of “Food”) and “Food away from home” is 4.8% of the CPI. The recent deceleration in the Food category has come entirely from “Food at home” (see chart, source BLS). That group got to about 14% y/y inflation, but most recently has fallen to a mere 8%. The steadier “Food away from home” is still plugging away, last at 8.8% y/y…a new high, actually.

As you might expect, while “Food at home” does not directly track, say, wholesale cattle or wheat prices, persistent changes in commodities prices does eventually percolate into pricing. The following chart shows a very simple relationship between “Food at home” and the Bloomberg Commodity Index “Agriculture” subindex (which tracks the performance of coffee, corn, wheat, beans, bean oil, cattle, hogs, cotton, and sugar. Aside from cotton, that list comprises a good part of what Americans buy to eat at home. So it isn’t terribly surprising that, at least for large movements in prices, these things eventually show up in the prices of things we buy. In this chart, the commodity index is lagged 12 months and shown on the right-hand scale. As an aside, consider how little of the price of what we buy must represent the actual commodity cost, if a 60% rise in commodities prices only results in a 14% increase in the price of Food at home, a full year later!

That chart says that “Food at home” should continue to decelerate and be a gentle drag for another year. On the other hand, “Food away from home” has completely different drivers that aren’t related to commodities prices hardly at all.

In contrast to the prior observation, consider how much of “Food away from home” must be labor, if the correlation between labor inflation and “Food away from home” is so high and of such a similar scale. Of course, we know that to be the case: the labor shortage hit the restaurant industry very hard and those effects are still being felt. There is not yet any sign of a decline in wage growth among these workers, and consequently there is not any sign of a deceleration in inflation of “Food away from home.” It should continue to be additive to CPI for a while.

The dichotomy between these two parts of the “Food” category is, of course, exactly what concerns the Federal Reserve and other economists who examine inflation. I’ve written about it here (and spoken about it on my podcast) a bunch of times: core services ex housing is where the wage-price feedback loop lives. It’s where the persistence of inflation comes from, and that is why it is the Fed’s main focus. Although I was writing about this before the Fed ever mentioned it, I have to give them credit – I thought they would seize on the fact that energy prices are pulling down overall inflation, or that rents may be decelerating soon, and use that as an excuse to take their usual dovish turn. They have not. The Fed actually seems to be focused on the right thing.

Maybe Powell is different, after all.

Categories: Causes of Inflation, CPI, Federal Reserve Tags: , ,

No Need to Rob Peter to Pay Paul

April 26, 2023 1 comment

So, I suppose the good news is that policymakers have stopped pretending that prices will go back down to the pre-pandemic levels. My friend Andy Fately (@fx_poet) in his daily note today called to my attention these dark remarks from Bank of England Chief “Economist” Huw Pill:

“If the cost of what you’re buying has gone up compared to what you’re selling, you’re going to be worse off…So somehow in the UK, someone needs to accept that they’re worse off and stop trying to maintain their real spending power by bidding up prices, whether higher wages or passing the energy costs through on to customers…And what we’re facing now is that reluctance to accept that, yes, we’re all worse off, and we all have to take our share.”

I think it’s worth stopping to re-read those words again. There are two implications that immediately leap out to me.

The first is that this is scary-full-Socialist. “We all have to take our share” is so anti-capitalist, anti-freedom, anti-individualist that it reeks of something that came from the pages of Atlas Shrugged. No, thank you, I don’t care to take my share of your screw-up. I would like to defend my money, and my real spending power, and my real lifestyle. If that comes at the cost of your lifestyle, Mr. Pill, then I’m sorry.

But the second point is that…it doesn’t come at the cost of someone else’s lifestyle. This is why I put “economist” in quotation marks above. There is still a lot of confusion out there between the price level and inflation, and what a change in the price level means, but if you’re an economist there shouldn’t be.

You see statements like this everywhere…”food prices are up 18%. If people are spending 18% more on food, it means they’re spending less elsewhere.” “Rents are up 17%. If people are spending 17% more on rent, it means they’re spending less elsewhere.” “Pet food is up 21%. If people are spending 21% more on pet food, it means they’re spending less elsewhere.” “New vehicle prices are up 22%. If people are spending 22% more on new vehicles, it means they’re spending less elsewhere.” “Price of appliances are up 19%. If people are spending 19% more on new appliances, it means they’re spending less elsewhere.”

You get my point. All of those, incidentally, are actual aggregate price changes since the end of 2019.

This is where an actual economist should step in and say “if the amount of money in circulation is up 37%, why does spending 18% more on good or service A mean that we have to spend less on good or service B?” In fact, this is only true if the growth in the aggregate amount of money is distributed highly unevenly. In ‘normal’ times, that might be a defensible assumption but during the pandemic money was distributed remarkably evenly.

Okay…the amount of money in circulation is a ‘stock’ number and the prices of stuff changing over time is a ‘flow’ number, which is why money velocity also matters. M*V is up about 24% since the end of 2019. So a 20% rise in prices shouldn’t be surprising, and since there’s lots more money out there a 20% rise in the price of one good does not imply you need to spend less on another good. That’s only true in a non-inflationary environment. The world has changed. You need to learn to think in real terms, especially if you are a “Chief Economist.”

