Causes of Inflation

Food Inflation Served Hot and Cold

May 4, 2023 Michael Ashton 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: food at home, food away from home, food inflation

No Need to Rob Peter to Pay Paul

April 26, 2023 Michael Ashton 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

Summary of My Post-CPI Tweets (February 2023)

March 14, 2023 Michael Ashton 1 comment

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! To be sure, the importance of this data point in the short run is much less than it was a week ago, but it would be a mistake to lose sight of inflation now that the Fed is likely moving from QT to QE again.
A reminder to subscribers of the tweet schedule: 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.
Afterwards (recently it’s been 9:30ish) 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 inflationguy.podbean.com .
I am also going to try and record the conference call for later. I think I’ve figured out how to do that. If I’m successful, I’ll tweet that later also.
Thanks again for subscribing! And now for the walkup.
This picture of the last month has changed quite a bit over the last few days! Suddenly, rates have reversed and the nominal curve is steepening. The inflation market readings are…of sketchy quality at the moment.

Now, the swap market has also re-priced the inflation trough: instead of 2.65% in June (was in low 2s not long ago), the infl swap market now has y/y bottoming at 3.34% b/c of base effects before bouncing to 3.7% & then down to 3.15% by year-end. I think that’s pretty unlikely.
Let’s remember that Median CPI reached a new high JUST LAST MONTH, contrary to expectations (including mine). The disturbing inflation trend is what had persuaded investors…until late last week…that the Fed might abruptly lurch back to a 50bp hike.
These are real trends…so I’m not sure why economists are acting as if they are still certain that inflation is decelerating. The evidence that it is, so far at least, is sparse.
Also, this month not only did the Manheim used car index rise again, but Black Book (historically a better fit although BLS has changed their sampling source so we’re not sure) also did. I have that adding 0.04%-0.05% to core.
But maybe this is a good time to step back a bit, because of the diminished importance of this report (to be sure, if we get a clean 0.5%, it’s going to be very problematic for the Fed which means it should also be problematic for equity investors).
Over the last few days we’ve read a lot about how banks are seeing deposits leave for higher-yielding opportunities. This is completely expected: as interest rates rise, the demand for real cash balances declines.
You may have heard me say that before. But it’s really Friedman who said that first: velocity is the inverse of the demand for real cash balances. DEPOSITS LEAVING FOR HIGHER YIELDS IS EXACTLY WHAT HIGHER VELOCITY MEANS.
And it is the reason for the very high correlation of velocity with interest rates.
So the backdrop is this: money may be declining slightly but velocity is rebounding hard. Exactly as we should expect. Our model is shown here – it’s heavily influenced by interest rates (but not only interest rates).

And if the Fed is going to move from its modest QT to QE, especially if they don’t ALSO slash rates back towards zero, then the inflationary impulse has little reason to fade.
You know, I said back when the Fed started hiking that they would stop once the market forced them to. What has been amazing is that there were no accidents until now, so the market let them go for it. And in the long run this is good news – rates nearer neutral.
But we have now had some bumps (and to be fair, I said no accidents until now but of course if the FDIC and Fed had been doing their job and monitoring duration gaps…this accident started many many months ago).
With respect to how the Fed responds to this number: it is important to remember that the IMPACT ON INFLATION of an incremental 25bps or 50bps is almost zero. Especially in the short run. It might even be precisely zero.
But the impact of 25bps or 50bps on attitudes, on deposit flight, and on liquidity hoarding could be severe, in the short run. On the other hand, if the Fed stands pat and does nothing but end QT, it might smack of panic.
If I were at the Fed, I’d be deciding between 25bps and 0bps. And the only decent argument for 25bps is that it evinces a “business as usual” air. It won’t affect 2023 inflation at all (even using the Fed’s models which assume rates affect inflation).
Here are the forecasts I have for the number – I tweeted this yesterday too. I’m a full 0.1% higher on core than the Street economists, market, and Kalshi. But I’m in-line on headline. So obviously as noted above I see the risks as higher.

Market reactions? If we get my number or higher, it creates an obvious dilemma for the Fed and that means bad things for the market no matter how the Fed resolves that. Do they ignore inflation or ignore market stability?
If we get lower than the economists’ expectation (on core), then it’s good news for the market because MAYBE it means the Fed isn’t in quite such a bad box and can do more to support liquidity (read: support the mo mo stock guys).
So – maybe this report is important after all! Good luck today. I will be back live at 8:31ET.

Well, headline was below core!
Waiting for database to update but on a glance this doesn’t look good. Core was an upside surprise slightly and that was with used cars a DRAG.
m/m CPI: 0.37% m/m Core CPI: 0.452%
Last 12 core CPI figures

So this to me looks like bad news. I don’t see the deceleration that everyone was looking for. We will look at some of the breakdown in a minute.
M/M, Y/Y, and prior Y/Y for 8 major subgroups

Standing out a couple of things: Apparel (small weight) jumps again…surprising. And Medical Care is back to a drag…some of that is insurance adjustment (-4.07% m/m, pretty normal) and some is Doctors Services (-0.52% m/m), while Pharma (0.14%) only a small add.
Core Goods: 1.03% y/y Core Services: 7.26% y/y

We start to see the problem here: any drag continues to be in core goods. Core goods does not have unlimited downside especially with the USD on the back foot. Core services…no sign of slowing.
Primary Rents: 8.76% y/y OER: 8.01% y/y

