Archive

Archive for the ‘Economy’ Category

Summary of My Post-CPI Tweets (December 2022)

January 12, 2023 1 comment

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy, but to get these tweets in real time on CPI morning you need to subscribe to @InflGuyPlus by going to the shop at https://inflationguy.blog/shop/ , where you can also subscribe to the Enduring Investments Quarterly Inflation Outlook. Sign up for email updates to my occasional articles here. 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!

  • It’s #CPI Day – and this one finishes up the book for 2022.
  • I am doing the walk-up differently today. I’m doing it as a thread on the night before, which I’ll re-tweet in the morning. I’m usually doing the analysis in the evening…why wait?
  • Today’s number, or I guess really we can say starting with October or November, starts the interesting part of the inflation cycle.
  • When inflation was going up, excuses abounded but the real debate was WHEN the peak was going to be, and HOW HIGH only to a lesser extent. Now that inflation appears to be clearly decelerating, the much more important debate is: where is it decelerating to?
  • If inflation drops back to 2%, and becomes inert at that level again, then the Fed will deserve considerable laurels. If inflation instead drops to 4% and appears resistant to a drop below that, then a much more interesting debate will ensue.
  • I think it should be clear that I am in the latter camp.
  • The other interesting thing that we’re going to see, and are already seeing, is manifestation of the basic tricks of the trade of macro economists.
  • Trick 1 is to assume that everything returns to the mean. Most things do, eventually, return to the mean – so if you are wrong on the timing, you’ll probably eventually be right. Economists love to forecast returns to the mean.
  • Economists though are very bad at forecasting departures AWAY from the mean, which is why there were so many forecasts of “transitory” this cycle.
  • Since they didn’t see it coming, it must have been a random perturbation (because that’s how their models work). But it’ll all go back to the mean and all is right with the world. Or so goes the assumption.
  • Trick 2 is to assume that the mean doesn’t change, or changes pretty slowly. In econometrics terms, the distribution is ‘stationary.’ If you’re going to forecasts returns to the mean, it is fairly important that the ‘mean’ is known or knowable and doesn’t move a lot.
  • The problem in inflation is that the (unobservable) mean of the distribution never appeared to be very stable until the mid-1990s; the hypothesis is that this anchoring happened because of “anchored inflation expectations.”
  • (A member of the Fed’s own research staff tore apart that notion in a devastating article a couple of years ago, but the Fed promptly ignored him because if he was right it’s really bad for forecasting the way that they like to forecast: everything returns to the mean.)
  • Getting to Thursday’s CPI figure, we can see these tricks in play in the economist forecasts.
  • As an example, one of the forecasts I saw from a large bank had drags calculated from Used Cars (and New Cars), a deceleration in shelter costs, a drag from airfares due to lower jet fuel costs, and a drag from health insurance. But what about accelerations?
  • Do you really think that NOTHING will accelerate, or are all of those pre-defined as “one-offs”?
  • It reminds me a little of what Rob Arnott says about the S&P earnings “ex-items”: any one company it might make sense to ex- the unusual events. But in aggregate, some level of unusual events is usual. So it is with inflation.
  • There will be some ups. So my forecasts are a little higher than others’, because I anticipate there will be some surprises.
  • Where would those surprises come from? Wage growth is strong, and that pushes up on prices in hospitality, domestic manufacturing, food away from home, and even shelter.
  • I also don’t think that airfares will be the drag that’s implied by jet fuel. Here’s the regression that would make you think they WOULD.

  • But here’s the one that makes you think maybe not. Airlines tend to push prices higher when there are spikes in jet fuel costs, but they don’t necessarily lower them very fast when jet fuel prices decline. And did I mention wage pressures? Airlines feel them.
  • I do think that used car prices will drag again, although the CPI has been falling a little faster than the Black Book and Mannheim indices would suggest they should. But I don’t see a strong argument for New Car prices to decline.
  • New Cars are in black in this chart, while Used are in blue. New car prices are up 20%, while used are up 40%, since the end of 2019. And the money supply is up around 40%. That doesn’t mean new car prices won’t decline, but it doesn’t look like a slam dunk to me.
  • Finally, a point I’ve been making recently on a longer-term horizon viewpoint. Markets are fully priced for inflation to totally and almost immediately mean-revert. Large declines in breakevens, especially short BEI. Some of that is the gasoline slide. Not all of it.
  • The short end of the inflation swap curve has NSA inflation at -0.38% m/m in December, +0.37% in Jan, +0.33% in Feb, and 0.30% in March. And that’s the last 0.3% print we see. According to inflation swaps, y/y inflation will be at 2% in June.
  • Even if I am wrong about inflation staying around 4-5%, you have a 2% cushion to bet that way. (I think I used an unfortunate analogy a few days ago saying that if you give me 21 points I’ll take TCU over Georgia, but you get my point.)
  • Ergo, for choice I’d be long breakevens going into this number.
  • The response in the stock market will be interesting. If the number is as-expected or better, I would think stocks will try and scream higher on the theory that the Fed can back off. The problem is that folks are already long for that, I sense.
  • So I’d probably sell that pop, especially because earnings may be a hurdle in the near future, though you have to be cognizant of the 200-day moving average in the S&P. The mo-mo crowd will try to get some prints above that so I’d be cautious.
  • What about on a strong CPI? Few seem to be thinking/talking of that, which means to me that folks are a little naked there. Do I think it would change the Fed trajectory? Not from what the Fed is SAYING they’re doing, but from what the market is pricing – yes.
  • As I said, this is the interesting part of the inflation cycle. Buckle up.
  • At 8:30ET, I’ll be pulling the data in & will post charts and #s – then retweet some of those charts w/ comments plus other charts. Around 9:30ish, I will have a private conference call for subscribers where I’ll quickly summarize the numbers.
  • Pre-release, both stocks and bonds are loving this number! May be that some are reading into the fact Biden has a speech this morn including inflation as a topic, and perhaps he wouldn’t if the number was bad. But even if it is, he can focus on y/y so not sure that means much…
  • That’s all for now. Good luck!

  • m/m CPI: -0.0794% m/m Core CPI: 0.303%
  • Last 12 core CPI figures
  • Overall, highest core number in 3 months, but clearly in a down trend. I think lots of people would be DELIGHTED with 3.6% annualized compared with where we have been, but that’s closer to what I am expecting than what the market/Fed is looking for.
  • M/M, Y/Y, and prior Y/Y for 8 major subgroups
  • Interesting thing is apparel, up for the second month in a row. Apparel is an almost pure import, so if it’s up then either (a) the recent dollar weakness is already affecting prices or more likely (b) there is pricing power at retail, and the markdowns for Christmas were lower.
  • Core Goods: 2.15% y/y Core Services: 7.05% y/y
  • The story continues to be bifurcated and we will look further at the four-pieces. More important than the fact that services are trending and goods are deflating, is whether the services part was all rents.
  • Here is my early and automated guess at Median CPI for this month: 0.378%
  • Clearly good news! Lowest median m/m in quite some time. So core was higher, but median lower. THIS is positive. And as I said, this is the interesting part now: inflation is decelerating, but why and how fast and how far? Median clearly shows it is.
  • Primary Rents: 8.35% y/y OER: 7.53% y/y
  • Further: Primary Rents 0.79% M/M, 8.35% Y/Y (7.91% last) OER 0.78% M/M, 7.53% Y/Y (7.13% last) Lodging Away From Home 1.5% M/M, 3.2% Y/Y (3.2% last)
  • Although the rent data is clearly bad news, there has been a strong campaign against this data to weaken its importance by claiming it’s just really lagged. That’s partly true but the recent research on the subject has enormous error bars for short-term forecasts so…
  • Some ‘COVID’ Categories: Airfares -3.12% M/M (-3.02% Last) *** Lodging Away from Home 1.47% M/M (-0.71% Last) *** Used Cars/Trucks -2.55% M/M (-2.95% Last) *** New Cars/Trucks -0.06% M/M (0.04% Last)
  • So, I was ‘on’ core even though I was wrong on airfares (it was weak, despite the fact that every fare I saw in December was about 2x normal). Used cars was the predicted drag, and New cars was not…but I was low on rents. That’s the ‘away from mean surprise’.
  • Incidentally, Lodging Away from Home was quite strong – and is one of those core-services-ex-rents that is driven a lot by wages.
  • Piece 1: Food & Energy: 9.31% y/y
  • Piece 2: Core Commodities: 2.15% y/y
  • Piece 3: Core Services less Rent of Shelter: 6.34% y/y
  • …and here is the spoiler: it wasn’t all rents. Core services less rents still strong. I’ll drill down further in a bit.
  • Piece 4: Rent of Shelter: 7.59% y/y
  • So, the swap market gets closest-to-the-pin on headline (SA). -0.079% was the figure, a bit lower than consensus econs and a fair bit lower than me. On Core, econs and I were both pretty close as it was right around 0.3% (0.303%).
  • I had managed to talk myself into the idea that food and energy would be a bit less of a drag than my model said, but food wasn’t up as much as it has recently been. Ergo, right on core and off on headline.
  • Interesting story in Medical Care, which has been a drag recently because of the huge adjustment to insurance company margins (huge and unlikely, btw). Doctors’ Services is slowly reaccelerating a little. Hospital Services continues to have problems getting sufficient sample.
  • Overall, Medical Care was up 0.1% m/m, but that’s after the continuing ‘insurance’ drag. Y/Y it was at 3.96%, down from 4.15% but looking like it’s leveling out.
  • The median category in the Median CPI will be Food Away from Home, +4.63% annualized monthly number. And the y/y Median will decline very slightly again. Was 7.00% in Oct, 6.98% in Nov, 6.93% in Dec. But heading down.
  • Biggest upward m/m movements in core categories were in Jewelry/Watches (+48% annualized monthly), Mens/Boys Apparel (+22%), Lodging Away from Home (+20%), Motor Vehicle Maint/Repair (+13%), and South Urban OER.
  • • Biggest decliners were energy things, including Public Transportation, plus Used Cars (-27% annualized monthly figure), and Car/Truck Rental (-18%).
  • Core ex-shelter: this includes core goods decelerating rapidly and core services accelerating so perhaps isn’t as useful as sometimes: 4.48% y/y, down from 5.2% last month and the lowest since April 2021. But if it stayed there, then it’s hard to get core to 2%.
  • While I’m waiting for the diffusion stuff to calculate, a word on what this does to the Fed: nothing. The Fed is aiming for 5% and then will keep rates high for a while unless something breaks.
  • Do markets love this data today because it means they were worried about a more-hawkish Fed, with higher rates or higher-for-longer? Or do they think it means the Fed will in fact start easing this year as the curves impound?
  • In my view, the latter is really unlikely. I can see the Fed starting QE again if auctions start getting difficult, but in my view there’s no evidence here that we’re going right back to 2% inflation and the Fed has been loudly consistent about this.
  • To be sure, they can turn on a dime and they have previously, but…I just think market pricing is really optimistic.
  • This [chart below] is consistent with the good news from Median – for the first time, our diffusion index has declined smartly. It’s still above the highs of the last couple of inflation ‘spikes’ (which no longer look like spikes!), but moderating.
  • This chart is not quite as good. The mean CPI is falling more because some high outliers (cars e.g.) are coming back to the pack, and some are moving from low to the low tail, and less because the middle is shifting a lot. Look at how >5% is barely declining.
  • I mean, that’s not TERRIBLE news, but obviously we need to see the “<2%” get close to 50% if the Fed is going to be confident they’re back near their inflation target. • One more point and then I’ll prep for the call. A lot of the positive-news things are well along towards delivering what they’re going to deliver. Health ins won’t be a drag in 2024. Used cars won’t drop another 20%. And >>
  • >>the dollar has turned south so core goods won’t be in retreat forever. The case for inflation going back to 2% rests on rents turning, and on wages slackening. And while those are expected, there are scant signs of them yet. So hold off on the celebrations in the Eccles bldg.
  • OK, let’s wrap up and get to the call. Thanks for subscribing. at 9:35ET I’ll be on this call; join if you want to hear me say what I just tweeted. 🙂 [NUMBER REDACTED]

The CPI figure was broadly in line with expectations, which means it was a “something for everybody” kind of number. Disinflationists see continued broad progress towards the Fed’s 2% PCE target, while sticky-inflation folks see the rents and core-services numbers and shake their heads, tsking ominously.