(N.b. to be sure, this is somewhat definitional since we define V as PQ/M, but the overarching point is that with 40% more money in the system, it should be not the slightest bit surprising to see prices up 20%. And, if velocity really does act like a spring storing potential energy, then we should eventually expect to see prices up more like 30-40%.)

Here’s a little bonus thought.

Rents are +17%, which is roughly in line with a general rise in the prices of goods and services. Home prices are up about 36% (using Shiller 20-City Home Price Index), which is roughly in line with the raw increase in M2.

Proposition: since the price of unproductive real assets is essentially an exchange rate of dollars:asset – which means that an increase in a real asset’s price is the inverse of the dollar’s decrease – then the price of a real asset should reflect the stock of money since price is dictated by the relative scarcity of the quantity of dollars versus the real asset. But the price of a consumer good or service should reflect the flow of money, so something more like the MV/Q concept.

Implication:

Discuss.

Categories: Causes of Inflation, Dollar, Housing, Theory

Who’s Afraid of De-Dollarization?

April 19, 2023 3 comments

Do we need to worry about the end of dollar dominance in international trade – the de-dollarization of global finance?

I am hoping to do a podcast on this topic in a few weeks, featuring a guest who is actually an expert on foreign exchange and who can push back on my thought processes (or, less likely, echo them) – but the topic seems timely now. There is widespread discussion and concern in some quarters, as China and Russia push forward efforts to establish the Chinese Yuan as an alternative currency for international trade settlement, that this could spell the sunset of the dollar’s dominance. Some of the more animated commentators declare that de-dollarization will dramatically and immediately eviscerate the standard of living in the United States and condemn the nation to be an also-ran third-rate economy as its citizens descend into unspeakable squalor.

Obviously, such ghoulish prognostications are ridiculously overdone for the purpose of generating clicks. But how much of it is true, at least on some level? What would happen if, tomorrow, the US dollar lost its status as the world’s primary reserve currency?

One thing that wouldn’t change at all is the quantity of dollars in circulation. That’s a number that the Federal Reserve exerts some control over (they used to have almost total control, when banks were reserve-constrained; now that banks have far more reserves than they need, they can lend as much as they like, creating as many floating dollars as they like, constrained only by their balance sheet). The holders of dollars have absolutely no control over the amount of them in circulation! If Party A doesn’t like owning dollars, they can sell their dollars – but they have to sell it to some Party B, who then holds the dollars.

What also wouldn’t change immediately is how many dollar reserves every country holds. From time to time, people get concerned that “China is going to sell all of its dollars.” But China got those dollars because they sell us more stuff than we sell them, which causes them to accumulate dollars over time. How can China get rid of their dollars? Their options are fairly limited:

  1. They can start buying more from us than they sell to us. We’ve been trying to get them to do this for years! Seems unlikely.
  2. They can buy from us, stuff priced in dollars, but only sell goods to us that are priced in Yuan. To get Yuan, a US purchaser would have to sell dollars to buy Yuan. Since China doesn’t want to be the other side of that trade (which would leave them with the same amount of dollars), the US purchaser would have to go elsewhere to buy Yuan. This would strengthen the Yuan. This is also something we’ve been trying to get them to do for years! The Bank of China stops the Yuan from strengthening against the dollar by…selling Yuan and buying dollars. Hmmm.
  3. They can just hit the bid and sell dollars against all sorts of other currencies. This would greatly weaken the dollar, and is perhaps the biggest fear of many of the people worried about de-dollarization.

Supposing that China decided on #3, they would be making US industry much more competitive around the world against all of the currencies that China was buying. Foreign buyers of US products would now be able to buy US goods much more cheaply. It would cause more inflation in the US, but it would take a large dollar decline to drastically increase US inflation since foreign trade is a smaller part of the US economy than it is for many other countries.

A much lower dollar, making US prices look lower to non-US customers, would help balance the US trade deficit. Yay!

A tendency towards balance of the trade deficit would have ancillary impacts. When the US government runs a fiscal deficit, it borrows from essentially two places: domestic savers and foreign savers. Foreigners, having a surplus of dollars (since they have trade surpluses with us), buy Treasuries among other things. If the trade deficit went down drastically, so would foreign demand for US Treasuries. That in turn would (unless the government started to balance its fiscal deficit) cause higher interest rates, which would be necessary to induce domestic savers to buy more Treasuries. Or, if domestic savers were not up to the task, the buyer of last resort would be…the Federal Reserve, which could buy those bonds with printed money. And that’s a really bad outcome.

Now, does any of this cause a collapse of the American system or spell an end to US hegemony? No. If policymakers respond to such an event by refusing to get the fiscal house in order, then things could get ugly. But it would be hard to blame that outcome on the end of the dollar as the medium of international trade – blame would more appropriately be directed at the failure of domestic policymakers to adjust in response.

In the end, it is hard to escape the idea that good or bad economic and inflation outcomes in the United States track mainly, one way or the other, back to domestic policy decisions. Whether the US economic system remains a dominant one is…fortunately or unfortunately…in our hands, not in the hands of foreign state actors.

Categories: China, Dollar, Federal Reserve, Theory, Trade Tags:
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