And rents…still accelerating y/y.
Further: Primary Rents 0.76% M/M, 8.76% Y/Y (8.56% last) OER 0.7% M/M, 8.01% Y/Y (7.76% last) Lodging Away From Home 2.3% M/M, 6.7% Y/Y (7.7% last)
Last month, OER and Primary Rents had slipped a bit and econs assumed that was the start of the deceleration. Maybe, but they re-accelerated a bit this month. Lodging away from home a decent m/m jump, but actually declined y/y so you can see that’s seasonal.
Some ‘COVID’ Categories: Airfares 6.38% M/M (-2.15% Last) Lodging Away from Home 2.26% M/M (1.2% Last) Used Cars/Trucks -2.77% M/M (-1.94% Last) New Cars/Trucks 0.18% M/M (0.23% Last)
FINALLY we see the rise in airfares that has been long overdue. I expected this to add 0.01% to core; it actually added 0.05%. Those who want to say this is a good number will screech “outlier!” but really it’s just catching up. The outlier is used cars.
Both the Manheim and Black Book surveys clearly showed an increase in used car prices. But the BLS has recently changed methodologies on autos. Not clear what they’re using. Maybe it’s just timing and used will add back next month. We will see.
Here is my early and automated guess at Median CPI for this month: 0.634%

Now, the caveat to this chart is that I was off last month (the actual figure reported is shown), but that was January. I think I’ll be better on February. I have the median category as Food Away from Home. This chart is bad news for the deceleration crowd, and for the Fed.
Piece 1: Food & Energy: 7.97% y/y

OK, Food and Energy is decelerating, but both still contributed high rates of change. Energy will oscillate. It is uncomfortable that Food is still adding.
Piece 2: Core Commodities: 1.03% y/y

This is the reason headline was lower than expected. Core goods – in this case largely Used Cars, which I thought would add 0.05% and instead subtracted 0.09% from core. That’s a -14bps swing. +5bps from airfares, but health insurance was a drag…and we were still >consensus.
Piece 3: Core Services less Rent of Shelter: 5.96% y/y

…and this is the engine that NEEDS to be heading sharply lower if we’re going to get to 3.15% by end of year. It’s drooping, but not hard.
Piece 4: Rent of Shelter: 8.18% y/y

…and I already talked about this. No deceleration evident. As an aside, it’s not clear why we would see one with rising landlord costs, a shortage of housing, and robust wage gains, but…it’s an article of faith out there.
Core inflation ex-shelter decelerated from 3.94% y/y to 3.74% y/y. That’s good news, although mainly it serves to amplify Used Cars…but look, even if you take out the big add from sticky shelter, we’re still not anywhere near target.
Equity investors seem to love this figure. Be kind. They’re not thinking clearly these days. It’s a bad number that makes the Fed’s job really difficult.
Note that Nick Timiraos didn’t signal anything yesterday…that means the Fed hasn’t decided yet. Which means they cared about this number. Which means to me that we’re likely getting 25bps, not 0bps. Now, maybe they just wanted to watch banking for another few days, but…
…the inflation news isn’t good. As I said up top, 25bps doesn’t mean anything to inflation, but if they skip then it means we are back in QE and hold onto your hats because inflation is going to be a problem for a while.
Even if they hike, they will probably arrest QT – and that was the only part of policy that was helping. Higher rates was just accelerating velocity. But I digress. Point is, this is a bad print for a Fed hoping for an all-clear hint.
The only core categories with annualized monthly changes lower than -10% was Used Cars and Trucks (-29%). Core categories ABOVE +10% annualized monthly: Public Transport (+46%), Lodging AFH (+31%), Jewelry/Watches (+20%), Misc Personal Svcs (+17.7%), Footwear (+18%), >>>
Women’s/Girls’ Apparel (+15%), Tobacco and Smoking Products (+13%), Recreation (+11%), Motor Vehicle Insurance (+11%), Infants’/Toddlers’ Apparel (+11%), and Misc Personal Goods (+10%). Although I also have South Urban OER at +10%, using my seasonality estimate.
On the Medical Care piece, we really should keep in mind this steady drag from the crazy Health Insurance plug estimate for this year. It’ll almost certainly be an add next year. Imagine where we’d be on core if that was merely flat rather than in unprecedented deflation.
Let’s go back to median for a bit. The m/m Median was 0.63% (my estimate), which is right in line with last month. The caveat is that the median category was Food Away from Home but that was surrounded by a couple of OER categories which are the ones I have to estimate. [Corrected from original tweet, which cited 0.55% as my median estimate]
I can’t re-emphasize this enough. Inflation still hasn’t PEAKED, much less started to decline.

One place we had seen some improvement was in narrowing BREADTH of inflation. Still broad, but narrower. However, this month it broadened again just a bit and the EIIDI ticked higher. Higher median, broader inflation…and that’s with Used Cars a strange drag.

Stocks still don’t get it, but breakevens do. The 10y BEI is +7bps today. ESH3 is +49 points though!
We’ll stop it there for now. Conference call will be at 9:30ET (10 minutes). (518) [redacted] Access Code [redacted]. I will be trying to record this one for playback for subscribers who can’t tune in then.
The conference call recording seemed to go well. If you want to listen to it, you can call the playback number at (757) 841-1077, access code 736735. The recording is about 12 minutes long.

In retrospect, my forecast of 0.4% on seasonally-adjusted headline and 0.5% on core looks pretty good…but that’s only because we got significant downward one-offs, notably from Used Cars. If Used Cars had come in where I was expecting (+1.4%) instead of where it actually came in (-2.8%), and the rest of the report had been the same, then core inflation would have been 0.6% and we would be having a very different discussion right now.