Two broad observations:

First, the disinflation from core goods is ‘on schedule,’ with Used Cars and other core goods categories doing approximately what they are expected to do. But the problem is that core goods inflation is down to 2.1%. If you are looking for the whole number to go back to what it was pre-COVID, you need core goods in mild deflation and core services down to 3%. But both parts of that story are difficult. With the world de-globalizing and near-shoring, it is going to be difficult to see core goods back in an extended period of mild deflation. Probably 0-1% is the best we can really hope for. And that means that the core goods sponge has been mostly wrung out. And core services back to 3%, even if rents are actually peaking (and just not showing up in CPI yet)? Well, core services-ex-rents remain pretty buoyant. So how do we get that back to 3%?

Second. The interesting part of the story is coming up. Inflation is probably returning to “the mean,” but what is the mean inflation now? For a quarter-century it was stable at 2-2.5%, but prior to that it had never been very stable. There are feedback loops in inflation, and those appear visibly to be at work here: higher wages help support higher services inflation, and rents, which in turn support higher wages. Social Security and other wage agreements that are explicitly linked to inflation help this process along. But it means this: the mean is not stationary. The real question of 2023, and probably 2024, is this: what is the mean, now?

My guess? It’s 4%ish, or even slightly higher. It’s very unlikely to still be 2-2.5%. Ergo, it is going to be very hard for the Fed to end 2023 in a happy mood…which means that it is going to be hard for investors to end 2023 in a happy mood!

2022 Year-End Thoughts About 2023

December 22, 2022 2 comments

Use: This article may only be reposted in its unedited entirety (including all links), including the title and author with linkbacks to the original. If you wish to repost in serial form, please contact me via the form at https://enduringinvestments.com to discuss.

When I was a Street strategist, and/or producing ‘sales and trading commentary’ as a trader, it was de rigueur to produce an annual outlook piece. Naturally, everyone does one of those; consequently, I stopped doing them. It seems to me like it would get lost in the shuffle (this is one of the reasons that Enduring’s “Quarterly Inflation Outlook,” which we distribute to customers and is also available by subscription here, is produced on the ‘refunding schedule’ of February, May, August, and November rather than at quarter-end). Having said that – it does seem that, given what inflation has done recently, there are more people asking for my outlook.

I do have to raise one point of order before I begin. As regular readers of this column know, in my writing, I generally try to propose the ‘right questions,’ and I don’t claim to have all the right answers. An outlook piece is often interpreted as being the analyst’s best guess at the answers. While it is that, for me the answers I suggest here are likely to be less valuable to the reader (I do not recommend that you blindly place trades based on my outlook for where markets will go!) than the thought process that is going into them. You may and probably will disagree with some of my answers. But hopefully, you’ll be able to identify where in my reasoning you have specific disagreements, which will either enhance your own view or cause you to thoughtfully reconsider it. That’s the whole point, and I don’t care at all if you disagree! That’s what makes markets.

Moreover…even if my guesses end up being “wrong,” or “right,” based on the actual outcomes in the future, that doesn’t mean they were wrong or right in terms of being a good approach/positioning. Investing is not really all about making the “right” bet in terms of whether you can call the next card off the deck, but about making the “right” bet with respect to the odds offered by the game, and betting the right amount given the odds and the edge. On this topic, I recommend “Thinking in Bets” by Annie Duke as excellent reading.

So, here goes.

MACROECONOMICS

For most of this year, I have been saying that we would get a recession by early 2023. In 2022Q1 and Q2, US GDP contracted. This produced the predictable shrill announcements of recession, coupled this year with sadly simple-minded declarations that the Biden Administration had “changed the definition of recession” by saying we weren’t in one. One television commentator I saw strongly profess the view that the two-quarters-of-negative-growth-is-a-recession definition is “in every economic textbook.” Having read my fair share of economic textbooks and having taught or tutored from a few, I can assure you that is not the case.

I was, and remain, sympathetic to the incoming fire that the Biden Administration took then, because they were basically right: whether we chose to call it a ‘recession’ or not, there was scant sign of any economic distress. Employment (which lags, of course) remained strong, corporate earnings were solid, confidence was reasonably high except for inflation, and citizens still had a substantial cash hoard left over from the COVID stimmy checks. However, while the critics were wrong on the timing they weren’t wrong about the eventuality of a recession. As I also said a bunch of times, there has never been a period where energy prices rose as rapidly as they did between early 2021 and mid-2022, combined with interest rates increasing as rapidly as they did thanks to Federal Reserve policy, that did not end in recession. But it takes Wile E. Coyote some time to figure out that there is nothing under his feet, before he falls, and recessions work similarly. We will have a recession in 2023.

We are already seeing the early signs of this recession. One indicator I like to look at is the Truck Tonnage index, which falls significantly in every recession (see chart, source Bloomberg). The last two months have seen a decline in this seasonally-adjusted index. It is early yet – we saw a similar-sized decline in 2016, for example, so there are false signals for small changes – but the fact that this decline happened heading into the Christmas season gives it more significance.

That’s the goods side. The services side shows up more in the labor market, which lags behind the overall cycle. Yet there too we have started to see some hints of weakness. Jobless claims are well off the post-COVID lows, although they are still roughly “normal” for the tight pre-COVID labor market. And the labor market is really hard to read right now, given the continuing crosswinds from the COVID-period volatility and the fact that so many services jobs now are at least partly virtual. Upward wage pressure is continuing, partly because virtual workers are less productive (shocker reveal there), so this recession in my view will probably not feel as bad as the last couple of recessions (GFC, Covid) have felt. However, we will have a recession in 2023.

The bad news, though is that a recession does not imply that inflation, ex-energy, will decline. Look at this chart, which captures the last three recessions. The post-GFC recession was the worst in 100 years, and while core inflation slowed that was almost entirely a function of the housing market collapse and not the general level of activity. The COVID recession was worse than that, and core inflation accelerated. And the post-tech-bubble recession wasn’t a slouch either; core inflation accelerated throughout 2001 until it started to decline, but only got down to 1.1%, in late 2003.

This chart shows y/y changes, but helpfully shows core-ex-shelter (Enduring Investments calculations). There isn’t a lot to see here in terms of the effect of these three huge recessions.

Lest you think I am just cherry-picking the 2000-2022 period, here is core CPI and GDP normalized as of December 1979. Again, you can see in the GDP line the recessions of the early 1980s, of the early 1990s, and that post-tech-bubble recession. I can’t see those, in the CPI line.[1]

And hey, as long as we are doing this…how about the 1970s malaise when the multiple recessions and flat growth led to … well, not disinflation.

I think the evidence is very clear: forecasters who are relying on the “recession” forecast (which I share) to make a “hard disinflation” forecast are simply ignoring the data. Those two concepts, outside of energy, are not related historically.

That being said, I expect core inflation and median inflation to decelerate in 2023. I just don’t think they will decelerate nearly as much as Wall Street economists think. Shelter inflation is already well above my model, and I expect will come back towards it, but my model otherwise doesn’t see a lot of downward pressure on rents yet. The strong dollar, and some healing of supply chains, will help core goods – but core goods inflation will remain positive next year and probably for a long time, thanks to secular deglobalization, instead of being in persistent slow deflation. And core services ex-rents will decelerate, but mainly because of the technical adjustment in health insurance. Until wages start to ebb, it’s hard to see a crash in core services ex-rents inflation. So that brings me to this forecast for core CPI:

Current2023 Fcast
Core Goods3.7%2.3%
Rent of Shelter7.2%4.8%
Core Services less ROS6.3%5.1%
Core CPI6.0%4.2%

Most of the Street is in the mid-2s for core inflation; the Conference Board forecast for Core PCE recently was raised to 2.8% which would put core CPI at 3% or 3.1%. They’re getting there, but frankly it’s hard to see how you can get to those levels. In my view, most of the risks to my forecast are to the upside.

MONETARY POLICY

An important disclosure should be made here: in 2022, I was utterly wrong about the path the Fed would take. Almost as wrong as it is possible to be. Ergo, take everything I say hereafter in this section with a grain of salt.

Coming into 2022, I thought the Fed would follow the same script they had used for more than a quarter-century with respect to tightening policy: slow, late, tentative, and quickly reversed. Although inflation was already plainly not transitory, I know that the Fed’s models assume a strong homeostasis especially with inflation, to the extent that the persistent part of inflation is essentially (albeit with a lot more math) modeled as a very slow moving average and overall inflation is assumed to pull back to that level. When the Fed talks about the “underlying inflation trend,” that is in simple terms what they are saying. But if you believe that, then there’s very little reason to pursue something similar to a Taylor Rule where policy is driven by simple deviations of growth and inflation from the target levels.

So, when the Fed started to move I expected them to tighten a few times and then to stop and ultimately reverse when financial markets started doing ugly illiquid things. One thing I didn’t anticipate: the markets never really did ugly illiquid things. Investors welcomed the tighter policy, and ran ahead of the Fed to give them room. Especially considering that, at the end of 2021, I think most sophisticated investors viewed the Fed as incompetent (at best) or counterproductive (at worse), the markets gave the Committee an amazing amount of latitude. The Fed, to its credit, saw the gap in the defense and sprinted through it. I did not see that coming.

After nearly 500bps of rate hikes, and a small decline in the Fed’s balance sheet, money supply growth has come to a screeching halt. That’s largely spurious, I think, since money supply growth is a function of bank lending and banks are neither capital-constrained nor reserve-constrained at the moment, and longer-term interest rates have risen but not very much (except in the mortgage market). I suspect that most of the decrease in loan demand that is evidently happening is not in response to the increase in short-term rates but rather to the increase in mortgage rates almost entirely. If that’s the case, then it’s a one-time effect on M2 growth: mortgage origination can only go to zero once. The chart below shows the connection between M2 growth (in blue) and the MBA Purchase index (black). The correlation is not as incredible as it looks, because one is a rate of change that is off-center by 6 months (it’s y/y) and one is a level of activity, but if I expressed both in rate of change you would still say they look suspiciously similar.

If I am right about that point, then the money supply will shortly resume its growth as the overall volume of lending continues to grow without the negative offset of declining mortgage origination. With money velocity on the upswing now, this will support the level of inflation at a previously-uncomfortable level. So what will the Fed do?

Importantly, the Fed won’t really know that inflation isn’t dropping straight to 2% until after the midpoint of the year. But they’ll make the decision to pause rate hikes sooner than that. I think a 5% Fed funds rate is a reasonable target given their assumptions, a key one of which is that if “underlying inflation” is really 2%-3% then a 5% nominal rate will be plenty restrictive.  