As it is, this is not the number that the Fed needed. Inflation has not yet peaked, and that’s with Health Insurance providing a 4-5bps drag every month. That’s with Used Cars showing a drag instead of the contribution I expected. The “transitory” folks will be pointing to rents and saying that it seems ridiculous, and ‘clearly must decline,’ but that’s not as clear to me. Landlords are facing increased costs for maintenance, financing, energy, taxes; there is a shortage of housing so there is a line of tenants waiting to rent, and wage growth remains robust so these tenants can pay. Why should rents decelerate or even (as some people have been declaring) decline?

Apparel was also a surprising add. Its weight is low but the strength is surprising. A chart of the apparel index is below. Clothing prices now are higher than they’ve been since 2000. The USA imports almost all of its apparel. This is a picture of the effect of deglobalization, perhaps.

So all of this isn’t what the Fed wanted to see. A nice, soft inflation report would have allowed the Fed to gracefully turn to supporting markets and banks, and put the inflation fight on hold at least temporarily. But the water is still boiling and the pot needs to be attended. I think it would be difficult for the Fed to eschew any rate hike at all, given this context. However, I do believe they’ll stop QT – selling bonds will only make the mark-to-market of bank securities holdings worse.

But in the bigger picture, the FOMC at some point needs to address the question of why nearly 500bps of rate hikes have had no measurable effect on inflation. Are the lags just much longer than they thought, and longer than in the past? That seems a difficult argument. But it may be more palatable to them than considering whether increasing interest rates by fiat while maintaining huge quantities of excess reserves is a strategy that – as monetarists would say and have been saying – should not have a significant effect on inflation. The Fed models of monetary policy transmission have been terribly inaccurate. The right thing to do is to go back to first principles and ask whether the models are wrong, especially since there is a cogent alternative theory that could be considered.

Back when I wrote What’s Wrong With Money?, my prescription for unwinding the extraordinary largesse of the global financial crisis – never mind the orders-of-magnitude larger QE of COVID policy response – was exactly the opposite. I said the Fed should decrease the money supply, while holding interest rates down (since, if interest rates rise, velocity should be expected to rise as well and this will exacerbate the problem in the short-term). The Fed has done the opposite, and seem so far to be getting the exact opposite result than they want.

Just sayin’.

Categories: Causes of Inflation, CPI, Federal Reserve, Monetarism, Tweet Summary, Uncategorized Tags: core cpi, core inflation, CPI, Fed, interest rates

The Powell of Positive Thinking

March 8, 2023 Michael Ashton 7 comments

Yes: Federal Reserve Chairman Powell was very hawkish at his Congressional testimony on Tuesday and Wednesday. He clearly signaled (again) that once Fed overnight policy rates reach a peak, they would not be declining for a while. He additionally signaled that the peak probably will be higher than previously signaled (I’ve been saying and thinking 5% for a while, but it’s going to be higher), and even signaled the increasing likelihood of a return to 50bp hikes after the recent deceleration to 25bps.

This latter point, in my view, is the least likely since all of the reasons for the step down to 25bps remain valid: whether the peak is 5% or 6%, it is relatively nearby and the confidence that we should have that rates have not risen enough should therefore be decreasing rapidly. Moreover, since monetary policy works with a lag and there has been very little lag since the aggressive tightening campaign began, it would be reasonable to slow down or stop to assess the effect that prior hikes have had.

But here is the bigger point, and one that Powell did not broach. There is really not much evidence at all that the Fed’s hikes to date have affected inflation. It is completely an article of faith that they surely will, but this is not the same as saying that they have. Consider for a moment: in what way could we plausibly argue that rate hikes so far have been responsible for the decline in inflation? The decline in inflation has been entirely from the goods sector, and a good portion of that has been from used cars returning to a normal level (meaning, in line with the growth in money) after having overshot. How exactly has monetary policy driven down the prices of goods?

This is not to say that higher interest rates have not affected economic activity, and this (to me) is the real surprise: given the amount of leverage extant in the corporate world, it amazes me that we haven’t seen a more-serious retrenchment. Some of this is pent-up demand that still needs to be satisfied, for example in housing where significant rate hikes would normally dampen housing demand substantially and seems to have. However, there is a severe shortage of housing in the country and so construction continues (and home prices, while they have fallen slightly, show no signs of the collapse that so many have forecast). Higher rates are also rippling through the commercial MBS market, as many commercial landlords have inexplicably financed their projects with floating rate debt and where the cost of leverage can make or break the project.

Higher interest rates, on the other hand, tend to support residential rents, at least until unemployment eventually rises appreciably. I think perhaps that not many economists are landlords, but higher costs tend to not result in a desire to charge lower rents. On the commercial side, leases are for longer and turnover is more costly, but the average residential landlord these days is not facing a shortage of demand.

So where have rate hikes caused inflation to decline? Judging from the fact that Median CPI just set a new high, I think the answer is pretty plain: they haven’t. And yet, the Fed believes that if they keep hiking, inflation will fall into place. Where else can we more plainly see at work the maxim that “if a piece doesn’t fit, you’re not using a big enough hammer?” Or maybe, this is just a reflection of the notion that if you want something bad enough, the wanting itself will cause the thing to happen. [N.B. this is really more in line with the prescription from Napoleon Hill’s classic book “Think and Grow Rich”, but the title of Peale’s equally-classic “The Power of Positive Thinking” suggested a catchier title for this article. Consider it poetic license.]

Moreover, what we have seen is that higher interest rates have had the predicted effect on money velocity. Although I have elsewhere noted that part of the rebound in money velocity so far is due to the ‘spring force’ effect, there is substantial evidence that one of the main drivers of money velocity is the interest rate earned on non-cash balances. Enough so, in fact, that I wrote about the connection in June 2022 in a piece entitled “The Coming Rise in Money Velocity,” before the recent surge in velocity began. [I’d also call your attention to a recently-published article by Samuel Reynard of the Swiss National Bank, “Central bank balance sheet, money, and inflation,” where he incorporates money velocity into his adjusted money supply growth figure. Reynard is one of the last monetarists extant in central banking circles.]

Now, nothing that I have just written is going to deter Powell & Co from continuing to hike rates until demand is finally crushed and, according to their faith but in the absence of evidence to date, inflation will decelerate back to where they want it. But with long-term inflation breakevens priced at levels mirroring that faith, it is worth questioning whether there is some value in being apostate.

Categories: Causes of Inflation, Economics, Federal Reserve, Monetarism Tags: fed chairman, fomc, Powell

Summary of My Post-CPI Tweets (January 2023)

February 14, 2023 Michael Ashton 2 comments

We get the first CPI of 2023 this morning! A fair number of things are changing, but I don’t think the net result is going to be all that large.
A reminder to subscribers of the path here: 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 retweet some of those charts with comments attached. Then I’ll run some other charts.
Afterwards (recently it’s been 9:30ish) 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 inflationguy.podbean.com .
Thanks again for subscribing! And now for the walkup.
First, let’s look at what the market has done over the last month. The front of the curve has gone from incorporating disinflation down to 2%, to disinflation down to 2.65%. Nominal and real yields are both higher as well.

It’s still hard for me to imagine we could be at 2.65% y/y CPI by this time next year. I suppose it’s possible but a lot of things need to go right.
For one thing, services inflation needs to stop going up, and reverse hard. Core Goods has already fallen to 2.1% y/y. It’s unlikely to go into hard deflation given deglobalization but even if the strong dollar gets us to 0%, that doesn’t get core to 2.65%.

Consider, for example, Used Cars. There is some talk this month about the surprising rise in the Manheim index, but Black Book has a higher correlation and BB is still declining. I don’t have Used Cars adding this month.
However, it’s probably about done dragging…this chart shows the aggregate rise in M2 versus the aggregate rise in Used Car CPI. Yes, prices probably went up ‘too much’ but they’re in the zone of what we SHOULD expect all prices to be doing.

FWIW, New Car prices haven’t risen nearly so much, but they’ve been steadily accelerating. This month, the BLS shifts to JD Power as its source for new car prices. No real idea what that should do to the report – one hopes, not much.
Let’s set the overall context, by the way: we have passed the peak of Median CPI (unless something really wacky happens today) and we are going to decelerate from here for a while. Probably to 4-5%.
But this is likely to happen lots more slowly than people think! Everyone expects rents to collapse. But everyone also expected home prices to collapse. Guess what: neither is going to happen.
Look, home prices were high relative to rents. But that doesn’t mean home prices need to plunge. What has happened so far has been what you’d expect: home prices have fallen a small amount in nominal space, and rents have gone up a lot. This will probably continue.

Rents can’t go down a LOT without home prices collapsing – and rents would have to lead that. But I have a hard time understanding how home prices OR rents collapse when you have a few million new heads to put roofs over, and a shortage of housing as it is.
Now, this month we also have a re-weighting of the CPI basket. It is based on 2021 consumption, which means it partially retraces the prior re-weight which was on 2019-2020 and so had a lot of COVID.
This means more weight on the sticky categories and less on core goods. Keep in mind that at the margin this only adds a couple of bps per month, but it will also lower inflation volatility a little bit and slow the disinflationary tendency. But just at the margin!
Putting this together, the consensus economists are a bit stronger this month than they have been. But there are some forecasters out there calling for a MASSIVELY bad print. I don’t see where they get that from. Here are my forecasts vs market.

I am a little higher, despite the fact that I am not weighting anything to a Used Cars bounce. I keep waiting for Airfares to stop declining in the face of fares that seem massively higher on every route I check. I don’t get that.
I have to think that the stock market is potentially quite vulnerable to a high number, unless there’s an obvious outlier. We are at high exuberance for the Fed pausing, despite declining earnings.
OK, that’s all for the walkup. As I am tweeting more stuff intra-month, I think the pre-CPI walkup can be a little shorter on CPI morning. LMK if you disagree as I’m trying to offer a service people think is worthwhile! Good luck today. I will be back live at 8:31ET.

m/m CPI: 0.517% m/m Core CPI: 0.412%
ok. Headline and core slightly higher than expected. Consensus was for +0.45% and +0.36%. I was at +0.44% and +0.42%, so closer on core. The NSA was the surprise, at +0.800%, which pushed y/y to 6.41% against expectations for 6.2%. Y/Y core barely rounded up to 5.6%.
Last 12 core CPI figures

Second month in a row with an 0.4% core. That means we’re running at just under 5% on core CPI. Not exactly great. But better than it was!
M/M, Y/Y, and prior Y/Y for 8 major subgroups

Note the drag on medical care. And note the large jump in Apparel, which goes in the ‘surprise’ category.
Core Goods: 1.44% y/y Core Services: 7.16% y/y

Yeah, this isn’t going to get us to a 2.0%-2.5% CPI at year-end. Core Goods continues to decelerate but the deceleration is running out of steam. Core Services is still rising!
Primary Rents: 8.56% y/y OER: 7.76% y/y