What is really amazing to me – which the ‘me’ of 2021 would never have anticipated – is that Fed watchers and market participants are starting to talk as if they believe the Fed might overdo the tightening, raising rates higher than needed to restrain the economy and inflation (yes, I know I said that a recession doesn’t cause lower inflation but it’s an article of faith at the Fed so we need to pretend as if we believe it). It’s incredible, when you think about it: the Fed hasn’t come close to ‘overdoing it’ in a tightening cycle in decades, if by ‘overdoing it’ we mean that they caused a deflationary crash. The Fed has caused plenty of recessions, but core inflation hasn’t been negative since the Great Depression. And we’re worried about them overdoing it?

Naturally, if you don’t think that raising rates causes inflation to come down then any rate hikes at all…actually, any active monetary policy at all…is too much. But in any event, it’s striking to me that the Fed has somehow restored some credibility as a hawkish central bank. Not that credibility per se matters, since expectations don’t cause inflation. But I digress. It’s still pretty amazing.

When Powell was first named Chairman, I was hopeful that a non-economist could help break the Fed out of its scholarly stupor. As time went on I lost that hope, as Powell trotted out various vacuous terms like “transitory” and leaned on discredited models (nevertheless still in vogue at the Fed) such as those which utilize the ‘anchored expectations’ hypothesis. But I have to say, my opinion of him has risen along with the Fed funds rate.

In my view, the biggest Fed error of the last forty years was Greenspan’s move to make the Fed transparent, which caused the pressures on the Fed to be entirely one-way. The second-biggest Fed error follows from that, and that is the tendency to move rates further and further away from neutral, holding rates at such a level by maintaining vastly higher levels of liquidity than were needed to run the banking system. The consequence of this has been a series of bubbles and asset markets at levels where the prospect of future real returns was abysmal. Plus, it led to the heyday of hedge funds where cheap money levered small returns into big returns.

The Powell Fed, for all of its flaws and awful forecasting, has succeeded in getting the yield curve to the vicinity of long-term fair value, which I define as sovereign real rates near the long-term growth rate of the economy (2.00-2.25% in the US – see chart below, source Enduring Investments before 1997 and Bloomberg after 1997). With a Fed inflation target at 2.25% or so in CPI terms, this means long-term nominal interest rates should be in the vicinity of 4%-4.5% over the long term in the context of a responsible central bank. We’re not there, but we’re getting close.

All of which means that I think the FOMC is just about done with hiking rates for this cycle. I believe they will get to 5%, pause, and stay paused for a long time. I do not expect them to lower interest rates, even if there is a recession, unless markets or banks start to have difficulties or Unemployment gets above 6%. That might happen in late 2023, but even if it does I think the Fed will be much more measured about cutting rates than they have in previous cycles. Credit to Powell for the change in attitude.

Those pieces, the Macro and the MonPol, along with my assessment of relative valuations, inform everything else.

RATES, BREAKEVENS, AND CURVES

The long, long, long downtrend in interest rates is decisively finished. As noted above, when inflation is under control and in the vicinity of the Fed’s 2% target, long-term interest rates should be in the vicinity of 4-4.5%. Over the last century, when rates have been away from the 3-5% range it has generally been either because inflation was unstuck on the high side (1970s, 1980s) or unstuck on the low side (1920s, 1930s, 2010s) (see chart, source Federal Reserve and Bloomberg). The long-term downtrend can be thought of as going from unstuck-high inflation, to normal, and overshooting to the downside in the last decade. But we have now definitively ended that low-rates period.

At a current level of roughly 3.5% nominal, 1.4% real, interest rates are ‘too low’ again, but this is normal for an economy headed into recession. Ordinarily, this configuration of events – a Fed nearing the end of a tightening cycle, a recession looming, and interest rates that have risen 320bps over two years – would make me bullish on bonds. And I do think that the first part of 2023 may see a decent rally as the Fed finishes their business and the stickiness of inflation is not yet apparent, but the recession is. Seasonally, you’d really prefer to be long the bond market/out of equities in the last quarter of the year and out of the bond market/long equities in the first quarter of the year, but I think the seasonal pattern will be reversed this year. So we will come in all happy as bond investors, and get unhappy later in the year.

The reason I think the first quarter of the year will be pretty decent for bonds is because of the timing of the recession and of the end of the Fed tightening cycle. But why the selloff as the year progresses? Well, investors will start to see that inflation is not falling as fast as they had expected, the Fed is showing no signs of easing…and the Federal deficit is blowing up.

In FY 2022, the US government had a $1.38 trillion deficit,[2] in an expansion during peacetime. But there are some inexorable effects pushing that higher next year. For example, interest on the debt: higher interest rates will affect only the part of the public debt that has rolled over, but that is an awful lot of it.

In December 2021, the rolling-12-month interest expense on US Debt Outstanding (see chart, source Bloomberg) was $584bln.[3] As of November 2022, the rolling-12-month expense was $766bln. It will be up another $100bln, at least, in 2023. Social Security benefits paid this year were roughly $1.2 trillion, and benefit payments are due to increase 8.7% next year – so, even neglecting the fact that there will be more recipients next year, Social Security should also be $100bln further in the red. That’s $200bln, on top of the approximately $1.4trillion deficit, and I haven’t even considered Medicare, the decline in tax receipts that will occur thanks to a decline in asset markets this year, or the decline in taxes on earned income when the economy enters a recession. A $2 trillion, peacetime deficit is easily in reach and will be much more if it’s a bad recession. The last time we had that big a deficit, the Fed happened to also be buying a couple trillion dollars’ worth of Treasuries. This time, though, the Fed is shrinking its balance sheet.

It is fairly easy to imagine that longer interest rates will have to rise some, in order to roll the maturing debt. As I said, higher interest rates don’t really bother me because I don’t run a highly-levered hedge fund. (But if the rise in rates were to get sloppy or rates were to rise enough to threaten a spiral in the deficit, then I can imagine the Fed stepping in to reverse its balance sheet reduction and being under even more pressure to guide rates lower. However, it’s not my base case.)

Also, as the year goes along the stickiness of inflation will become more apparent and investors will rightly start to put that assumption back into their required return for nominal bonds. One of the really crazy things that happened in 2022 was that inflation compensation in nominal bonds (aka ‘breakevens,’ the mathematical difference between yields on nominal bonds and yields on inflation-linked bonds that pay inflation on top) declined even as the overall level of inflation continued to climb. At the time of this writing, Median CPI has not yet even decisively peaked, although I think it will. But with Median CPI at 6.98%, it’s incredible that the market is demanding only 2.28% annual compensation for inflation over the next decade (see chart, source Bloomberg). That basically says investors are comfortable earning an increment that underpays them for inflation in the near term, and in the long term will only compensate them for what the Fed says they are trying to pin inflation at.

That’s not as easy a trade as it was when 10-year breakevens were at 0.94% in March 2020, but it still seems to me that most of the risk over that decade would be for inflation to miss too high, rather than too low. I understand that the FOMC wants inflation down around 2%. And as for me, I want a Maserati. Neither one of us is likely to get what he wants, just because we want it.

As the first quarter of the year passes and long-term interest rates decline, the curve may invert further from its current level. But I don’t think it can invert that much, which limits the value to being long, say, 10-year notes from this level. Given the current level of inversion, it is fairly easy to construct steepener trades that throw off positive carry. For that matter, a leveraged investor who is financing at 4.5% and earning 3.75% is more likely to want to go the other way! I think it’s going to be difficult to get a good bull market rally going in bonds, and if I was a leveraged hedge fund investor I’d be playing from the short side/steepener side even in the first quarter of the year (albeit cautiously). The chart below (source: Bloomberg) shows 2s/10s monthly going back to 1980. The only time the curve was more inverted was in the early 1980s, a couple of years after Volcker’s Saturday Night Special and with the hiking campaign solidly underway as it is now. I’m expecting 2s/10s to go positive in 2023, although the best shot at something like +50bps would come if the Fed actually did ease. Ergo, a steepening trade is also nice because it works in my favor more if I’m wrong about the Fed staying on hold for a while after they finish hiking to 5%.

Put those together and I see Fed funds at 5%, 2yr Treasuries at 4.25%, and 10s at 4.5%.

We obviously look deeper than that, though, on this channel. We can separate nominal yields into real yields (represented by TIPS) and inflation compensation (breakevens, or inflation swaps). Here are what the curves look like today (source: Enduring Investments).

From here, it looks fairly obvious that a good deal of the steepening should come from longer-term real rates rising. The 2y TIPS bond is at roughly 2%, so 2s-10s in reals is about the same as it is in nominals. The inflation curve is ridiculously flat. I do think that the inflation curve is more likely to shift higher in parallel than to steepen; a steepening inflation curve would imply accelerating inflation going forward and I don’t think investors really believe we’ll get acceleration. So I think that the movement in the shape of the TIPS curve will be very similar to the movement in the nominal curve, but with the level of the nominal curve being driven by an upward parallel-ish shift in the inflation curve.

2y10y
Current TIPS Yields1.96%1.42%
EOY TIPS Yields1.80%1.85%
Current Breakevens2.30%2.27%
EOY Breakevens2.45%2.65%

VOLATILITY

Generally speaking, a higher-inflation environment is a higher-volatility environment. The chart below (source: Bloomberg) shows core CPI in blue against the ICE BofA MOVE Index of fixed-income option volatility. True to form, the higher-inflation regime has correlated with higher levels of fixed-income volatility.

It isn’t terribly shocking that volatility is higher in bonds than it had been during the years when interest rates were fixed within a stone’s throw of zero. And it shouldn’t be terribly shocking that I expect volatility to stay somewhat higher than the 2017-2019 and 2020-early 2021 levels, even as core inflation recedes somewhat. What may be surprising is the observation that a sizeable gap has opened up in the behavior of fixed-income volatility and equity volatility, as the following chart comparing the VIX (equity vol) and MOVE (fixed-income vol) shows. Note that these are different axes, but you can clearly see the uptrend in the MOVE that has not been replicated by the VIX.

I mentioned earlier how regular and controlled the decline in the stock market has been, and how this has allowed the Fed to push rates further than anyone thought they would, a year ago. There have not been too many periods where option sellers have been punished for being short vol in equities. On the other hand, bond vol has been very different now from what it was a few years ago. In short, there has been a regime change in bond vol, but not in equity vol. At some level, this will continue, but the spread should narrow as the Fed gets to the end of the tightening regime. I think we will end 2023 with the VIX above 22 log vol – where it is today or slightly higher – but with the MOVE around 90 norm vol.

Both of those figures represent more-volatile conditions than we have seen for some years pre-COVID.

EQUITIES

It hurts to say, but equities are still far, far, far overvalued.

For many years, there has been a running tension between people who use the “Fed model” as a way to justify the current level of the stock market and the people who point out that the “Fed model” does not imply that the current level of the market is fair. The “Fed model” essentially says that when interest rates are very low, the present value of future cash flows is higher; ergo, the equilibrium value of the average equity (whose fair value is dependent on the present value of future earnings) and hence the overall stock market is higher, when interest rates are lower. This is analytically true. However, it does not mean that your expectation of future returns, when P/E multiples are at 40 but interest rates are low, should be the same as your expectation when P/E multiples are at 15 but interest rates are high. The level of interest rates explains higher equity prices, but it does not imply that those are now long-term fair value levels.

But this tension was almost always resolved in favor of the people who thought that rock-bottom interest rates meant that stocks should be at sky-high multiples, and value investors were left in the dust for more than a decade.