Further: Primary Rents 0.74% M/M, 8.56% Y/Y (8.35% last) OER 0.67% M/M, 7.76% Y/Y (7.53% last) Lodging Away From Home 1.2% M/M, 7.7% Y/Y (3.2% last)
Again, this isn’t playing to form if you’re looking for disinflation. It’s consistent with my view, but lots of people will scream about this since “private surveys of rents” show something very different. But it would be a weird conspiracy theory to push inflation HIGHER.
Do note, the m/m for shelter decelerated a little bit (except for Lodging Away from Home) on a m/m basis. But 0.67% m/m on OER and 0.74% m/m on Primary Rents is still very strong.
Some ‘COVID’ Categories: Airfares -2.15% M/M (-2.05% Last) Lodging Away from Home 1.2% M/M (1.1% Last) Used Cars/Trucks -1.94% M/M (-1.99% Last) New Cars/Trucks 0.23% M/M (0.58% Last)
AIRFARES MAKES NO SENSE. Who is seeing lower airfares? I’m trying to book RT to San Antonio from Newark and it’s $600. New Cars continues to rise. The Used Cars increase that some people were looking at from Mannheim (I wasn’t!) didn’t materialize and we STILL got a high core.
Here is my early and automated guess at Median CPI for this month: 0.481%

This is not coming down very fast, but it’s coming down on a y/y basis. I have the median category as Recreation, so this is probably a decent guess at median.
Add’l observation on rents: Piped Gas was +6.7% m/m (SA) this mo. Utilities are subtracted from some rents to get the pure rent number, when utilities are included in the rent. Mechanically this means that a high utilities number will tend to shave a little off of Primary Rents.
Piece 1: Food & Energy: 9.63% y/y

Food and energy actually slightly higher y/y this month. Food & Beverages at +0.50% for the month, still running about 10% y/y. That hurts.
Piece 2: Core Commodities: 1.44% y/y

Piece 3: Core Services less Rent of Shelter: 6.03% y/y

Core Services less Rent of Shelter – this is the big one where the wage feedback loop happens. It’s not decelerating very quickly. At least it’s going in the right direction but since wages aren’t decelerating, there’s really not much good news here.
Piece 4: Rent of Shelter: 7.96% y/y

The deflation in Medical Care is basically all due to the continuing drag from Health Insurance. Pharma was +1.2% m/m, matching the highest m/m since 2016. Y/y that’s still just 3.15%. Doctors’ Services was flat, Hospital Services +0.7% NSA. Med Equipment negative but small cat.
Some good news is that core ex-shelter is down to 3.9% y/y. But with the huge divergence between core GOODS and core SERVICES ex-rents, I’m not sure that number means as much as it once did. Still, the lowest it has been since April 2021.
I ran this chart earlier. Assuming the same seasonal change in median home prices this month as last January, the rise in rents pushes this down to 1.43. Almost back to trend. Home prices are NOT as extended as people think.

Kinda funny watching stocks. They really don’t know what to think. Hey, stocks! This is a bad number. Higher than expected, even with Used Cars still a drag. Airfares a drag. Health Insurance a continued drag. I am looking at the breadth stuff now.
In fact, outside of Used Cars, the only other non-energy category with a <-10% annualized monthly change was Public Transportation. On the >10% side we have:
Infants/Toddlers’ Apparel (55% annualized m/m), Misc Personal Goods (+44%), Car/Truck Rental (+43%), Mens/Boys Apparel (+18%), Motor Vehicle Insurance (+18%), Vehicle Maint & Repair (+17%), Jewelry/Watchs (+16%), Lodging Away from Home (+15%), Motor Vehicle Fees (+15%), >>>
Medical Care Commodities (+14%), and Water and sewer and trash collection services (+11%).
So, this is NOT the picture of a disinflationary price distribution. It’s actually a little quirky because the Median CPI is lower than the median category arranged by the y/y changes. (Median CPI is chained monthlies).

I mean…this is improving? But not crashing.

Last “distribution” chart. Our EIIDI is weighted a little differently, and it’s still declining but this month it was only a BARE decline. It tends to lead median, so I remain confident Median CPI is going to drop significantly this year…but it isn’t going to 2-3%.

Last chart and then I’ll wrap up. This is just showing that the CPI for Used Cars and Trucks was just about where it should be this month. The Mannheim though may just be leading by more. As I said in the walk-up, there’s no reason to expect used car prices to drop much more.

OK, here’s the bottom line today: higher number than expected and for all the wrong reasons. The things which were supposed to push the number higher didn’t, but we got there anyway. The sticky categories didn’t look good, and they have higher weights.
We will have to wait another month for good news. The Fed is still going to tighten to 5% before they stop, and this isn’t a good enough reason to keep going…but it’s a good enough reason to talk tougher this month. And they already were talking kinda tough.
In 5 minutes, let’s say 9:35ET, I’ll have the conference call. <<REDACTED>> Access Code <<REDACTED>> and we’ll sum it all up.
BTW here is another reason to not worry too much about rents plunging. These are quarterly series that tracked very well until the pandemic/eviction moratorium. Red line is sourced Reis; blue is census bureau. ASKING rents are coming down. EFFECTIVE still rising.

Here’s the simple summary for today’s number: the data was close to expectations, although a bit on the high side. But you have to remember that some of the reasons people were forecasting that high of a number in the first place included “Manheim used car survey suggests an increase” (Used Cars actually were -1.9% m/m), “Medicare re-pricing should push medical care higher for the consumer sector too” (Medical Care CPI actually was -0.4% m/m), and “Airfares are going up, not down” (Airfares actually were -2.2% m/m).

Okay, that last one was mainly me because I still don’t understand how airfares are dropping steadily when I can’t find a single fare within 50% of the normal price I pay for the regular routes I price. But the point is that we did not get a boost from the expected places, but still exceeded expectations; ergo, the boost came from unexpected places. It was broader. Forecasters were looking for a broader slowdown with some one-off increases keeping the m/m number high; in fact they got broad strength with one-off decreases holding it back. This is not good news.

Now, if I am on the FOMC I still want to pause at 5% and take a look around – this isn’t so surprising, unless you really were looking for inflation to hit 2.2% in June (the inflation swaps market’s last trade for June y/y is still at 2.54%, which remains mind-boggling to me). But I keep saying it and everyone will gradually come around to this view: inflation is not getting to 2% in 2023. It’s not getting to 3%. We should count ourselves fortunate if median inflation gets to 4%. The disinflation will be a multi-year project, and the tough part frankly doesn’t even happen until we get to 4%.

Right now, you’ve squeezed most of the juice out of the Core Goods category. You need to see Core Services at least stop accelerating. Deceleration of Core Services inflation, especially rents, are a sine qua non for the Fed getting to its target. We aren’t on the bombing run to the target yet. We’re still at 40,000 feet and slowly descending.

**Late breaking news, after I’d written this whole thing. The Cleveland Fed’s calculation of Median CPI was a LOT higher than mine. The m/m figure was 0.654% and the y/y rose to a new high of 7.08% y/y. I am not sure how I missed by that much and will need to do some diagnosis (it’s not that hard a number to calculate, except for the regional OER numbers), but the bottom line is that we evidently have not yet reached the median CPI peak!

Categories: Causes of Inflation, CPI, Tweet Summary, Uncategorized Tags: core cpi, core inflation, CPI, Fed, inflation

Transcript: “What the Money Velocity Comeback Means for Inflation, and Investors”

January 31, 2023 Michael Ashton 6 comments

Episode #50 of the Inflation Guy Podcast was well-received. In particular, my analogy of the car-trailer-spring system to explain why velocity is doing what it is doing garnered some strong positive feedback. Several people suggested that I publish a transcript, for those people who would prefer to read it (or who don’t know I do a podcast). What follows is a somewhat-edited version of the podcast. I took out a lot of “um” and repeat words, and the usual sorts of things that you’re embarrassed to see when you read a transcript of what you said. I tightened it up a little bit in some places and added a clarifying word here and there in brackets. But for the most part, it’s true to the original.

If you have any questions, ping me. And subscribe to the podcast, follow me on Twitter @inflation_guy (or subscribe to the private Twitter feed), or hmu to talk about how we manage money at Enduring Investments for individuals and small institutions.

Hello and welcome to Cents and Sensibility, the Inflation Guy Podcast.

I am Michael Ashton, I’m the Inflation Guy, and I’m your host. And today we have Episode 50 of The Inflation Guy Podcast and I’m going to return to money velocity because we had data out today for the fourth quarter of 2022 and there was a significant move higher in money velocity. I’ll get to that in a bit and talk about the implications that we should take away – the practical implications for what this means.

But I want to talk about this because it’s sort of become de rigueur among certain bond bulls to point at the massive drop that we had in money velocity that coincided with the massive increase in M2 during the COVID-crisis response. And those bond bulls say that velocity is permanently impaired and so the velocity plunged and it’s never gonna come back. And so it successfully blunted the importance of the massive rise in money. But we don’t have to worry about about that ever coming back. We don’t have to worry about it from now on.

This is obviously crucial to the case for lower inflation because that case basically boils down to: money growth has rapidly decelerated – it’s been negative over the last…I think it’s negative over the last 12 months now. But for a while it’s been flat to negative and so “therefore inflation will fall.”

That’s only true, though, if the sharp fall that we had in velocity is not reflected in now having a sharp rise in velocity at the same time that the sharp rise in money is being mirrored by insufficient money growth or money supply decline.

So if money…that spike now comes back and velocity plunged but doesn’t come back, then that’s the case for why we had some inflation, but not as much as the money supply spike would suggest, and now we’re going to have disinflation (or some people even say deflation – hard to believe that though).

To believe that money velocity plunged and then isn’t gonna come back, you have to believe that velocity declined for a permanent reason. But it didn’t, and that’s the bottom line here: that’s not how velocity works.

[This podcast] Episode 10 was about money velocity…and Episode 30. [Periodically in] this podcast [I have] also talked about how money velocity had turned higher last summer; at the time it was just sort of a the beginning of a turn higher. But in this quarter, the quarter just completed – the fourth quarter of 2022 – the velocity of M2 rose at an 11.4% annualized rate (which means it went up 7.3% for the whole year).

That happened, naturally, because we had money supply down while we had fourth quarter growth – real growth “Q” – that was positive, and obviously an increase in prices as well. So your PQ side of things was quite positive for the fourth quarter and M declined. And since velocity is essentially a plug number, it means velocity had to go up a lot to balance the left side of that equation, the MV=PQ equation.

Essentially, what’s really happening with velocity and the reason that velocity sort of had to come back – obviously it’s a plug number, but here’s the bottom line story of why velocity plunged. It wasn’t any permanent impairment. You should think about it this way:

You have a rapid-moving variable in in the money supply which spiked all of a sudden and you have a slower-moving variable, which is prices (because it takes time for people to change prices and for that price change to be picked up in the survey measures at the BLS and so on). And so that’s sort of like you have an automobile attached to a trailer, but instead of having a sort of a fixed rig that is attached to the trailer, you have a spring. So as the car moves away…the car goes into gear and starts to pull away. It’s moving faster than the trailer and so the spring stretches and eventually the trailer starts to move and eventually comes along. And as long as the car doesn’t continue to accelerate forever, eventually that spring will compress again and the trailer will catch up.