Unfortunately, this tension is being reduced because interest rates are going higher, and may never go back to those levels again. Consequently, equity price/earnings multiples need to re-rate for the new level of interest rates. The same logic that was used to justify the stock market at a 35 Shiller P/E, reconciles to lower prices now and going forward. The chart below (source: Robert J Shiller, updated with Enduring Investments calculations) shows the Shiller P/E (aka Cyclically-Adjusted P/E Ratio, or CAPE) versus 10-year interest rates in the post-WWII period. There is, ex-Internet bubble, a pretty clear relationship between interest rates and valuations. The red dot is where current multiples and interest rates are.

My forecast of 4.5% 10-year Treasuries implies something like a 23 Shiller P/E, down from 30 now. Without earnings growth, that 23% decline in the multiple implies a 23% decline in the stock market from these levels. I don’t think earnings themselves will increase or decrease very much unless the recession is much worse than I think it’s going to be, but the same lag between wages and product prices that flattered earnings when inflation was heading higher will detract when inflation decelerates. Moreover, if I’m right that Powell is intentionally steering interest rates to a level that is consistent with a long-term equilibrium around 4%-4.5% then this 23% adjustment in prices will not necessarily be followed by another massive bull market the likes of which we became accustomed to during the long bond bull market of the last 40 years. A Shiller P/E in the low-20s is still fairly generous historically but it may be sustainable.

So, my point forecast is for the S&P to get to 3,000 sometime in 2023. I don’t think the current bear market will last the entire year, and in fact I am sure there will be a rollicking rally when it is clear the Fed is done tightening. But sticky inflation will hurt here, too, and after that rollicking rally I think we’ll have another low, and from that low is where a modest bull market will begin.

However, I should also note that 1-year equity vol is around 25%, so my projection is within 1 standard deviation of unchanged!

COMMODITIES

From 1999 through 2008, commodities were in a bull market. After a brutal crash in the Global Financial Crisis, commodity indices had another mini-bull market from 2009-2011 before enduring a 9-year bear market. Since March 2020, the massive increase in the quantity of money has driven down the value of money relative to commodities or, to put it in the normal way, has driven up the price of commodities.

The Bloomberg Commodity Index (spot) rose from 59 in March 2020 to 124 in March 2022, and has come off the boil a bit since then. At the highs, though, the level of the index was only back to the levels of 2014. This is normal with spot commodities, which thanks to improved production and extraction technology over time tend to be perpetually deflating in real terms.[4] The good news is that an investor in commodities does not generally buy spot commodities but rather invests through collateralized futures contracts or invests in an index based on collateralized futures contracts. Over time, the collateral return happens to be a very important source of return (in addition to spot returns, the return from normal backwardation, and the volatility/rebalancing return), and this year there is terrific news in that collateral returns are ~4% higher than they were before the Fed started to hike. This means that, all else equal, commodities index returns should be expected to be 4% better (in nominal terms) this year than over the last couple of years. All else is not equal, but I expect gains in investible commodities indices in 2023.

That’s entirely separate from the question of whether we are in a commodity supercycle, due to chronic underinvestment in exploration and extraction technologies and more difficult geopolitical pressures that increase the costs of mining, growing (e.g. because of fertilizer costs/shortages), and transporting the raw commodities. I think the answer there appears to be ‘yes,’ which means that in general I want to play the commodity market from the long side more than from the short side. Of course there will be brutal moves in both directions, and bears will really want to sell commodities as the recession comes to the fore. But most of that is already in the price, with gasoline at levels much closer to the GFC lows than to anything approximating the highs. The chart below shows retail gasoline prices, adjusted for inflation (using 2012 dollars).

Energy prices of course could fall further, but considering that part of the reason prices have fallen this far is that the Strategic Petroleum Reserve has been flushing oil into the system (and that has ended, in theory) and China’s economy has been sputtering under Zero Covid (which has also ended, in theory), it is hard to think that is the better direction at the moment.

OTHER THINGS

I want to append one very important admonition for investors and investment advisors. I mention this frequently on podcasts, TV and radio appearances, at cocktail parties and to random strangers on mass transit:

The next decade will be very unlike the decades we have just experienced. Not only will inflation and interest rates be higher than we’ve become accustomed to, and markets more volatile, but some important drivers of portfolio construction will shift. The good news is that at least some of those shifts are systematic and predictable. The table below shows how 60/40 returns correlate with inflation, with inflation expectations, and with inflation surprise over two periods. The first period was the 30 years ending in 2004, when inflation averaged 4.89% and was three times as volatile as during the subsequent period. During that period, a 60-40 portfolio was significantly exposed to inflation. The more-recent period, during which inflation was low and stable, produced placid 60/40 returns and correlations with inflation that are mostly spurious because there was more noise than signal. Inflation didn’t move!

The first implication of this is that portfolios which have productively ignored inflation-fighting elements over the last two decades need them now, because the main asset classes used in portfolio construction are terribly inflation-exposed. All portfolios for investors who do not have sufficient ‘natural’ inflation hedges should include such assets as commodities and an allocation to inflation-linked bonds in lieu of some of the nominal bond allocation.

The second implication is related but less conspicuous. The entire correlation matrix is shifting away from what it has been over the last couple of decades, and back to something that incorporates the inflation factor that has been dormant. As the most obvious example, stocks and bonds which have been inversely correlated for a while, due to the fact that they respond differently to economic growth, are becoming correlated again. This is not an aberration but entirely normal for regimes in which inflation is not low and stable. The chart below illustrates this. When 3-year average inflation is above 3% (the red shaded area), then 3-year correlations of stocks and bonds tend to be positive (blue line). When inflation is below that level, correlations tend to be negative.

Negative correlations between stocks and bonds are great because they lower portfolio risk. But in the coming decade, 60/40 won’t be as low risk as it has been. But beyond that, the entire covariance matrix that an advisor relies on to simulate and optimize portfolios needs to be examined. The normal way is to use recent returns (say, the last 10 years) to generate this covariance matrix, which then is used to find the mean/variance-optimized portfolio for a given level of risk. That’s normally okay, but as inflation proves sticky that sort of covariance matrix will be wrong, and wrong in a systematic way. What I am doing for our customers is comparing portfolios optimized with a recent covariance matrix to portfolios optimized using a covariance matrix from the 1980s-1990s. It’s important to be aware of this potential problem in portfolio construction, and to get ahead of it.


Finally, let me take a moment to thank the readers of this blog for their interest in it. I write partly because the discipline of arguing my points out thoroughly makes me (I think) a better trader and investor, but I also garner a lot of value from the information and ideas I receive reciprocally from readers who agree or disagree with what I write. I appreciate this feedback very much, and I thank the readers who take the time to share their opinions with me.

Aside from the personally selfish reason I have for writing, there is also the corporate mission the blog is meant to accomplish, and that is to raise the profile of Enduring Investments and the Inflation Guy franchise with prospective clients, and to encourage them to do business with us. If prospective clients see value in these musings, then I hope they will choose to do business with us. Yes, that’s crassly commercial. But ‘tis the season! And if you read this far in this missive, please consider what that means about the value you’re getting, and how much more value you might get from a deeper relationship with Enduring Investments!

And if not, Merry Christmas anyway! Happy holidays and Happy New Year.    

– Mike ‘The Inflation Guy’ Ashton

DISCLOSURE – My company and/or funds and accounts we manage have positions in inflation-indexed bonds and various commodity and financial futures products and ETFs related to them that are discussed in this column.


[1] It bears noting, though, that until 1982 the shelter component of CPI was tied to mortgage rates and home prices and not rents, so that the early-80s rise in core CPI partly reflected the Volcker rate hikes. Fixing that problem was what released the conspiracy nuts who plague us to this day claiming that the BLS “manipulated” CPI downward.

[2] https://fiscaldata.treasury.gov/americas-finance-guide/national-deficit/

[3] Net interest was about $110bln less, since some of that interest is paid to other parts of the government, for example the Federal Reserve system. For now.

[4] I wrote a nice, short little piece called “Corn Prices – Has the Correction Run its Course?” that is worth reading if you are interested in commodities.

Summary of My Post-CPI Tweets (November 2022)

December 13, 2022 4 comments

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

  • It’s #CPI Day – the last one of 2022!
  • 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.
  • Last month, the CPI was significantly weaker than expected. Against expectations for 0.5% core, we got 0.3%. Apparel and Medical Care (specifically in Health Insurance but there was weakness in other parts of Medical Care) were the main culprits.
  • However, Used Cars CPI was also more negative than private surveys had led us to believe. A decline in Airfares rounded out the list of usual and unusual suspects.
  • But on the other hand…
  • Other than Health Insurance, no services were on the “largest decliners” list. While Used Cars was droopy, New Cars inflation remained solidly positive. Rents were lower than in the prior month, but still increased at annualized monthly rates of 8.7% (Primary) and 7.7% (OER).
  • Median inflation was still +0.53%, a 6.4% or so annualized rate of increase. The Enduring Inflation Diffusion Index and other measures showed that inflation pressures remained quite broad.
  • This month, economists are calling for a repeat of softer core inflation, although the forecasts have been drifting up slightly as more economists add their estimates. Since economists like to shade vs other economists, this is like sharp money coming in on the “over.”
  • …although come to think of it, calling economists “sharp money” is probably wayyyy more generous than they (as a group) deserve.
  • Those prints (the economists’ estimates) would take y/y to 6.1% on Core (and 7.3% on headline).
  • I think the consensus is giving too much signaling weight to the deceleration in goods. It’s real, it’s important…but it is completely divorced from what is happening in services. There, we have a feedback loop in full swing.
  • Inflation leads to higher wage demands and settlements, which leads to higher inflation. Or at least, it slows the deceleration of inflation. Next year, we get an 8.7% increase in Social Security payouts, and wages are rising rapidly.
  • Median wage growth is basically steady around 6.5%ish. That’s 0.5% below median CPI, when it’s usually ~1% over. Now, I don’t think Median is about to jump another 1.5%, but another interpretation is that wage settlements suggest workers feel like 5.5% is what they’re seeing.
  • That doesn’t seem terribly wrong, and I think Median is in the process of peaking, but the point is that people are getting wage increases that in the Fed’s words are “not compatible with 2% inflation.”
  • To reiterate something I’ve been saying recently: I think the peak is in, and will show in Median CPI soon, but the real question is whether core goes back to 2%. This is ASSUMED by many economists these days. Peak=”inflation is done.” I think that’s very unlikely.
  • We also have to recognize that rents in the CPI are not going to slow soon, and I think economists are getting ahead of themselves on that one as well.
  • Yes private rent indices are declining. So? They were also skyrocketing at +18% when the CPI was not (this chart is sourced from https://en.macromicro.me).
  • That’s because only a tiny proportion of rents were turning over at those increases  The CPI was designed to capture the broad trend of expenses to consumers, NOT to mark-to-market the whole rent market. So CPI goes up less, and down less.
  • To be sure, rents are higher than my model “expected” them to be, but it’s not really egregious and I don’t expect them to slow markedly and immediately. **I think some economists are mistaking timely data for quality data.**
  • Another effect, more minor, I discussed on the private blog a week or so ago: the possibility that Hospital Services has some catch-up this month after not being reported last month. See the tweet at https://twitter.com/InflGuyPlus/status/1600503515121680384 Worth a couple of bps max.
  • So, I’m on the ‘over’ for this report, but I can make a case for a higher-than-0.4% core more easily than I can make a case for a lower-than-0.3% number.
  • Now since last month’s surprise, breakevens have dropped and so have real yields. It helps that Powell and others have basically committed to decelerating Fed hikes this month, and the market clearly believes (as do I) that they’re nearly done.
  • I don’t think this number will change that trajectory unless it’s, say, 0.7% on core or something like that. Even then, it would be very hard for the Fed to produce 0.75% tomorrow with no time to leak the change…and a quarter point wouldn’t matter much anyway.
  • BUT, if we got a crazy number then the market would immediately price a higher peak rate and push the pivot out further in the future. And stocks would get shellacked.
  • We’d need a lot of messaging pretty quickly in that case, and liquidity is very thin at this point of the year. Fortunately I don’t think we get anything that outlandish. Knock wood!
  • Good luck! Done with the walkup a bit early this month since I started early. Auto charts will follow the print fairly quickly. I still curate the charts rather than totally auto-tweet them; one of these days I’ll trust the Machine but not yet.

  • Someone is pretty sure they know the number three minutes early! Equity futures just popped 20 points.
  • …looks like he did! Weak figure.
  • m/m CPI: 0.0963% m/m Core CPI: 0.199%
  • Last 12 core CPI figures
  • Just to be clear, core at 0.2% almost exactly was the best in years. Doesn’t really feel like that when you are out shopping, IMO.
  • M/M, Y/Y, and prior Y/Y for 8 major subgroups
  • Apparel back in positive territory, which is slightly surprising. In Medical Care, Medicinal Drugs were +0.08% m/m, and Doctors’ Services +0.04%. Pretty weak, but not negative. The negative is entirely from Health Insurance and I’ve said my piece there.
  • Here is my early and automated guess at Median CPI for this month: 0.477%
  • Always a caveat here when the median category is a regional housing index. Still, it would be the lowest in more than a year although 5.7% isn’t exactly great.
  • Actually, when I calculate this using my spreadsheets I get 0.456% m/m with Recreation the median category. That would put y/y still at 7%, but slightly (very slightly) lower than last month. Fairly easy comp next month, so high might not quite be in, but pretty close.
  • Core Goods: 3.68% y/y   Core Services: 6.82% y/y
  • story here is that core services reaccelerated a tiny bit. NOT that core goods plummeted. Core goods reverting lower is something we knew already.
  • the SIZE of the core goods adjustment is what was surprising. I wonder how much of this involves early Christmas discounting. There was certainly some fear among retailers that they’d over-ordered. I don’t have an easy way to measure that.
  • Suffice to say that I’d like this number better, if it was services which had decelerated.
  • Primary Rents: 7.91% y/y       OER: 7.13% y/y
  • Further:
    • Primary Rents 0.77% M/M, 7.91% Y/Y (7.52% last)        
    • OER 0.68% M/M, 7.13% Y/Y (6.89% last)        
    • Lodging Away From Home -0.7% M/M, 3.2% Y/Y (5.9% last)
  • So, rents were HIGHER than last month, 0.77 vs 0.69 on Primary rents and 0.68 vs 0.62 on OER. This is convenient since economists have convinced themselves that they can look past this. Again, the question isn’t whether it decelerates. It’s HOW MUCH, when it does.
  • Some ‘COVID’ Categories:
    • Airfares -3.02% M/M (-1.1% Last)
    • Lodging Away from Home -0.71% M/M (4.85% Last)
    • Used Cars/Trucks -2.95% M/M (-2.42% Last)
    • New Cars/Trucks 0.04% M/M (0.37% Last)
  • Just want to say that Christmas airfares are way above normal, but nationwide fares are about right for the level of jet fuel prices. Weak Lodging Away from Home too. Note that New Cars is still rising, though weakly this month.
  • Piece 1: Food & Energy: 11.5% y/y
  • The story here continues to be that it isn’t down more than it is. Food is staying buoyant.
  • Piece 2: Core Commodities: 3.68% y/y
  • Piece 3: Core Services less Rent of Shelter: 6.33% y/y
  • It is funny to me that all of a sudden, this is the category everyone is talking about. And…it’s really not showing anything super positive, especially when you consider that health insurance is a drag. This is actually pretty bad news.
  • Piece 4: Rent of Shelter: 7.19% y/y
  • OK, so let’s hold the phone here.
  • Today’s number is a core goods story. Core goods y/y went to 3.7% from 5.1%. But core services went UP to 6.8% from 6.7%. Used cars large decline (& CPI is now ahead of private surveys a fair amount). And that’s despite health insurance, a large fall in airfares and auto rental.
  • Overall Core ex-housing (which includes core goods) is down to 5.2% y/y. That’s the lowest since…well, September 2021. Going the right direction but unless core services start to decelerate, there’s a limit to how good this picture can be.
  • So here’s the distribution story. Here is the overall distribution. You can’t tell much from this unless you have the prior chart handy. But there was a shift in the middle.
  • In red is the weight of components above 6% y/y growth. In blue, the weight of components above 5% y/y growth. This doesn’t tell you much about the monthly figure exactly but it tells you the middle of the distribution is shifting left. Still pretty high though!
  • Let’s see. Biggest monthly decliners in core were Used Cars and Trucks (-30% annualized monthly ROC), Car/Truck Rental (-26%), and Public Transport (-22%). Nothing else in the Median set declined faster than 10% at an annualized rate (Health Insurance is one level lower).
  • There were actually a lot of big gainers: Misc Personal Goods (+27%), Infants/Toddlers Apparel (+21%), Personal Care Services (+18%), Vehicle Maintenance/Repair (+17%), Communication (+13%), Jewelry/Watches (+11%), Vehicle Insurance (+11%), and the South Regional OER (+11%).
  • Lots of decliners in Recreation/Goods: TVs (-3.8% m/m), Other Video Equipment (-4.1%), Audio Equipment (-1%), Sports Equipment (-0.9%), Photographic Equipment/supplies (-1.6%), Toys (-1.8%)…see any common theme there? That looks like XMas.
  • Now, those are NSA, so some of that is the natural seasonal discounting of Christmas. But that is usually bigger in December.
  • First real pullback in the Enduring Investments Inflation Diffusion Index. So that’s also supportive of the notion that the peak is in.
  • Let me sum up. This supports the idea of a Fed taper, but I didn’t think there was much chance of derailing that unless we got a BIG number. But it’s not all it’s cracked up to be. I suspect early seasonal discounting had a lot to do with this.
  • Core services ex-rents is the fly in the ointment and will continue to be so until wages start to decelerate. No sign of that yet. I think next month we are unlikely to see another 0.2% on core.
  • But that’s not the market story. The market is celebrating because the Fed is nearly done.  Now, they are not going to start easing unless there’s a market crack-up and there’s no sign of that happening while people are happy about rates peaking.
  • The story is intact, despite the fact I was surprised by the overall figure: inflation is peaking, the Fed is nearly done…but inflation isn’t going back to 2% any time soon. *Nothing in this number suggests it is.* The sticky stuff is all still ugly.
  • To me…that’s a story of a steepening curve next year. Short rates aren’t going to go up when the Fed is sidelined but long rates will eventually have to adjust to a higher-inflation reality (and increasing deficits along with a balance sheet taper).
  • I’m going to give this summary verbally if anyone wants to listen! Call the conference number at <<REDACTED>>  Access Code <<REDACTED>>. We will start at 9:40ET (9 minutes).

This CPI print was definitely a surprise, but let’s just tap the breaks a touch. It was a one-tenth surprise on core CPI – certainly welcome, but it hardly changes the overall narrative. Let’s review the points of the overall narrative:

  1. Inflation is in the process of peaking, or has already peaked.
  2. Goods price inflation is decelerating markedly, for both demand- and supply-side reasons.
  3. Rents will eventually decelerate, of course, but private surveys seriously overestimate the degree of the deceleration and the timing.
  4. Core services ex-rents, where wage inflation lives, is going to prove sticky.
  5. All of this means that after the peak, median and core inflation will drop…but not to 2%. More like 4%-5%, where they will be disagreeably stubborn about declining further.

In today’s number, nothing in that list really changed. The deceleration in goods price inflation was sharper than I expected, but a lot of that was used cars and a lot of it were in categories that smell a lot like early Christmas discounting. Notably, rents reaccelerated from last month and core services ex-rents showed no signs of weakness.

What does this mean for the Fed? 50bps tomorrow, probably 25bps at the next meeting and possibly one more 25bps hike after that. And then the Committee stays on hold for most of the rest of 2023, unless something breaks. The bond market is pricing the former, but not the latter. The Fed is very unlikely to overreact to an 0.1% miss in core CPI, especially when their expectation is that inflation is decelerating.

So nothing really changes about the story on the basis of today’s number. I will add a few final thoughts, though. (a) part of the miss today came from Used Cars being down more than it “should” have given private surveys. That’s likely going to be a give-back in the future. (b) if part of the miss was due to early Christmas discounting, then that will come back in December or January. (c) someone really needs to look into the huge trades right before the number was released. This wasn’t an accidental post on the website. And you don’t put that much money into an illiquid market on a guess. Someone knew something. Do I expect anyone to investigate? Not really.

Summary of My Post-CPI Tweets (October 2022)

November 10, 2022 Leave a comment

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy, but to get these tweets in real time on CPI morning you need to subscribe to @InflGuyPlus by going to the shop at https://inflationguy.blog/shop/ , where you can also subscribe to the Enduring Investments Quarterly Inflation Outlook. Sign up for email updates to my occasional articles here. Investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments! Check out the Inflation Guy podcast! Note that this month and going forward, I will be delaying the drop of this tweet summary and the podcast until the afternoon rather than dropping it late morning. So subscribe if you want it live!