In fact, actually that analogy is so apt in this case, I wonder if you can’t model the whole situation with a k constant, like you would with spring physics. Because the analogy is very good. Essentially what’s happening is that, you know, money supply went zooming away and prices came along, but they came along more slowly. And so now the car is sort of sort of decelerating and the trailer (prices) is catching up to the spring, which is money velocity is starting to go back the other direction.

It’s best to think about this…and I mentioned this in the other times that I’ve talked about velocity…it’s best to think about this as being caused by (if you have to think about in terms of a cause: obviously it’s mainly a quantitative thing that sort of has to happen because we have two variables that are moving in two different paces)…it’s best to sort of think about that as being caused by precautionary demand for cash. Which is kind of what happened, right?

So, during the crisis, the government dumped tons and tons of cash into everybody’s accounts and it wasn’t spent immediately. It took some time to spend it.

So why wasn’t it spent immediately? Well, part of it was people had to figure out what to spend it on, but part of it was it was a scary time and so people figured, “well, maybe I’ll hang on to this a little while or maybe I’ll use it to pay off some debts or whatever.” It took a while for it to actually be spent until people’s financial situation got stressed enough that they had to go dip into the money that they swore they were gonna save…or what have you.

That’s the way I have modeled this is as a precautionary demand or a demand [for liquid cash] based on fear and concern about things. But the real reason is that this happened so fast, the money was flushed so fast into the system that there just was no way that prices could really respond that quickly.

Now the bottom line here is that velocity is not permanently impaired. In fact, it should rise with interest rates, as interest rates go up. And that is in fact kind of what’s happening…although I think most of what we’re seeing is this decline in the precautionary demand, but some of it is that with higher interest rates, there are more opportunities to do something other than hold cash earning zero. There’s some opportunities to take that away from true cash balances and checking balances and stuff and put it into term deposits and stuff like that.

And that means that velocity is going to come back (and it is), and that means that prices will eventually have to catch up with the car, right? The trailer eventually has to catch up with the car.

Money supply has risen since the beginning of this crisis, something around 40%, which means that prices are going to have to go up something in that neighborhood.

Actually, if velocity was unchanged over the entire length of this period and money supply only went up 40%…if you want to know how much prices are gonna go up, you have to divide the increase in money supply (that’s 40%) by the increase in GDP, whatever that turns out to be. So if GDP is up 10% then we need to see prices up an aggregate of 30%-ish or so. And so that’s sort of where I think we’re eventually going to go.

So what’s the takeaway? What does that mean, and what should you do about it?

The important takeaway is that while we are past peak inflation for now, there’s no sign that we’re going to crash back to 2% anytime soon. If in fact money velocity had not initially plunged – if velocity had been flat through this whole period – then I would be looking at the [recent] decline in the money supply growth going down to zero, and even negative, and I would say, “look, inflation should be coming down hard here; it should be going negative.” The problem is that we still haven’t had the rise in prices that you would have expected from the initial rise in money. Where that shows up is [in] that velocity plunge and [it] hasn’t come all the way back over the long haul.

The level of prices, as I said, is closely related to the level of M2 over GDP. And that’s just a consequence of the algebra of MV=PQ. So since 1990 that…well, let’s just go back further.

If you go from like 1959 to 1991, about 32 years, that relationship was super tight. M2 over that time period roughly tripled: it was up 286%. Sorry, roughly quadrupled. I’m sorry: M two divided by GDP was up 286% And the GDP deflator was up 303%. So they both roughly quadrupled over that time frame. Since 1990, that tight relationship has been less tight, which has shown up as a lot of velocity volatility.

Now, this is not irrelevant, volatility. Some of it is because there’s a changing definition of money; M2 and M1 have kind of become blurred over time. Some of that volatility is an error in measuring nominal GDP. Some of it, and maybe most of it, is excessive Fed activism on interest rate management…you know, pushing interest rates for example artificially too low since the Global Financial Crisis, which artificially depressed money velocity and so on.

But the basic relationship over a long period of time is still there. There are people out there who sort of adjust money supply in certain ways to get a better fit and I’m just I’m just not super comfortable that I know exactly the right way to do that.

I’m looking at the big picture here and I know if M2 divided by GDP goes up a lot, then we should have prices go up a lot.

Anyway, the bottom line is that inflation is not going to crash back down. We still have a lot of potential energy in the system that is pushing prices higher. And that means that market expectations of inflation are too low right now. The inflation swaps market is pricing that by June we’ll have year-on-year inflation back to 2.16%, which would just be an amazing crash back down without gasoline plunging back down. That would be truly, truly amazing. And 10 year inflation expectations, as measured by breakevens (the difference between 10 year nominal treasuries and 10 year TIPS, the difference in those yields), is 2.3% right now. That’s just crazy. Tthose expectations are just too low unless velocity’s permanently impaired.

And what that means practically for you, the investor, is that if anything you should be overweight (still) inflation hedges even though inflation is coming down from its recent peak. At the very least you should be no worse than flat – you shouldn’t be short inflation here.

You probably should be in inflation-linked bonds still rather than nominal bonds. [There are] a couple of different reasons for that, but one of them is that right now inflation-linked bonds, or [rather] the nominal bond market, is pricing inflation way too cheaply. Inflation-linked bonds will give you actual inflation and it’s likely to be higher than what’s being priced in the nominal bond market.

Real estate, commodities…all these things which are classic inflation hedges are probably still good here,even though inflation is coming down. In general, equities are not good in that kind of circumstance, but if you’re going to be in equities – and everyone tends to hold some equities – you should look for firms with pricing power. What does that mean? Hell if I know what “firms with pricing power” means exactly. Everyone thinks they have pricing power until they don’t, and they think they don’t have it until they try it and discover that they do, right?

Right now, all kinds of firms do have power to raise prices and many of them are raising prices. So it’s hard to tell which ones are the ones that will be able to keep raising prices to keep up with the input cost pressure (largely wages) that they’re going to continue to have here going forward.

Which companies have the ability to sort of stay ahead of that? I’d say in general, you’re gonna look at firms that have a lower labor content, because commodity prices have come down…or they’re going up less fast, I guess. But labor rates continue to rise rapidly and probably will for some time.

I think firms with domestic supply chains are probably better off, or at least North American supply chains, are probably better off than the ones with long international supply chains.

I think that maybe something like apartment REITS could be interesting, especially because everybody was so convinced that that real estate was going to collapse – and it’s clearly not collapsing. Rents is something that tends to keep up with wages over time. Maybe rents have gotten a little bit ahead of themselves, but I think that the decline or the deceleration in rents is probably already kind of priced into those markets.

As always, by the way, podcast musings should not be construed as recommendations.

You know, I try to avoid mentioning specific tickers all the time because I’m an advisor and that gets sticky because if you recommend, say, Tesla, [then] you have to then give all the reasons why Tesla might go down and, you know, there’s all kinds of rules about that. So I try to not spend a lot of time recommending specific securities. But you know, you can always become a client! And we can talk all about it. Or you can send me email at inflationguy@enduringinvestments.com and we can have some conversations about that, but the bottom line is that you shouldn’t be letting your guard down.

Money velocity has been coming back for a while; it’s starting to come back more seriously. Even though money supply is declining, or flat to declining, it does not mean that inflation is going to plunge back to 2% because we have this potential energy that’s still working its way through the system. There’s no sign that velocity is permanently impaired.

So, don’t let your guard down. Defend Your Money! …and if inflation is coming for you, remember: you know a guy.

Categories: Analogy, Causes of Inflation, Podcast Transcript Tags: inflation, m2, velocity

The Quintillion-Dollar Coin

January 25, 2023 Michael Ashton 3 comments

I was going to write a technical column today about how the sensitivity of bonds (and consequently, lots of other asset prices) to interest rates increases as interest rates decline, and discuss the implications for equity investors nowadays as interest rates head back up. That article will have to wait another week. Today, I want to just quickly dispense with a really silly idea that keeps making the rounds every time there is a standoff on the debt ceiling, pushed by the same guys who think Modern Monetary Theory (MMT) will work (even though we just tried it, and it didn’t).

The idea is that, thanks to a law passed back in the 1990s, the Treasury has the right to issue a platinum coin of any denomination. Ergo, it could produce a $1 Trillion coin, deposit it at the Federal Reserve (who does not have the option to not accept legal tender, Secretary Janet Yellen’s recently-voiced concerns notwithstanding), and continue to pay the government’s bills. Why? One well-traveled and entertaining simpleton started explaining the reasoning for doing this by saying “there’s this silly, anachronistic and ineffectual law on the books called the Debt Ceiling…”

If we started doing really really silly, not to mention stupid, things to get around every law that we thought was silly and anachronistic, legislators would be busy 24 hours a day, 7 days a week. (And, obviously, the law isn’t “ineffectual”; if it was then we wouldn’t need to get around it.)

I am continually amazed by how durable the really stupid ideas are. For instance, the notion that the government is lying about inflation to the tune of 6% per year is an idea that never seems to die even though you can show with basic math that it can’t possibly be the case. So, let’s dispense with this one even though I am sure I will have to keep slaying this dragon when it inevitably comes back from the dead.

A useful tool of logic that’s handy when you are trying to smoke out a dumb idea is to ask, “If that works, why don’t we do lots more of it?” Let’s not try to figure out why a $1 Trillion coin is a bad idea. Let’s try to figure out why a $1 Quintillion coin (a million trillions) is a bad idea.

After all, if we are going to mint a coin anyway, it doesn’t cost much more to stamp “Quinti” than it does to stamp “Tri”. And if the Treasury minted a Quintillion-dollar coin and deposited it at the Fed, it would be much more significant. With that balance, the Treasury could pay off all outstanding debt, fully fund Medicare and Social Security, and cancel all taxes basically forever while also dramatically increasing services! Why isn’t that a better idea? I spit on your Trillion-dollar coin.

Naturally, that would be a terrible idea and it’s now obvious why. I can think of several reasons, but I’ll leave most of them for other people to highlight in the comments. The immediate one is that by paying off all federal debt, increasing spending and decreasing taxes to zero, the money supply would increase immensely and immediately. As we saw quite recently, the result that rapidly follows is much higher inflation. Much much higher inflation. I will see your 8% and raise you 800%. Yes, to some extent that would depend on the Congress deciding to do that spending and cut those taxes – but do you doubt that would happen? And the Treasury offering to buy back all of the outstanding bonds wouldn’t need Congressional authorization. That’s trillions in money being suddenly returned to bondholders, which puts it back in circulation.

A trillion here, a trillion there, and pretty soon you’d be talking real money.

Categories: Analogy, Bond Market, Causes of Inflation, Government Tags: debt ceiling, trillion-dollar coin

Summary of My Post-CPI Tweets (June 2022)

July 13, 2022 Michael Ashton Leave a comment

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.

Categories: Causes of Inflation, CPI, Federal Reserve, Tweet Summary, Uncategorized Tags: core cpi, core inflation, CPI, inflation, interest rates

“The Great Demographic Reversal”

July 6, 2022 Michael Ashton 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.

Categories: Book Review, Causes of Inflation, China, Employment Tags: demographics

The Coming Rise in Money Velocity

June 28, 2022 Michael Ashton 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.

Categories: Causes of Inflation, Economics, Monetarism

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