  • It’s CPI Day – and here we go again!         
  • 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 (hopefully 9:15ish) I will have a private conference call for subscribers where I’ll quickly summarize the numbers.    
  • Thanks again for subscribing! And now for the walkup.  
  • The chance of more-lasting inflation just went up a lot. With the much-narrower-than-expected margins for the Republicans in the House – and perhaps no margin at all in the Senate – this is “divided government” IN NAME ONLY.     
  • Republicans are notoriously bad at whipping their vote, and with a narrow margin it will be very easy to pick off a couple of votes with well-chosen pork to pass large stimulus measures if the Democrats want it. And they probably want it.             
  • And why shouldn’t they want it? The Republican message in the midterms was “Biden caused this inflation and we voted against the Inflation Redution Act.” The Democrat message was “Putin caused this inflation and we PASSED the Inflation Reduction Act.” Evidently, that resonated.          
  • Politicians will keep pushing MMT as long as the populace allows them to get away with it. And with such a narrow majority, Republicans can probably not ‘hold the line.’ Ergo, there will be more stimulus ahead.  
  • To say nothing of other continuing pressures, on resources & a need to shorten supply chains as the world fractures the post-Berlin-wall detente. To say nothing of demographic challenges. To say nothing of the fact that prices still have far to go to catch aggregate M2 growth.      
  • Those are not stories for the October CPI, but they are the backdrop.      
  • I was at a conference the last 2 days and several mainstream economists stated (it was barely phrased as an opinion) that core inflation will definitely be around 3% by middle of next year and low 2s by end of 2023.               
  • This seems ignorant of the composition of the CPI. EVEN IF you think inflation pressures in a macro sense are ebbing, we haven’t yet seen any signs of that in the data. Y/Y median CPI has accelerated 14 months in a row. Rents remain buoyant. 
  • Rents will eventually slow, but it will be a while before they slow very much. So far they are still accelerating! And core-services ex-rents is my recent focus. As a reminder, that’s where you find the wage-price feedback loops. And it has recently started spiking higher.
  • But there is a potential fly in the ointment in that group this month, and that’s the question about the CPI for health insurance. Here is the issue that some people are worried about.
  • Medical care is paid for by consumers directly, and indirectly for consumers by insurance companies. It is straightforward (if complex) to measure the part of medical care paid directly to providers – just ask doctors and hospitals.
  • The problem is that there is a difference between what insurance companies receive from consumers (which is part of consumers’ cost) and what they pay to doctors. That is, profit.
  • That’s still a cost to consumers but not captured if you just ask doctors. It shows up in the “Health Insurance” part of Medical Care CPI. So, periodically (because it’s not at all straightforward) the BLS tries to figure out this difference and adjust for it.
  • It tends to happen roughly this time of year, which is why people were looking for it last month and still looking for it this month. Here’s the problem – it isn’t always important.
  • You can see in the m/m changes in Health Insurance that sometimes there’s a discontinuity in the monthly figures, and sometimes not. Here’s the salient point, though – the adjustment doesn’t really matter.
  • If it’s done right, then the overall inflation in Medical Care will be about right. Could be seasonal issues, so any given month it could be wacky, but the REAL question is: is inflation in Medical Care overall accelerating/decelerating? Sure looks to me like it’s accelerating.
  • So I don’t pay a lot of attention to this nuance but be aware that it COULD have an impact potentially today.
  • Last month, big drivers were Rents again (primary=0.74%, OER=0.71%), Medical Care (0.68%, with Hospital Services 0.78% m/m and y/y Prescription Drugs at 3.2%, highest since 2018). Oh, and “Other” at +0.73%.
  • Inflation is of course very broad, and that means it is going to keep being pretty resilient. Until one day it starts narrowing and being less resilient. There’s no good way to say when rents will roll over. They will eventually. Probably not today.
  • But breakeven market is being very optimistic generally about this eventual occurrence! There’s almost no penalty to betting inflation will NOT go back to its old level. Or at least, a pretty small one.           
  • Used cars this month will again be heavy, but probably not as heavy as last month’s -1.1%. Used car prices have retreated (in the Black Book survey) about 12% from the highs but remain up about 35% since end of 2020. That’s about the same as M2, so it’s roughly “right”.       
  • Of course not everything will be up the same amount as the general price level, but that’s a decent touchstone. On average, once velocity finishes correcting back, the aggregate price level should be +30%-+35% (based on current M2) from 2020. Currently +15%. Long way to go.
  • Markets since last month: breakevens are up a bit, but real yields close to unchanged. Reals are pretty close to a long-term fair level. They’ll go higher if nominals go higher but they’re a pretty decent deal esp relative to nominals given the long term breakevens.
  • …and the nominal auction yesterday was pretty ugly, so I don’t know that the fixed-income bears are done. I suspect the Fed is getting close, though. My guess for terminal rate is currently 5%.          
  • Econ consensus for today’s CPI is 0.62% m/m on the headline and 0.47% m/m on core, bringing y/y core to 6.52%. With the medical insurance issue I’m reluctant to hazard a guess but 0.47% seems optimistic. Avg for last 6 months has been 0.56%. But interbank is LOWER than 0.47%.         
  • In any event, good luck! Auto charts will follow the print fairly quickly. I don’t know how many months I will be doing this before I stop being nervous about the automation. But I throttle those charts still to make sure that if something looks wrong it isn’t followed by 9 more.

  • m/m CPI: 0.438% m/m Core CPI: 0.272%       
  • OK now let’s look at these. Obviously the core figure was a disappointment but I can already see it’s not something I’m terribly worried about and not likely to signal that we’re done. That said, it should be a nice rally number.     
  • Last 12 core CPI figures        
  • Primary Rents: 7.52% y/y OER: 6.89% y/y     
  • Further: Primary Rents 0.69% M/M, 7.52% Y/Y (7.21% last) OER 0.62% M/M, 6.89% Y/Y (6.68% last) Lodging Away From Home 4.9% M/M, 5.9% Y/Y (2.9% last)
  • Well, 0.69% m/m is better than last month’s 0.84% on primary rents, but not exactly the deflation that people are expecting to happen ‘soon.’ Soon, it seems, is still a bit far away.
  • M/M, Y/Y, and prior Y/Y for 8 major subgroups          
  • Immediate observation – huge decline in Apparel (yes, a small weight) and in Medical Care (which I suspect is the technical adjustment). Housing, Food, Other, Recreation, all high.
  • Here is my early and automated guess at Median CPI for this month: 0.613%
  • Median: definitely better than recently! but a 7.6% compounded annual median rate isn’t GOOD news. And it suggests that most of the miss was in a few categories, not the main body of the distribution.
  • By the way, a little asterisk on my median calculation – I have the median category as West Urban OER. Since the individual components of OER are seasonally-adjusted (but we don’t know the seasonals), my estimate will be slightly off.
  • Core Goods: 5.08% y/y Core Services: 6.74% y/y        
  • And you can see the effect of Apparel (and Used Cars, which was down more than I expected it would be and more than Black Book suggested it would be) on core goods. This is partly a delayed dollar effect, and some supply-side relaxation, and not surprising in a macro sense.
  • Some ‘COVID’ Categories: Airfares -1.1% M/M (0.84% Last) Lodging Away from Home 4.85% M/M (-1.04% Last) Used Cars/Trucks -2.42% M/M (-1.07% Last) New Cars/Trucks 0.37% M/M (0.67% Last)           
  • So Used Car prices are coming down, and New Cars still going up. Remember in mid-2021 Used Car prices in some cases exceeded New Car prices b/c New weren’t available. They are now, so this is the convergence. Used is correcting, New is trending.
  • Used cars on top, New Cars on bottom, since day 1 of COVID. New have another 10% to go higher, Used another 15% lower, is my guess.
  • Piece 1: Food & Energy: 13.3% y/y   
  • Piece 2: Core Commodities: 5.08% y/y          
  • Piece 3: Core Services less Rent of Shelter: 6.42% y/y              
  • The y/y for health insurance went from 28.1% to 20.6%. Obviously, those numbers are way too high. But it caused the y/y for Medical Care to drop from 6% y/y to 5% y/y. This seems exaggerated.
  • Now, to be sure Medicare is dropping the amount that it is reimbursing health care providers. But Medicare is not in CPI and a squeeze on Medicare reimbursements may make the consumer part of health care more resilient. Got to pay health care providers somehow.
  • Piece 4: Rent of Shelter: 6.99% y/y  
  • No sign of any slowdown in rents yet. And without that, we’re not getting 2% inflation next year, period.
  • That really was an amazing adjustment to health insurance. I applaud those who decided it was going to be huge. Again, though, it’s just a question of how Medical Care inflation gets allocated. And it’s a one-off thing.          
  • Outside of food and energy, the biggest monthly decliners were Infants and Toddler’s Apparel (-32% annualized), Jewelry and Watches (-30%), Used Cars and Trucks (-25%), and Footwear (-13%). No services. OTOH…             
  • Biggest gainers were Lodging Away from Home (+77% annualized), Misc Personal Goods (+26%), Vehicle Insurance (+23%), and Food Away from Home (+11.8%). That last one is obviously Food & Energy but it’s also a wages indicator.
  • Looking at Median some more, probably the lowest it could be (if my West Urban OER seasonal is way off) is 0.55%. And could also be higher than my estimate. 
  • Core inflation ex-housing fell to 5.9% from 6.7%. That’s the lowest it has been since 11/2021. And it’s a good sign. A lot of that is goods.            
  • The deceleration in goods inflation is completely real. But that doesn’t mean goods prices are going to go DOWN, which is what consumers are expecting. Some places where there were overshoots like in Used Cars will go down, but in most cases we’re talking small.             
  • Here’s the challenge on the Fed question. I wouldn’t take a victory lap even though this is the lowest core m/m in more than a year. Median has still not obviously peaked! Next core comps are 0.52%, 0.56%, 0.58%, 0.50% before 0.32% in March.       
  • That means we are probably looking at core which will be steady to declining slowly, but not coming down rapidly. There aren’t 0.6s or 0.7s to roll off until May. So it will look like a peak but not a rapid drop. Unless of course rents roll over and drop like a stone.
  • OR, suddenly workers start getting wage cuts. Keep in mind that the Social Security adjustment for next year will flush a lot more money into the system. There’s just a lot of bad feedback loops that are in play.
  • By the way, Lodging Away from Home was high (+4.9% m/m) this month. That’s a volatile category but surprised me. Hospitality is having difficulty with finding workers though and so this is another one of those pass-throughs I suspect.      
  • Here’s the distribution of lower-level price changes y/y. It’s an interesting tale. The lower tail are mostly goods (insurance won’t be there for a long while), upper tail has some foods and some services. The middle part is still 7-9%.
  • Having said that, this is starting to look more like a disinflationary distribution where the mean is below the median because long tails start showing up to the lower side. I think we’ve likely seen the peak, although Median will take a bit yet.
  • I mean we still have 65% of the distribution above 6%…        
  • That health care insurance adjustment is odd. Normally the BLS smears the adjustment over 12 months roughly equally. I can’t imagine this is going to be 4% PER MONTH for a year. That would be really weird. Something to dive deeper on. For now I’m treating it as one-off.   
  • Last chart. I didn’t run this last month because of tech issues. The EI Inflation Diffusion Index remains high but dropped to 41. It’s not yet really signaling a peak in pressures but if we get down to 30 or 35 I’ll feel better that the peak is real.       
  • OK, let’s try the conference call for anyone who wants to hear this verbally. 🙂 [REDACTED] Access Code [REDACTED] Let’s say 9:35, 5 minutes from now.       

The number today made a lot of folks very happy, but it is a trifle early to declare victory over inflation yet. Core goods remains in deceleration mode. This is no surprise; the extended strength of the dollar helps depress core goods prices with a lag. The sharp drop in apparel prices is sort of the poster child for this effect. But the dollar will not be strong forever, and when it goes back to something like fair value – when the Fed stops hiking aggressively relative to the rest of the world – then there will be a little payback in this category. That doesn’t mean 10% core goods inflation but neither does it mean that we’re going back to the old normal of -1% inflation in core goods year after year. Given the re-onshoring trend and the general unsettled nature of geopolitics, I suspect core goods will end up oscillating around low-positive numbers. Think 1-2%, not -1% to -2%.

Rents remain strong, and there is no sign that they’ve rolled over yet. They will eventually, but it takes a long time for rents to reflect changes in home prices and even longer for asking rents to be fully reflected in rent CPI and OER. Rents will decelerate from here, but not for a while. And they’re also not going back to 2%.

Core services ex-rents is in a continued uptrend. There was a small correction this month, but the feedback loop has been triggered. Next year’s Social Security adjustment will throw more fuel on the fire, and even if unemployment rises so that real median wages decelerate nominal wages are going to keep climbing faster than they have historically. Core services ex-rents…and we saw similar effects in Lodging Away from Home and Food Away from Home, both of which have a big wage component…is going to stay strong for a while.

By the way, on Medical Insurance…that 4% per month drag over the next year is going to add up to 0.3% on headline and a bit more than that on core. But only if this isn’t offset elsewhere in the medical care category. This is bean-counting: insurance in the CPI doesn’t really measure the cost of insurance premiums but insurance company profits. If our estimate of profits declines it’s either because people are paying less for insurance (not likely) or because insurance companies are paying more out to doctors, which means the inflation should just show up there instead. So it will be a consistent drag that is mostly irrelevant in a practical sense.

All of which is to say that while core CPI has likely peaked, and median inflation will probably peak in a few months, the folks who are looking for it to drop to 2% next year are going to be terribly disappointed. I’m sticking with my view that we will be at high-4%, low-5% for 2023.

The Fed, though, will take the peak in Core as a reason to step down to 50bps at the next meeting, then probably 25bps, and ending at around 5%. If rates are at 5% and median inflation is around the same level late next year, it isn’t clear that much higher rates would be called for especially in a recession. But neither will much lower rates. So I think overnight rates get to 5% and then stay stuck there for a while. If you found this useful, and would like to get it in real time during next month’s CPI report, go to https://inflationguy.blog/shop/ and subscribe to my private Twitter feed. You can also subscribe to my quarterly, or purchase a single issue of the Quarterly Inflation Outlook (either current or historical). Thanks a lot for your support.

Summary of My Post-CPI Tweets (September 2022)

October 13, 2022 8 comments

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

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

  • It’s CPI Day – and here we go again!
  • 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 (hopefully 9:15ish) 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 . Busy day for the IG.
  • Thanks again for subscribing! And now for the walkup.
  • Last month, we again had a large upward surprise. Median CPI actually had its highest m/m print of the entire debacle-to-date. While y/y numbers are the big focus in the media, until we have a convincing peak in Median CPI we can’t really say the inflation pressures are receding!
  • Median CPI has moved back above core; this means that for the first time since April 2021 the longer tails are to the downside (the distribution skews lower, so the average is lower than the median).
  • If this is still true once inflation levels out a little bit, it will be encouraging. In inflationary cycles, the outliers show up on the high side and core moves above median. In disinflationary cycles, the opposite is true. Let’s give it some time and see what happens.
  • Rents in last month’s report were big, and though Used Cars set back a little bit New Cars had a big up. But the BIG eye-opener was the rise in core services less rents.
  • I wrote last month: “If core services ex-shelter is really taking the baton from core goods, that’s really bad news. Because core services ex-shelter is where wage pressure really lives. If you want a wage-price spiral, look in core services ex-shelter to see if it’s happening.”
  • So that is my main focus in this report. More later but let’s look at the consensus figures going in. Consensus for headline CPI is 0.21%/8.09%, while consensus for core CPI is 0.43%/6.52%. That will be a small acceleration in core (again).
  • For my money, the implied drag for food and energy (0.22%) looks slightly too large, and the interbank market seems to agree with an implied headline number of about 0.26% m/m. But I also think the core might come in a teensy bit lower than 0.4%.
  • I don’t know if what I am looking at would be enough to round it lower, but an 0.3% core print would make the markets very excited and COULD make the Fed favor a smaller move at this meeting. Not only because of 0.3%, but because things are starting to break.
  • …and the Fed’s models say that inflation should be slowing, so…why not taper the tightening? I think we MIGHT be having that discussion later this morning.
  • Certainly, the mkts have let the Fed go pretty far without throwing up a stop sign. 2y rates +72bps in the last month and 10y rates +54bps? Tens at 3.90% are pretty close to a long-term fair number (still a trifle low) after YEARS of being too low. Naturally, we could overshoot!
  • The decline in forward breakevens is very curious – I don’t see any sign that 2.25%-2.5% as a long-term equilibrium is still the attractor we will drift back to. The fun house mirror is broken for good I think.
  • So where do I see some potential softness? Our models have rents leveling off – not peaking per se, but leveling off – and that means that a trend projection of last month’s number might be overdone. Of course, those are just models.
  • More important (and obvious to many) is the decline in Used Cars prices. Last month, Used were a small drag but New cars added a bunch. We could still get the bump in New, but Used ought to be a decent drag based on the Blackbook figures.
  • But as an aside, this goes back to the error being made by a whole lot of people and politicians especially. See that last chart? Does it say “used car prices are coming back down and reverting, now that supply chain issues have cleared up? NO.
  • It’s a mistake, the same one people are making in rents & home prices. Rates of change could mean-revert. Prices will not. Prices are permanently higher, b/c the amount of money in the system is permanently higher. This chart shows the price level. Not going back to the old days.
  • Politicians saying inflation should ebb soon SEEM to be telling constituents that prices are going back down. At least, that’s what the constituents hear. They will be mad when the politicians say “see?” and they see all prices 30% higher than pre-COVID.
  • (I actually think something similar may be the root of a lot of conspiracy theories about how the government ‘cooks’ the numbers. They’re just talking past each other, with one talking price level and one talking rate of change.)
  • And speaking of money in the system – money supply growth has come to a screeching halt over the last few months, which is great news. Unfortunately, we are still catching up to the prior increase in money, which is why it will take a while for inflation rates to come back down.
  • There’s still work to do. Anyway, a lot of that is wayyyy beyond the trading implications for today’s figure. The key for me is to look past used cars and rents, and look at CORE SERVICES EX RENTS. That’s one of our “four pieces” that you’ll see in a few minutes.
  • If there’s softness in core, it will be taken well by both stocks and bonds and while I might fade stocks in a day or two, I’m not sure I’d fade a rate rally at least at the short end. If I’m wrong, and the core number is HIGHER…it could get pretty ugly. Liquidity is bad.
  • That’s all for the walk-up. Ten minutes until kickoff. Good luck today and thanks again for subscribing! Charts will launch a minute or two after 8:30, assuming data drops on time at the BLS.

  • welllllp. Not soft!
  • m/m CPI: 0.386% m/m Core CPI: 0.576%
  • Further: Primary Rents 0.84% M/M, 7.21% Y/Y (6.74% last) OER 0.81% M/M, 6.68% Y/Y (6.29% last) Lodging Away From Home -1% M/M, 2.9% Y/Y (4% last)
  • Last 12 core figures. About the same as last month. And if you exclude the two little dips, the other 12 are all pretty much 0.58% ish. That’s uncomfortable stability! Don’t want to see that. Comps get tougher going forward so core might not go up much more…but no sign of down.
  • Here is my early and automated guess at Median CPI for this month: 0.667%
  • Now, Median stepped down so that’s good news…but 0.667% m/m is not terrific. This is still the third-highest m/m in the last 40 years or so!
  • M/M, Y/Y, and prior Y/Y for 8 major subgroups
  • In the major subgroups, the drop in apparel stands out. The dollar’s strength is definitely affecting goods prices, and Apparel is one place where we see that most clearly.
  • Core Goods: 6.63% y/y Core Services: 6.65% y/y
  • It’s cute to see Core Goods and Core Services kissing. We know that goods are eventually going to go back down to 0-3%…especially if the dollar remains strong.
  • Primary Rents: 7.21% y/y OER: 6.68% y/y
  • This is a surprise – a further acceleration in rents. Economists might look past this, because with home prices leveling off rents won’t keep shooting higher and higher. Will they? Our model has a peak happening but if wages keep rising then rents need not decline, just slow.
  • Some ‘COVID’ Categories: Airfares 0.84% M/M (-4.62% Last) Lodging Away from Home -1.04% M/M (0.08% Last) Used Cars/Trucks -1.07% M/M (-0.1% Last) New Cars/Trucks 0.67% M/M (0.84% Last)
  • In the covid categories, Used Cars was in fact a drag. And New Cars was in fact a bump higher. There have been some big stories recently about markups for new trucks etc so this isn’t a surprise. But again, core goods will eventually decelerate.
  • Piece 1: Food & Energy: 14.2% y/y
  • Again Food & Energy is decelerating, but again it’s not as much as expected BECAUSE food, which we ordinarily mostly ignore, keeps rising. 10.8% y/y on Food & Beverages!
  • Piece 2: Core Commodities: 6.63% y/y
  • Piece 3: Core Services less Rent of Shelter: 6.62% y/y
  • Soooo…this is the piece that’s sort of ugly and I was worried about this. Core services less rent-of-shelter continues to accelerate. Medical Care was another 0.77% m/m, with Hospital Services 0.66% m/m. I’ll look at some of the other categories in a bit.
  • Piece 4: Rent of Shelter: 6.68% y/y
  • Core ex-housing (not just core services ex-housing) rose to 6.7% y/y. It had gotten as low as 6.04% two months ago but is reaccelerating. We know core goods is decelerating so the upward lift is core services ex-housing. And as I noted, that’s bad.
  • I forgot to mention that the median category was New Vehicles. As always with my Median CPI estimate, I caution that I have to estimate the seasonals on the OER subindices and if I’m off, and an OER category is near the median, then my Median guess might be off too.
  • Food AT HOME was 0.6% m/m (SA), 12.98% y/y. That’s slightly lower than it has been. Food AWAY FROM HOME, though, was +0.94% m/m, 8.48% y/y. This is bad – food commodities are leveling off a little, but wages show up in food away from home.
  • This number could have been worse. Airfares being -4.62% m/m helped. Airfares are largely driven indirectly by jet fuel, but had been positive last month so this is a catch-up. However, jet fuel is probably not going to go down much futher.
  • Conclusions: (a) this number is worse than expected. And not from little ‘I don’t care’ one-off things. (b) Where wages show up in the economy, we are seeing more inflation pressure show up in CPI. That’s not evidence a wage-price spiral has begun, but it is suggestive.
  • (c) since in yesterday’s FOMC minutes, participants had been musing about the risk of a wage-price spiral, this is especially salient right now. (d) This seals 75bps. They won’t do 100bps, and this report doesn’t let them do 50bps.
  • (e) This MAY raise the terminal rate. We will get more inflation data, but median CPI isn’t showing a deceleration and the m/m core is pretty solid at a 7%-ish rate (0.58%/mo) with occasional dips. Need at least 2 dip months.
  • (f) The deceleration in core goods is already happening. It has been happening. The dollar’s strength will help it to continue. But the acceleration in core services is more durable and not dollar-sensitive.
  • (g) it’s also not particularly rate-sensitive. (h) Higher wages also support higher rent growth. I am surprised at the extent of the strength in rents but put that (somewhat) in the wage-price spiral camp.
  • And finally (i) inflation markets are ridiculously mispriced. There is no reason to think that 2.25%-2.5% is the fair bet for 10-year inflation, especially when it’s going to be at 5% or above for the first 2 years of that 10 years. This is going to take a while.
  • I’m going to do a quick call right now and present my thoughts. Dial-in is <<redacted>> and Access Code <<redacted>>.
  • I will throw another housing-related chart here. Here is OER in red, against two home-price indices that are often used to model rents as a lagged function of home prices. The leveling-off should happen soon. BUT>>
  • …BUT the betas have changed and OER is higher than we would have expected based on the prior relationship. Those regressions were all based on nominal changes, not real…part of home price increase should be pass-through of value of real property, greater when infl is higher.
  • Either way, the timing suggests we should level off, and if you believe this model then in 6-12 months rents should be in sharp retreat. Maybe. But like I say, things have changed from the 2001-2020 baseline!

We keep waiting for a clear turn in inflation, and it hasn’t happened yet. Moreover, the longer it lasts then the more likely that it feeds back into wages, since workers have more and more evidence to take to the bargaining table when it’s time to discuss increases. Some of the feedback loops are purely automatic: For example, on the basis of today’s figure Social Security benefits next year will jump 8.7%, giving retirees an additional slug of cash to spend next year. That automatic adjustment also creates a feedback loop in deficits, of course – that big increase in benefits will also increase federal outlays! So, if you were hoping to balance the budget rather than pour more fuel on the fire…it just gets harder and harder.

The slight drop in m/m median CPI is nice, but not sufficient to signal that inflation pressures have turned. For a very long time, everyone else was surprised with the resilience in inflation and I was not – but now I’ve joined the ranks of those who are surprised. I haven’t thought, and do not think, that inflation will fall back to 2% any time soon, but I also didn’t think it would keep accelerating into year-end. I still don’t think that. But…it’s also hard to see where the deceleration is going to come from. Our models (and the final chart above) give reason to think that rents might level off from here, but not decelerate much; core goods will continue to retreat but core services seem to have a feedback loop going. The fact that food away from home is accelerating while food at home is correcting slightly is emblematic of the passing of the torch from raw materials pressures to wage pressures. This is not good.

That being said, and while 75bps is pretty much cemented now at the next Fed meeting, I still think that the FOMC is looking for reasons to slow the pace of hikes. Things are starting to break around the world, and there’s no appetite (I don’t think) to test the limits of the system’s fragility right now. But the balance sheet is going to continue to shrink slowly, and that’s a big part of the decline in market liquidity. Certainly, the market has been generous with the Fed so far and hasn’t offered them the Hobson’s choice of saving the markets or pushing inflation lower…but that choice is going to come sooner or later especially as inflation has not yet shown any real signs of slowing down.

And yet, as I write this the stock market has closed the gap by rallying up to yesterday’s closing level, and is spiking higher. That’s remarkable, and I think it’s fadeable!

Fair is Fair, and TIPS are There (Almost)

September 30, 2022 6 comments

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

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

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

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

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

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

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


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

[2] (1+1.67%)^10 – 1 = 18%.

Categories: Bond Market, CPI, TIPS Tags:

Do Rents Really Actually Lead Home Prices?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Summary of My Post-CPI Tweets (July 2022)

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

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

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

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

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

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

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

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

Categories: CPI, Tweet Summary

Summary of My Post-CPI Tweets (June 2022)

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

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

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

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

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

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

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

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

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

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

Summary of My Post-CPI Tweets (May 2022)

June 10, 2022 2 comments

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!

  • It’s #CPI Day and, possibly, mea culpa day.
  • Last month I, & most everyone else, said the CPI peak was behind us as it dropped from 8.5% to 8.3%. In fact, I went out of my way to be sure people understand that peak CPI doesn’t mean peak PRICES (see my podcast at https://inflationguy.podbean.com/e/ep-28-this-month-s-cpi-report-peak-changes-not-peak-prices/ , e.g.)
  • We may have been premature. Today, while the consensus estimate is that headline will print 8.3% y/y the interbank market is exchanging that risk at 8.48%. And moreover, prices in the interbank market have the best guesses for headline CPI above 8.6% until October.
  • Of course that is because gasoline prices did NOT peak and kept on climbing. The national average is about to surpass $5/gallon. And this is keeping headline inflation bid.
  • Core CPI is still very likely to decline y/y. Consensus for the m/m is 0.5%, and the comp from May 2021 is +0.75%, so core should drop. The m/m consensus seems a little low, but 6 of the last 7 core prints have been between +0.5% and +0.6% so we are probably talking shading.
  • And I focus on Median CPI, which is still rising. It will keep going up for at least a few more months. And this is the salient point. Median is the best measure of the main thrust of the distribution – and while it’s rising, you can’t say price pressures have peaked yet.
  • Before I go on: 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.
  • In the bad news category this month, new cars and apparel are likely to continue to be contributors. Used cars are a little less clear. But these are three of the big “core goods”. So it isn’t just used cars. It was never just used cars, of course. That was just a foil.
  • Also in the bad news category for the general inflation outlook (although not for this month’s CPI perhaps) is that wages are still accelerating. The Atlanta Fed Wage Growth Tracker is now up at 6.1% y/y.
  • The good news is those wages are maintaining a steady spread over median CPI. Bad news is that so far gasoline and food aren’t mean-reverting and so the wage slaves of the world (and that’s most of us) are still getting killed. But maybe apres le deluge things will be better.
  • Hey, more good news is that M2 is decelerating. It’s down to 8% y/y, and only 1-2% over the last 3 months. Problem is that prices still haven’t caught up with the money growth SO FAR, but at least maybe we’re stopping the digging of the hole. Early to say that yet.
  • Unfortunately, commercial bank credit is growing at 9.5% y/y. Which is exactly what you would expect when non-reserve-constrained banks are able to lend at higher market rates.
  • This is one of the mechanisms for velocity rising when rates go up: the supply of credit gets better, and the demand for credit is fairly inelastic (50bps means more to your bank than it does to you).
  • We have never ever tried to restrain inflation with rates alone. Repeat that to yourself: monetary policymakers have NEVER tried to restrain inflation anything like this level with just interest rates. In the past, they restricted reserves. Not this time. So, here’s hoping.
  • Pretty short walk-up today but that’s because all the stories are the same: rents, and breadth, and we are still looking for a peak. Rents still look strong, breadth is still wide, and the peak in headline and median appears to still be ahead.
  • Question to ponder is: if CPI hits a new high, how bad for equities is that? If inflation stays at 6% for 2022, how long can the Fed sell the idea that 2.75% is the highest they’ll need to hike? The Eurodollar curve doesn’t believe it, but it also thinks this is all over in 2023.
  • I’m still thinking the Fed will pause the first time stocks get sloppy or unemployment starts to rise, but maybe I’m wrong. So far no signs of that. Still, they’ve not been tested yet.
  • OK, number in a few. Good luck.

  • ok, well…I guess we weren’t at peak CPI yet. M/M headline +1%; Y/Y up to 8.6%. Core slipped, but not as far as expected. To 6.01%. The decline is base effects. Bad news is that this is the HIGHEST m/m core CPI since last June.
  • It wasn’t just gasoline helping the headline to new highs; Food & Beverages was +1.13% m/m, now up to +9.73% y/y. Again, that hurts the wage earners most.
  • Used Cars was +1.8% m/m. New cars +0.96% m/m. Airfares, after +19% last month, were +12.6% this month. And can I say, the quality of air travel is as bad as I can remember it, speaking anecdotally.
  • Remember how everyone said that when core goods inflation came down, this would pass? Well, it is! core goods fell to 8.5% y/y from 9.7%. But core services jumped to 5.2% from 4.9%.
  • Owners’ Equivalent Rent leapt +0.6% m/m and now at 5.1% y/y. Primary Rents +0.63%. I have to look back and see the last time we saw any m/m jump that big. Lodging Away From Home +0.9%. So Housing subcategory was +0.85% m/m, +6.9% y/y.
  • That was the biggest m/m change in OER since 1990. And it doesn’t look like it’s rolling over.
  • Doctors’ Services fell -0.14% m/m, and are at only +1.1% y/y. Amazing. Hospital Services +0.46% m/m, so y/y went to 3.87%. Overall Medical Care subcategory was +0.4% m/m, to 3.74% y/y.
  • Core inflation ex-housing declined to 6.4% y/y. Yay!
  • This is kind of what I was afraid of. Housing inflation is moving above our model. It’s more in line with one of the subcomponents of the model, which is income-driven. And since wage income is still rising rapidly, there’s no reason to expect rents to slow very much.
  • More good news is that alcoholic beverages inflation is only +4.04% y/y. We’re gonna need it.
  • Household energy was +3.96% m/m. Fuel Oil +11% on the month, +76% y/y. Piped gas +7.8% m/m, +30.2% y/y. Electricity +1.9% m/m, +12% y/y. Break out those sweaters.
  • (That was an allusion to Jimmy Carter telling folks to turn down the thermostat and wear a sweater, in the 1970s energy crisis).
  • So Communication was -3.5% on the month. No idea what that is all about. Misc Personal Services was -1.3% m/m. Tenants and Household Insurance -0.8% m/m. Without that 5% of the basket declining, this would have been WORSE.
  • Median also looks like it should be 0.63% m/m or so. If true, that would be the biggest median since 1982. And folks…pressures aren’t ebbing; they’re BUILDING. Core highest in a year (m/m); median highest in decades.
  • About 8% of the consumption basket inflated faster than 9% annualized this month (m/m * 12, not y/y). That’s ridiculous. Normally there are a handful of outliers.
  • Four Pieces charts. Food and Energy, no surprises.
  • Piece 2, core goods. Like I said, good news. Dollar strength doesn’t hurt, but this ebbing is mostly due probably to declining trucking/shipping. Still not exactly soothing.
  • Piece 3 is core services less rent of shelter. Highest in a very long time. Over the last few years, this has persistently been the one spot that was showing gradual disinflation. No more.
  • Piece 4 rent of shelter – I’ve already discussed. It’s taking the top off my model.
  • As predicted, stocks not loving this. Short end of the Treasury curve also less than pleased.
  • I forgot: CPI for baby food unchanged on the month, +12.75% y/y.
  • One more chart and then I want to wrap up. The Enduring Investments Inflation Diffusion Index declined slightly this month, but still at a very high level. Those few weird negative categories might have rounded its edges a little. Nothing soothing though.
  • So, look. This was worse than even the pessimists were looking for. Housing accelerating to new levels, as a slow-moving category, is really, really bad news.
  • Headline inflation, thanks to continued rises in gasoline prices, may advance still further. Core inflation was down, and may be down again next month, but ONLY because of really rough comps. May-2021 (dropped off today) was +0.75%. June was +0.80%.
  • But then July, August, and September 2021, on core CPI, were +0.31%, 0.18%, and 0.26%. We’re going to shatter that. So core CPI probably doesn’t really peak until September…at best.
  • Meanwhile, Median CPI is still rising, months away from a peak also, and more importantly still setting new highs in m/m prints. That’s amazingly bad news.
  • We all know the Fed is behind the curve. And we know that their 2.75% terminal dot was based on the assumption that inflation would ebb to a level they think is the natural equilibrium around 2.25%.
  • That ain’t gonna happen. Now, that doesn’t mean they’ll hike rates to where they really need to be, but the choice between saving the nation from inflation on the one hand and saving the stock market on the other hand just got real.
  • Remember this chart. All of the models the Fed is using assume the canopener. They assume inflation is pulled by anchored expectations or some other potion to 2.25%. This is false.
  • Image
  • What am I saying? DEFEND YOUR MONEY. That’s all for today. You can catch this summary on https://mikeashton.wordpress.com later, and I’ll drop a podcast tonight. Stop by Enduring Investments if you feel so inclined. Thanks for tuning in.

Maybe we will look back on this day and say “that’s the day that everyone caught on that this inflation isn’t going to just gently fade away.” Every crisis has an inflection point where suddenly everyone realizes they’re on the wrong side of the boat – the day that our assumptions up to that point became plainly and obviously wrong. In the global financial crisis, the day that Lehman failed (without being merged into some other firm like Bear was) was the day when the last sleeping people woke up.

This isn’t quite so dramatic, but banks aren’t failing so it is what we have.

So, peak CPI isn’t yet behind us. Some of that is gasoline, of course. But the core CPI figures were also stronger-than-expected, and the strongest month in a year. Median CPI is still getting stronger every month, with new m/m records every month and y/y still rising. Rents are still accelerating. So not only are prices still rising, but inflationary pressures appear to still be rising even though in some cases (notably in core goods) there are some signs of improvement.

Those pressures should eventually ebb, if money supply growth remains flattish as it has over the last few months. But the price level has not yet caught up with prior increases in the money supply. Even after the microwave is turned off, the kernels in the popcorn bag still pop for a little while. That’s the best case at this point – that we are witnessing the final kernel pops.

%d bloggers like this: