Federal Reserve | E-piphany

Summary of My Post-CPI Tweets (January 2022)

February 10, 2022 Michael Ashton Leave a comment

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

Suddenly, going to #CPI Day is like going to the circus! Not least because of all the clowns opining about #inflation. For me, it’s just one more day as the Inflation Guy; it’s just that I have more company now since it seems EVERYBODY is an inflation guy all of a sudden.
Today we will set some more multi-decade highs in CPI, and in core CPI, and in Median CPI. The last three core CPI figures have been (after revisions) +0.60%, +0.52%, and +0.56% and the Street sees another 0.5% today.
It’s hard to disagree too strongly with that forecast, because the recent numbers have been very broad and not just used cars or Covid categories. Rents have been accelerating, as expected (more on that later). But it’s the breadth that has changed the story.
That said, I would not be terribly shocked with a somewhat softer used cars number this month, though I think New Cars will stay strong for a while, and we could get some weakness in airfares thanks to the brief Omicron scare.
Also, it’s February which means we are looking at January data – January data always have a larger error bar, which is why last week’s Jobs figure wasn’t really “surprising” econometrically. We also have the annual adjustments in seasonal factors and in component weights.
Those changes, despite some breathless analyses that circulated about how dramatic all of this will be and how profoundly it will affect CPI…won’t be the story. Sorry. The quick summary is that energy and vehicles gained 3% in weight and everything else lost a little.
Weights on apparel, medical care, food and beverages, rents, education/communication, and “other” all declined. But there were lots of little changes camouflaged in there. The weight of elder care just about doubled, for example, even while medical care as a whole went down.
But again – don’t stay up late worrying about it. It’s an effect that tends to dampen inflation slightly over time, since stuff that goes up gets a higher weight – and if it mean reverts, it has a higher weight when it goes down (and v.v.). But it happens every year.
With more volatility in the figure, it will matter more than most years, but the absolute value of the whole darn number is much larger too. I don’t worry about the second and third-order effects right now. There’s enough to look at with first-order effects.
OK back to the current market and today’s number. This chart shows the changes from 1 month ago for real rates, inflation expectations, and nominal rates. Some of the decline in infl expectations is carry, by the way.

As I said up top, expectations are for a big number this month, and we’ll see an even higher y/y next month before we get to a peak thereafter. So right about the time the Fed starts to raise rates, y/y inflation will start coming down. Mostly b/c year ago comps get harder.
Think that’s an accident of timing? It’s important to remember that the Fed is a political animal (ever since Greenspan), and it’s politically expedient to talk tough about inflation. It’s not politically expedient to crush markets, so they’ll try not to ACTUALLY be tough.
If y/y headline inflation starts to decline when they start to tighten, it will make it much easier to take it easy. I think the extent of rate hikes embedded in the curve right now are very unlikely. But the Fed will still TALK a good game.
Is the FOMC serious though? Well look at this chart of y/y changes in M2 in the US, Europe, and Japan. All are off the highs, but…in the US, money growth REMAINS very high; higher in fact than at just about any time other than the 1970s.

That doesn’t look like a hawkish central bank to me. And if they are just going to slow-play it while waiting for inflation to go back to 2%, they’re going to be disappointed. “Normal” is more like 4% now. And I’m not sure we’ll get back there quickly the way things are going.
A couple of items on rents, because that’s the big, slow moving piece with momentum. On the one hand, Owners’ Equivalent Rent has finally caught up with our model now that the eviction moratorium is over, but it has more to go. And parts of our model are less sanguine, actually.

The gap between asking and effective rents is also still wide, though narrowing. It will take another 3-6 months for it to close, and that’s when we can say the eviction moratorium is out of the data. This chart is as of the most recent data, quarter ended December.

Here’s something else fun. This chart is option-implied dividends on XHB, the SPDR Homebuilders ETF. It seems to have been leading rents by about 6mo. So again, we have at least 6 mo of further high prints in rents I think.

Anyway, the bottom line is that even if today’s number surprises on the low side, there are still high numbers ahead. And if it surprises on the high side, the Fed isn’t doing 50bp in March (unless they really change their talk first, because they aren’t into surprises).
Only market-clearing price if the market is free. With the eviction moratorium in place it wasn’t, and we’re still working through that.
Replying to @MarketInterest
Good luck! I will have a summary of all my tweets at mikeashton.wordpress.com sometime mid-morning and then I plan to put out an Inflation Guy podcast (inflationguy.podbean.com) sometime today.
Podcast #18 discussed how inflation is the cost of the option to be long cash waiting for opportunities. It was a good one. Are you curious how my investors are sidestepping that cost while retaining liquidity? Ping me via the contact form at enduringinvestments.com
Also look for the Inflation Guy app in your app store/play store (once we get enough users we will probably do livestreams to those users, rather than on Twitter).
That’s all for the walk-up. And still time to grab a coffee. CPI is in 5 minutes.

Welp, 6% on core. Now that we have exceeded the early ’90s high we can say it: highest core in 40 years.
Congratulations all around. Take a bow, fiscal spendthrifts. Curtain call, monetary firebugs. 0.58% on core CPI, 6.04% y/y.

Primary Rents were +0.54% m/m, 3.77% y/y. Wow. Owners’ Equivalent Rent was 0.42% m/m, 4.09% y/y. But hey, Lodging Away from Home fell 3.92%. Thanks, Omicron!!!!
Airfares, though, rose 2.3% m/m. There was some expectation of softness there thanks to the brief virus surge. But I guess it didn’t last long enough, since plans for flights have longer lead times.
Cars befuddled me. I thought Used might be soft, but they were +1.47% m/m (+40.5% y/y). I thought New Cars would stay strong, but they were flat m/m.
Food & Beverages +0.85% (not a core category obviously). Apparel +1.06%. Medical Care +0.66%. Recreation +0.88%. “Other” +0.76%. Criminy.
Medicinal Drugs +0.86% m/m. That’s NSA, so the y/y rose but only up to 1.33%. Still, drug prices are on the rise.

Hospital services +0.5% m/m, +3.6% y/y. But this has been more trendless around that figure. Doctors’ Services fell another -0.08%, down to 2.63%/yr. Why do people not want to pay doctors?
Overall, core goods rose to +11.7% y/y. Core services rose to +4.1% y/y. To review, the HOPE is that overall inflation settles down to…which one? Happy with 4.1% are we?

Lots of household services rose. Water/sewer/trash collection +1% m/m. Window/floor coverings +1.6%. Furniture/bedding +2.4%. Appliances +2.6%. Housekeeping supplies +1.6%. Tools/hardware +1.8%. These are NSA but still.
Core inflation ex-housing: 7.22%. I only have this series back to 1983. Fun chart.

Only two categories fell more than 10% annualized on the month: Car/Truck rental (-58% annualized), Lodging Away from Home (-38%). There were 20 that rose more than 10% annualized. To be fair, 6 of those were food and energy.
My first guess at median CPI is that it will be 0.54%, which would be the highest so far.
OK, four pieces charts. Piece 1, food and energy. We feel this but it almost seems like it isn’t a big story any more! At least it mean reverts…but the period of mean reversion might be longer this time because of knock-on effects (energy affecting fertilizer, e.g.)

Piece 2. No commentary needed.

Piece 3, Core services less rent of shelter. This is starting to be disturbing. For a long time this was steady to lower. Not clear it is any longer. It’s still pulling DOWN on core, but not as much.

[Piece 4] Rent of Shelter was SLIGHTLY higher in 2001, but otherwise you have to go back to the very early 1990s. And this is still going to go a bit higher at least.

Here is a plot of the distribution of price changes. About 80% of all categories are now inflating faster than 3%. About 65% of them are faster than 4%.

So, this is a record high for the Enduring Investments Inflation Diffusion Index. Not that any actual consumer needs to be told that inflation is hitting everything.

At this hour, 10y inflation swaps are up about 0.5bp. That’s less than you would expect just from 1y swaps are +20bps. It’s incredible how committed people are, mentally, to the idea that inflation will return to the neighborhood of 2%.
But look at this chart again. Four core prints in a row in a nice tight spread around a 6% or so annualized rate. The central point of the inflation distribution HAS SHIFTED. I don’t think it’s actually at 6%, probably more like 4%. But ain’t 2%.

What will the Fed do? 25bps. Remember, when forecasters started saying 50bps was possible there was firm pushback from policymakers. Equity markets don’t believe that either. They will go slower than expected and stop earlier than expected, IMO.
A dove doesn’t change his stripes.
That’s all for today’s train wreck. I’ll have a summary up on mikeashton.wordpress.com a little later. And a podcast on inflationguy.podbean.com later today. And of course all of that will be linked on the Inflation Guy app. Thanks for tuning in!

I keep hearing talk about “the ongoing inflation debate.” This starts to be confusing. What exactly is this debate about? At one time, it was a debate about whether there would be inflation at all. “No way,” said the non-inflation camp, “there’s too much slack in the labor market.” That debate ended a long time ago, as inflation began to surge long before the employment gap closed. Then there was the debate about whether inflation was “transitory.” That debate, too, ended as it’s eminently clear that except in the trivial sense that all things are transitory, inflation right now is not. There was a debate about causes, as some people pointed to the clogged ports and said “see, that’s why we have inflation. It’ll decline once we get the ports moving!” Other people pointed to shortages of various things, like computer chips, that have knock-on effects in other products. At one time, the Biden Administration argued for spending another few trillion for infrastructure, because that would lower inflation by improving those bottlenecks. Seriously. And I think they believed it. But how does that explain rents? How does it explain core services inflation above 4%? It doesn’t.

I’ll tell you what does explain all of that, though: money supply growth still in the teens, and government still riotously spending as if we remain in a calamitous depression.

I mean, wouldn’t it be weird if the single clearest prediction of monetarism happened to be right but it was a total coincidence and not because monetarism is right?

Inflation is going to ebb in 2022, probably. It is at 6% on core, and that’s probably going to go a little higher before it comes down. But there’s nothing in the data to suggest that inflation is going to drop back to 2%. Or even 3%. There’s nothing in the data that suggests the culprit is clogged ports or other bottlenecks. I expect core inflation to slowly decelerate to the 4% neighborhood…but the last four months of Core CPI have averaged a 6.8% annual rate, and in a pretty tight spread of 0.52% m/m on the low side to 0.60% on the high side. You can make an argument that the new distribution is coalescing around 6%, and that is not at all inconsistent with 13% money growth.

If you want lower inflation, then the prescription is pretty plain: decelerate money growth to at or below the desired pace of nominal GDP growth (real GDP + desired inflation). And stop spending from the federal coffers as if there is no cost to doing so. You may end up with, and probably will, less real GDP and more inflation in the near-term than you’d like, but that’s the way you get back to reasonable inflation in the medium term.

Of course, that path would be disastrous for stock and bond markets, so I give it a very small chance of happening. Not zero, but it’s hard to do this when the Fed is now an overtly political creature. They give press conferences for goodness’ sake! How do you run difficult policy when you have to face the microphones every month? Ask the coach of any team that’s in a rebuilding year.

Monetarily-speaking, we need to be in a rebuilding year. But it’s so much easier to just extend and pretend…

Well, here is one positive thought anyway: I wonder if numbers like this will finally quiet the “BLS is cooking the CPI figures!” crowd. Because if they’re cooking the numbers, they’re doing a darn poor job of it.

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

Summary of My Post-CPI Tweets (December 2021)

January 12, 2022 Michael Ashton 2 comments

Welcome to the first #CPI Day of 2022 (although technically it’s really the last of 2021 since we’re releasing December #inflation figures). Exciting times, as headline inflation might sport a 7% handle and core inflation definitely will be well above 5% y/y.
The last three numbers have been so broad, so worrisome OUTSIDE of the “Covid Categories”, that even the Federal Reserve is saying the right things. Will they really hike rates 4 times this year? I’m skeptical but we will see.
Core CPI for October and November were 0.599% and 0.535% m/m, respectively…but most importantly, there wasn’t a clear outlier causing these jumps. Median inflation, which is unaffected by those tails, has had three straight months above 0.45% (5.4% annualized).
Not only the Fed, but also the market, is finally starting to listen a little. This chart shows the changes from 1 month ago for real rates, inflation expectations, and nominal rates. All higher from mid-December.

But the theme from economists over the next few months – brace for it – will be “But economists expect inflation to moderate in the months ahead.” You’ll see this everywhere.
That’s because after easy year-ago comps for the next 3 months, they get difficult in April-June. So, while core inflation should get to 6% in early Q2, the y/y numbers PROBABLY won’t get worse than that (in 2022).
So, mix that story with “see, the Fed is serious and inflation is already coming down” and you’ll get the touts for stonks going in full force. Don’t worry, be happy. Buy the stuff that Wall Street needs to sell. Etc.
And there IS some good news. For example, the rate of increase in overland truckload rates is declining. Still high, but declining. Since trucking goes into all kinds of goods, it’s often a leader of the rate of change (not always).

Similarly, some modest good news from global shipping rates, which are down from their highs although edging back up a little (chart shows east-west container rates).

but … Other than those big base effects in April/May/June, there’s not a lot of reason to think the m/m #inflation figures will drop down to 0.15-0.2 again.
Going forward there will be a peak…but won’t be as serious as you think. We can all imagine used cars fading eventually. But no one bothers to imagine what will go up. So if you forecast a reversion to the mean for the first and ignore the second, of COURSE you forecast a peak.
Example: what about insurance? President Biden’s latest plan is to force insurance companies to provide 8 free COVID tests per person per month. Ignore whether the tests exist, but … Who do you think pays for that? Insurance company? Nope. More policy error.
What about China re-shutting some parts of its economy due to Omicron? Remember, (as I wrote in February 2020): “COVID-19 in China is a Supply Shock to the World” https://inflationguy.blog/2020/02/25/covid-19-in-china-is-a-supply-shock-to-the-world/ This is not policy error, just bad luck. But bad luck happens.
Last month I said “This is not about the pandemic any longer; it is about policy response to the pandemic. It is almost entirely policy error.” I feel strongly about this. While there is tough talk on this from the Fed, let’s see if it’s followed by tough action.
I’m concerned about that, since the Fed is still getting the story wrong. Powell says higher labor costs are not driving inflation. Well – that’s because labor costs generally FOLLOW inflation. Labor pushes when they see their own cost of living going up. Not before.
And thanks to workers’ pricing power, wage increases should rise around another 1% y/y by Q3, based on the current unemployment rate (green). This is good news for workers, bad news for consumers. Wages don’t cause inflation but they DO give it momentum.

So inflation will peak around April, but core will ebb to maybe 4%, not 2%.
Back to today’s number. Consensus is 0.4%/0.5% headline/core for the month and 7.0%/5.4% y/y. The ‘inside market’ is really 0.46-0.52 on core. The interbank market has the headline figure reaching 7.03%.
But remember this is December, and there are lots of weird seasonals, so anything can happen.
We are still watching rents, which should remain solid for a while here. Catching up from the end of the eviction moratorium, but there’s still plenty of heat in the housing market generally. And amazingly, we’re still watching used cars.
Here’s a chart of the level of used car prices. Not exactly collapsing! I mean, wow! I don’t know anyone who thought we’d get another leg higher.

And even the rate of change is reaching new highs. So we will likely get another push in the CPI from used autos, and new cars as well since they’re a substitute.

But most important in today’s #CPI remains the breadth. That’s the main focus today. If we get 0.7% but it’s all used cars, that’s not nearly as significant as if we get 0.4% and there are no outliers at all. That has been the recent story and I expect it to continue.
Good luck! I will have a summary of all my tweets at https://mikeashton.wordpress.com sometime mid-morning and then I plan to put out an Inflation Guy podcast (https://inflationguy.podbean.com) sometime today. Like, click subscribe, all that.
Also look for the Inflation Guy app in your app store (once we get enough users we will probably do livestreams to those users, rather than on Twitter).
And finally, book your free place at the Institutional Fixed Income Virtual Summit on January 22nd. https://lnkd.in/dab2WfEP

Hey! I finished with the walk-up early. Still time to grab a coffee. Number in 7 minutes.

A bit higher than expected 0.5%/0.6% on core. Headline did get to 7%, core hit 5.5%. Bloomberg kinda slow-rolling the seasonally-adjusted core number so don’t know the 2nd digit yet.
OK, here we go. The seasonally-adjusted core number, m/m, was 0.5501. So it just BARELY squeaked out the 0.6%. Still, higher than expected but not drastically.

Jumping out at me is the 1.72% rise in Apparel prices m/m. Apparel is only 2.7% of the basket but has been in deflation for years, punctuated by occasional attempts at price increases. Right now Apparel is +5.8% y/y. Some of that is likely shipping b/c apparel isn’t made here.

Used Cars, true to form, +3.5% m/m after +2.5% last month. Y/Y up to 37.3%. New cars +1% m/m.
Overall, core goods and services continue to look…um…disturbing?

Here is core services by itself. 4% looks like the big level. However, it’s no longer the case that this inflation is all about goods. Ergo, it isn’t all about supply chain.

OK in the COVID categories, 1.18% m/m from lodging away from home; +2.72% m/m from airfares. Car and truck RENTAL though was -5.3% m/m. That’s only 0.13% of CPI though!
Rents: Primary rents +0.39%, 3.33% y/y. That’s slightly lower than the last couple of months but still pretty hot. Owners’ Equivalent Rent +0.40%, 3.79% y/y. Ditto – lower but still hot. 4.8% annualized from a third of core would make it hard to get core back to 2%!
Medical Care was +0.28% m/m. But Pharma (+0.01%), Doctors’ Services (-0.05%), and Hospital Services (+0.16%) were all lower. Which means it came from insurance.
Here is medical insurance, y/y. Up 1.6% m/m. Medical insurance is a residual in the CPI (not directly calculated), but this is where added costs to insurance companies is showing up.

So core inflation at 5.5% is still “the highest since 1991”, but starting next month it will probably be “the highest since 1982” since the 1991 high was 5.6%.
Vehicle insurance (-16.8% one-month change, annualized) and Car and Truck Rental (-48%) were the only core categories that fell more than 10% annualized.
Categories that ROSE >10% annualized: Jewelry/Watches (+59%),Used Cars/Trucks(+51%),Womens/Girls Apparel(+30%),Public Transport(+26%),Motor Vehicle Parts/Equip (+21%),Footwear(+20%),Lodging Away from Home(+15%),Household Furnishings(+14%),Mens/Boys Apparel(+14%),New Cars(12%)
I am afraid this also looks like we are going to have another 0.45% or so on Median inflation. Hard to tell b/c regional OERs are the median categories it looks like, so it might be as low as 0.38% but unlikely I think.
Core ex-housing is +6.4% y/y. It’s worth remembering that core is currently being pulled DOWN by rents.

Folks, grab the reins on the change in the CPI weightings. They are a totally normal biannual thing. The changes will be larger this time than normal because consumption patterns changed – but there’s no conspiracy. Consumption patterns DID change. That’s all that’s happening.
Stories remain approximately the same for the four-pieces charts. The first is Food & Energy – most volatile, and the best chance for dropping the y/y headline number. But still, pretty ugly and this likely affects wage negotiations as people pay more for food and gas!

Core goods – a chunk is new and used autos. And there is upward pressure from shipping and trucking rates. But those are ebbing a little. This will eventually come back to earth, on a rate of change basis, but that doesn’t mean the price LEVELS will decline.

Core services ex-rents. This is still looking a little perky although not breaking to new highs like a lot of the rest of the index. Medical Care is actually holding down inflation. But uptick in health insurance is concerning.

Rent of Shelter – totally expected if you’ve been watching housing. Still has more to go! Again, it’s going to be hard to get core CPI back to 2% while rents are running 4-5% or more.

Slight good news on distribution. The weight of the consumption basket that’s inflating more-slowly than 3% is back above 25%!

OK, one more chart and then a quick wrap-up. Remember later to check out the summary at https://mikeashton.wordpress.com and look for the podcast version of it at https://inflationguy.podbean.com
I said the most important part of this report was the breadth. And it was again a very broad report; Median CPI will again be around 0.4%-0.5%. The Enduring Investments Inflation Diffusion Index reached a modest new high.

There is nothing in today’s number that suggests the underlying inflation pressures are ebbing. The y/y change will eventually come down because the comps will get more difficult, but there is NO SIGN that core will be dropping back to 2%.
My base case is that we end 2022 with something like a 4% core inflation rate. Could be as low as 3.5%, but the potential miss on the upside is larger than that.
The Fed is talking tough, but talk is cheap. They’re still easing at this hour! Eventually they’ll stop digging the hole. When will they start filling it in – not by raising rates which has small effect if any on inflation, but by selling bonds? Don’t hold your breath.
I think they’ll raise rates once or twice, maybe even thrice if bond and stock markets don’t seem to mind. But eventually, they’ll mind because discount rates matter. When that happens, I can’t imagine the Fed keeps sticking the knife in.
We have Volcker-like inflation, but we have no Volcker.
And that’s the problem. Thanks for tuning in! If you’re curious about what we do at Enduring Investments, come by http://enduringinvestments.com and say hi. I do these tweet storms for many reasons – but some of those reasons are commercial! See you soon.

This was, sadly, not a very surprising report. Inflationary pressures remain broad and deep, and the Fed today is still purchasing bonds and adding more reserves to the system. The FOMC is in a bit of a pickle since they labored so long under the false “inflation is transitory” story. The fact that they couldn’t foresee that the natural consequence of massive fiscal stimulus financed by massive monetary stimulus would be inflation is mind-boggling, but it does seem that they really did think that inflation was transitory and caused by supply-chain issues. Amazing.

So now, they’re behind the curve and really need to catch up and get ahead of this process. The inflation mindset is becoming entrenched (and I think already has), and all the Fed can do is talk about how they’re going to be gradual, gradual, a few hikes this year; maybe they’ll eventually think about shrinking the balance sheet; please don’t panic please don’t panic please don’t panic. But the slower the Fed goes, the harder they’ll have to squeeze liquidity to get inflation out of the system. And that will break a few eggs.

Volcker was not afraid to break some eggs. He saw that it was better to break eggs now than to be unable to afford eggs tomorrow. I do not currently see anyone at the Federal Reserve, or in central banking circles generally, made of that stern stuff. Ask me what inflation this year will be and I will say 4-5% on core. Ask me what it will be next year and I’ll say, probably about the same. Ask me what inflation will be in 2025 and I will say…

Do you have a Volcker? Because if not, we’re Volcked.

Categories: CPI, Federal Reserve, Tweet Summary, Wages Tags: core cpi, Fed, inflation

Summary of My Post-CPI Tweets (October 2021)

November 10, 2021 Michael Ashton 1 comment

Hello #CPI Day. Is it my imagination or do these keep getting better? Today we should see a 31-year high in headline inflation and the second-highest Core #inflation in 30 years. And, honestly, there’s a chance we break June’s high on core.
It actually doesn’t matter much if we move to 30-year highs on core this month because it will certainly happen over the next few. We are entering the easy-comparison part of the year. Oct ’20 through Feb ’21 had a CUMULATIVE 0.42% on core CPI.
And it isn’t just core. Last month, the theme of broadening price pressures took a big step forward as MEDIAN CPI had the largest m/m jump since 1990.
A lot of that has to do with rents, which are starting now to catch up after the lifting of the eviction moratorium. As expected. There is a lot more to go on rents.
So the underlying themes this month are the same as they have been recently: broadening pressures and less attention on the one-off COVID categories…although…
There will be plenty of volatile noise – that’s not going away soon, and it will contribute to inflation expectations since people encode price volatility as increase. Food inflation will probably be the highest in a decade.
Wholesale gasoline has risen 10 months in a row. Hey, how long has Biden been President, roughly? I mean, counting his naps? (Sorry, that’s piling on and a 15-yard penalty.)
Used cars (and new cars) are also a risk this month. Last couple of months, used cars were a drag as the spike was fading. Not so much. Private surveys are spiking again. We probably see that this month, “a chunky amount”. Here is the Black Book survey.

And here is the change, vs the CPI for used cars, lagged. You never know about the lags though.

Now, policymakers are expressing the opinion that the very high inflation numbers we are seeing now will fade later in 2022. They’re right. There are some signs here and there that certain bottlenecks are easing.
The inflation noise is going to gradually lessen. Unfortunately that means we’re seeing more of the SIGNAL, which remains strong. Pressures OUTSIDE of the ‘reopening categories’ are broad. So core inflation will stay high (just not THIS high, probably) through 2022.
And as shortages get resolved, they’ll likely resolve at HIGHER prices, not lower. See my article “Shortages are Unmeasured Inflation.”
& the causal elements remain. The Fed is tapering but credit growth has been hot.The idea banks are being stingy w/ credit is either false, or they’re being replaced by non-banks. M2 growth is down to ~13%, but that’s still WAY too fast. Especially as velocity recovers.
Onto this month’s report: the Street is expecting a soft +0.4% on core, which would be the highest since June. I kinda think that’s the best case unless OER and Rents abruptly slow down again. Last month’s 0.24% on core only happened because the one-offs pulled it DOWN.
The interbank inflation derivatives market has y/y headline hitting 5.94% today, breaking to 6.5% next month, and staying over 6% until April. (Some of that is due to base effects in energy and core.)
I expect Rents to continue to move higher. Looking for that, & watching Median CPI. It’s at 2.42% y/y and will be higher this month; will be over 3% before very long. That’s where I think everything ends up settling out, late in 2022: 3.5%ish. Not as bad as now…but not good!
Good luck this morning. I will have a summary of all my tweets at https://mikeashton.wordpress.com sometime mid-morning and then I plan to put out an Inflation Guy podcast (https://inflationguy.podbean.com ) sometime today. And let me take a moment this month to say: Thank you Veterans.

Welp. Golly. 0.60% m/m on core CPI, putting the y/y up to 4.58%. A new 30-year high! And easy comparisons still to come…

So let’s see. Used cars +2.5% m/m, which we sort of expected. OER +0.44% m/m, and Primary Rents +0.42%, which we sort of expected.
Apparel? 0.00% m/m. Which means all the other 7 major subcategories contributed. Recreation +0.69%. Medical Care +0.50%. Housing +0.72%. Food/Bev 0.84%. Other +0.85%. Educ/Communication only +0.16%. Transportation +2.37%. Broad.
Airfares: -0.66% m/m. But lodging away from home +1.35%. If you consider used cars a covid category (I don’t), then covid still net adding to this number. But then, everything was.
New cars +1.36% m/m after +1.30% last month. Used car prices can’t be above new car prices for long – but one way to resolve that is new car prices up, not just used car prices down.
Car and truck rental +3.1% after -2.9%.
In Medical Care, “Medicinal Drugs” +0.59% m/m. It is still down y/y, but is this a sign up upward pressure in a category that has been soft for a while?
Doctors’ Services flat, but Hospital Services +0.45% m/m, up to 4.04% y/y. I wonder if laying off lots of unvaccinated nurses will lower prices for health care? Hmmm. Guessing no.
Overall Core Goods rose back up to 8.4%. But more disturbing is core Services jumping to 3.2%. Again, a lot of that is in rents.
Food prices y/y up at 5.33%.
Oh my. Oh my oh my. My first guess at median CPI is +0.57% m/m. That would EASILY be the highest since 1982 if I’m right.
The really scary thing is that I’m looking for a big outlier. And I can’t really find one.
Postage and delivery services were up +3.87% m/m. But that’s 0.11% of the CPI. Cigarettes +2.08%, but that’s 0.53% of the CPI. Health Insurance +1.99%, and that’s 1.2% of the CPI. Airline Fares, +3.5%, but 0.6% of the CPI.
The only category that declined more than 10% annualized was Jewelry and Watches (-26% annualized m/m). There were 19 that ROSE more than 10% annualized.
Core CPI ex-shelter back up to 5.35%. Sure, a lot of that is autos. But you kinda want that to go down especially when shelter itself…
OER is catching up to the model…but the model is running away from it too.

Here are the four-pieces. Piece 1, food and energy. Highest since just before the GFC.

Piece 2 – Core goods. Near the highest since 1981 (only the bump in June was higher).

Piece 3: Core services less rent of shelter. At last! Something that isn’t near 30-40 year highs. But these are the slower-moving pieces. Maybe it’s because they haven’t had time yet to adjust…

Piece 4. Rent of Shelter. The part everyone was hoping wouldn’t follow home prices and asking rents. Sorry about that. It’ll shortly be at 30-year highs too.

So this is starting to be less-subtle. Last month’s distribution of y/y changes vs this month (“OCT”). Left tail vanishing. Right tail growing. And whole middle shifting to the right. Not subtle. Not isolated.

Here is the weighting of components of CPI that is inflating faster than 4% y/y. Almost 40% of the entire basket.

10y breakevens +5bps on the day to 2.69%. But that’s okay, Secretary Yellen tells us there’s no way that inflation expectations get unanchored.
I suppose it should be no surprise that the Enduring Investments Inflation Diffusion Index has reached an all-time high.

OK, let’s sum up. Different month, same story. There is still noise associated with “shutdown categories” and specific bottlenecks. But the underlying “signal” of inflation is getting stronger, as the pressures get broader. You can’t blame all of this on Long Beach.
Those pressures don’t come from the bottlenecks and shortages. They come from the fact that people can afford to pay higher prices because there’s more money in the system. Here is a chart of personal income vs GDP. Demand and supply. Where did the difference come from???

This ain’t rocket science. If you want the fire to stop, remove the oxygen. Oh, wait, actually that IS rocket science. Like, actual rocket science.
The Fed is finally slowing the rapid increase of its balance sheet. Be still my heart. Honestly, I don’t think they’ll even finish the taper, much less start to raise rates. Especially under Brainard. So buckle up. Lock in long-term contract prices.
I need to go take a shower. As much as the trajectory of inflation makes it fun to be “Inflation Guy,” this is monetary malpractice and it’s disgusting. This didn’t have to happen. Sorry. That probably shouldn’t be tweeted.
Anyway – the beatings will continue until morale improves!
Thanks for tuning in. There will be a tweet summary on https://mikeashton.wordpress.com in a little while.And I’ll drop a podcast later today. Interested in the new strategy we’ve launched, or want to work with us to launch one for your clients? Go to https://enduringinvestments.com & contact us.

Seriously, this month’s report – while expected, at some level – turns my stomach. We have learned these lessons, painfully, long ago: you can’t spend in an out-of-control fashion and you can’t print the money that you’re spending. That’s fiscal policy 101 and monetary policy 101. Flunk them all, I say.

The good news is that we no longer need to argue about whether or not inflation is coming. It’s here. We don’t need to argue about whether inflation will broaden beyond the re-opening categories. It has. The only questions are: how much? For how long? And how do we stop it? The third question we already know the answer to: restrain money growth; even shrink the money supply if velocity continues to rebound. No, that’s not against the rules. But it is against current monetary orthodoxy, which regards no particularly interesting role for the quantity of money. Flunk them all, I say.

The answers to the first two questions, how much and for how long, depend on how long it takes for policymakers to change course. On the fiscal side, there seems to be growing resistance to the idea that you can spend any amount of money because you can always print a trillion-dollar coin. But there are still some who profess to believe that if you spend more, you can solve bottlenecks by improving infrastructure. Maybe, if this was about infrastructure. But it’s not. It about spending in an out-of-control fashion and printing the money that you’re spending. On the monetary side, our choices seem to be another ride with Chairman Powell – who is the one who brung us to this party and I don’t really want to dance with him – or Lael Brainard, who thinks Powell has been too hawkish.

Do you see the problem?

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

Average Inflation or Price-Level Targeting: Where Are We Now?

August 19, 2021 Michael Ashton 3 comments

One of the reasons the Federal Reserve has been slower than usual to respond to the upswing in inflation, in addition to claiming that it believes any acceleration to be ‘transitory,’ is that the FOMC cleverly changed its modus operandi a couple of years ago to focus on “average inflation targeting,” or AIT. This adjustment in policy had been debated for many years, as the Committee grew concerned that the Fed could lose credibility (ha ha) in the downward direction if it did not commit to its 2% target symmetrically. They were afraid that, if investors believed they would respond aggressively to inflation but not to disinflation, they would start to incorporate this asymmetry into their investment decisions and push the economy uncomfortably close to price stability.

Parenthetical editorial comment – the idea that the Fed needed to fight against the notion that it might be too hawkish is a head-scratcher. It is unclear how the Federal Reserve could be less dovish than it has been in practice for the last dozen years.

In any event, AIT is similar to price-level targeting, although it is more flexible in terms of the period over which the average is intended to be taken. The Fed meant to signal that it would allow a period of above-target inflation to persist, until at least the period of below-target inflation had been compensated. But again, AIT is vague about what all of this means. However, it happens to have been timely as the Fed now can evince patience with higher inflation, since there had been an extended period during which prices were “too stable.”

How are they doing?

In my recent article “CPI Forwards Show Inflation Concerns Aren’t Ebbing,” I discussed how inflation forwards could be estimated, and give a steady reading on particular points in the future. Here is what that would look like today. If we measure 2.25% target CPI growth (which is roughly 2% on PCE, given the historical spread), then from the announcement of AIT the chart below shows the actual inflation index, and what is implied about the future.

This chart would suggest that the Fed chose an inauspicious time to begin focusing on AIT, since already the undershoot from 2019 has been fully retraced and then some. Moreover, the market seems to believe that the Fed is going to have to focus on a new level, as prices will never get back down to a level implied by 2.25% from the inception of AIT.

As I said, though, the great thing about AIT (from the standpoint of a political economist) is its vagueness. If we instead take as the starting point of the average the period just after the global financial crisis, when rents were recovering at last, then you get a much more agreeable picture. Looked at this way, the market is generously giving credit to the Fed for making a perfect landing, very gradually, over the next 5-10 years.

That seems a bit too generous by half in my opinion, but the takeaway is this: even choosing an extremely long averaging period, the Fed has already used up as much slack as it had saved up. If the next year’s worth of inflation outturns deliver what I think they will deliver, then either the inflation curve is going to become increasingly inverted or the Fed will have to recognize that investors are not buying the AIT framework.

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Categories: Federal Reserve, Uncategorized Tags: AIT, average inflation targeting, Federal Reserve, inflation

Summary of My Post-CPI Tweets (April 2021)

April 13, 2021 Michael Ashton 2 comments

Good Morning #CPI observers! Prepare for what is potentially the most entertaining #inflation figure in a while.
Before I get started, let me first note that I’ll be a guest on tdameritradenetwork.com (http://tdameritradenetwork.com) with @OJRenick at around 10:20ET this morning. Tune in!
Today’s walk-up is a little different. I usually try and focus mostly on the y/y numbers because the m/m numbers are an accumulation of random distributions around 280 other numbers. That is a lot of noise compared to signal and so I don’t like to forecast monthlies.
However, on a y/y basis the noise tends to cancel so it’s a clearer reading. Median CPI is even better because it lessens the impact of the tails.
This month, however, and for the next few months the y/y number is a distraction. We KNOW it’s going to jump a lot because the comparisons to March, April, and May 2020 are super easy. So instead, we want to focus on what happens to the monthlies.
I warned about this back in February in “The Risk of Confusing Inflation Frames.” https://inflationguy.blog/2021/02/04/the-risk-of-confusing-inflation-frames/ And now…here we are.
So looking back at the last couple of months, we see that the core CPI figures were soft. Last month, core CPI (but not median CPI!) was soft because of surprising movements in goods, outside of housing. It had been goods pressing core inflation higher so that was surprising.
Turns out that some of that was (probably) due to the fact that the weather prevented the BLS from surveying certain prices. So we’d expect a little catch-up from last month’s +0.10% core, just as a null hypothesis.
Some of the places we are pretty sure to see strength are in autos, apparel, and the travel categories. Used car prices are nuts. But in the bigger picture, there are a lot of shortages out there and they all push prices the same way.
I talked about some of those shortages in my article at the end of March. https://inflationguy.blog/2021/03/30/how-many-shortage-anecdotes-equal-data/ How Many ‘Shortage’ Anecdotes Equal Data?
There are shortages in autos (due to semiconductors as well as lower fleet sales into the used car channel), packaging, cotton, containers, rental cars, Uber drivers, other goods…and shelter.
In shelter, rents have been artificially soft because of the eviction moratorium, which has made realized rents decelerate while asking rents are rising rapidly with home prices. That divergence is unusual and it’s due to the eviction moratorium.
The Biden Administration just extended that moratorium (was due to expire end of March) so that catch-up will come later. However there are SOME signs that rents are improving anyway. I’ll be looking for that. Rents were not as soft last month as they had been recently.
The economist consensus is for a core CPI m/m of about 0.2%. That seems low to me with all of the potential upside disturbances, and has got to mean that economists are expecting further shelter weakness. I don’t.
The market doesn’t either. Interbank trading of the (headline) price number implies about 0.1% higher than the economists expect. Most of that in core presumably. I would not be surprised in the slightest at +0.3% core.
We will see. Remember, the Fed doesn’t really care – and they’re working hard to tell you that you shouldn’t either. Eventually, the market will win. But not for a while. It will be late 2021 before the dust clears on the base effects.
So keep an eye on those underlying pressures and don’t get distracted by the y/y fog of war. I will talk today in terms of y/y figures, out of habit, but rest assured I’m watching the small ball too.
Thanks for coming along today on this crazy ride. Good luck! 6 minutes to print.
OK, core came in at 0.34% m/m, so quite a bit higher than estimates. y/y rose to 1.646%…so ALMOST rounded to a 2-tenth miss on the y/y figure.

Note in that chart, they’re not y/y. There’s no base effects there. In fairness, we probably should combine the last two figures, and get something like 0.22% per month, but that’s still faster than the Fed would like. Except they don’t care.
So Core Goods jumped back up to 1.70% y/y, where it had been 2 months ago before dropping to 1.3% y/y last month. Collection issues. Core Services up to 1.6%.
Primary rents +0.15%; OER +0.23%. Not as soft as a couple of months ago, but not overly strong either. Lodging Away from Home was +3.84% m/m, which pushed the Housing category to a +0.34% m/m rise…same as core, weirdly.
Apparel fell again. That’s a bit odd. Apparel had been doing well partly because cotton imports from part of China were being held up at the ports…maybe that’s lessening now. Anyway Apparel isn’t a big piece.
Pharmaceuticals: +0.08%. Doctors’ Services: +0.28%. Hospital Services +0.63%. First time I can remember them all three being positive in a while! Softness in Pharma is still surprising to me.
Doctors’ Services highest in years (y/y).

Hospital Services, despite this month’s jump…not so much.

Back to used cars. Part of what is happening here is that rental fleets shrunk last year so they are providing fewer cars to the used car markets. Part is the semiconductor shortage making new cars expensive. But Black Book says…this has a lot further to go in months ahead.

Ah. Core CPI ex Shelter jumped up to 1.61% y/y. Yeah, I know I said y/y. But that was at 1.7% last February BEFORE the COVID slide. Arguably it means price pressures are higher now than before COVID, and CPI is being held down by rents.
This isn’t from the CPI report but a reminder of what is happening in rents. If a landlord is unsure of being able to collect the rent, it goes in a zero. Doesn’t take many zeroes to lower measured rent. And the number of zeroes is higher when the gov’t says you can’t evict.

Other COVID categories: Airfares +0.44% m/m (fell 5% last month!), Lodging away from home I already mentioned +3.8% (-2.3% last month). Motor Vehicle Insurance +0.85% m/m.
New Cars, interestingly, was flat. That’s odd – there’s clearly a shortage of semiconductors so maybe this is more a situation of you can’t get ’em so the price doesn’t change? I’d expect that to rise going forward.
Car and truck RENTAL: +13.4% (SA) m/m. Here’s the m/m and y/y, which is now up to +31%. If you can’t buy ’em, you can try to rent ’em. Remember how I said fleets are smaller?

Now, Median CPI giveth and Median CPI taketh away. Hard to tell because median category will probably be a regional OER, but m/m will be probably 0.2-0.22%. Median y/y won’t change much b/c base effects were mainly from a few small categories with large moves.
That warrants further comment: the fact that we didn’t see a GENERAL deceleration in prices, but a very focused one, should make you wonder about output gap models. Most of the economy wasn’t in deflation. Hotels and airfares were though!
Only two core categories with more than a 10% annualized decline this month: Women & Girls’ Apparel (-28%), and Infants’ and Toddlers’ Apparel (-22%).
On the gainer side, tho: Car/Truck Rental as noted, Jewelry/Watches (+80.7% ann’lz), Lodging AFH (57%), Motor Vehicle Insurance (+47%), Men’s/Boys Apparel (+35%…hey!!), Misc Personal Svcs (+16%), Motor Vehicle Maintenance & Repair (+12%).
Core goods & Core services. Both rose, and remain atop one another. How long can goods stay elevated? Port traffic is improving, slowly. But materials prices remain stubbornly high and global trade remains fractious.

ok, gotta wrap it up and get to makeup for my appearance on @TDANetwork at 10:20. KIDDING, no makeup. You can dress a monkey in silk but it’s still a monkey. Anyway, I’ll do the four-pieces and then conclude. Will put out the diffusion indices later.
Piece 1: Food & Energy. No surprises here: it was expected to jump as gasoline prices continue to recover.

Piece 2: Core Goods. Back to the highs.

Core services less Rent of Shelter. This still remains bizarre to me. But medical finally showed some life this month and there’s sign of pressures in the PPI there so maybe it’s coming. Hard to see an uptrend here though unless you turn it upside-down.

Finally, Rent of Shelter. It seems it may be done going down, and there’s a lot of catch-up to do when the moratorium ends. But the last 2 months of rents have been more normal.

So at this hour, 10-year breakevens are +1bp and stocks are flat. Because the Fed doesn’t care, and the punch bowl remains. I guess that’s about the summary here. The base effects are going to obfuscate whatever is really happening underneath.
BUT, what is happening underneath (per the chart of core-ex-shelter) appears to be price pressures that are certainly no smaller than pre-COVID. Are they temporary? How will we know? If the Fed says they are, and are wrong…bad.
If the Fed says the pressures are NOT transitory, and are wrong, and over-tighten, that’s also bad – but for employment. And here’s the thing, this Fed has said repeatedly that full Employment is their main goal. So errors are designed into the system to be inflation-enhancing.

Here’s the summary of the main points today. Ex-housing core inflation is back at the level it was prior to COVID. Housing is artificially depressed because of the way the BLS accounts for rents (which is reasonable, since someone who isn’t paying has certainly decreased his cost of living), and asking rents tell a totally different story. But since measured rents are soft, it means that core isn’t low right now because of COVID categories: it’s low right now because of one thing, really, and that’s rents. If realized rents converge upward to asking rents, you can tack another 0.7%, 0.8%, 0.9% or so onto core CPI.

Inflation is already higher than it “should” be coming off the greatest global economic contraction since the Black Death. And that’s without consumers being truly unleashed. But the Fed has adopted an asymmetric policy stance, because they very publicly feel that the risk of higher inflation is something they ‘have the tools to manage’, whereas they believe they have some sort of moral obligation to make sure everyone is employed. I don’t want to draw too many parallels to prior hyperinflations because that’s not what I’m looking for, but the current asymmetric stance is very odd for any policymaker who learned history and knows that one of the reasons that Weimar Germany printed so many marks was because they believed having everyone employed and paid was absolutely crucial, and so they ran massive deficits and printed money to pay for them.

This is why the Bundesbank has always been willing, ever since, to rein in inflation even if it meant short-term pain in labor markets. They remember that the best route to maximum employment in the long run is to maintain a stable pricing environment. As recently as the 1990s, the Fed (Greenspan at the time) would regularly say that. It is no longer the core belief of the FRB.

The Fed believes they have the tools to rein in inflation, the knowledge about how to calibrate them, and the will to use them, but at least for the next 6 months they will wave their hands vaguely at ‘base effects.’ After that, if inflation is higher than they would like once the base effects are past, they’ll vaguely wave their hands and say ‘average inflation targeting.’ It it going to be a very long time before central bankers willingly hike rates without the market forcing them to do it. And before that, there may very well be a showdown where the Fed decides to defend the longer-term yield environment and implements Yield Curve Control. These actions and possible actions have very different implications for stocks and bonds depending on the path, especially with equities pricing in a goldilocks environment. Get ready for a bumpy year.

Categories: Causes of Inflation, CPI, Federal Reserve, Tweet Summary

Average-Inflation Targeting, In a Nutshell

August 26, 2020 Michael Ashton 1 comment

Let the bow-tie set argue about the niceties and the nuances. Here is what I can tell you about inflation targeting so that we can all understand the debate: suppose they changed the rules of baseball in an analogous way.

A new pitcher comes in to the game. He throws a pitch over the batter’s head. His next pitch skips behind the batter. His third pitch sails 2 feet high and outside. His fourth pitch almost hits the mascot.

“Yer out!” barks the umpire. Because the four pitches averaged out to strikes. My questions:

I don’t know that the new rule gives me any greater confidence in the pitcher.
It isn’t clear to me how that rule would help the batter.
Maybe this helps a bad pitcher. But I wonder why a good pitcher would need that rule.

That is all.

Categories: Analogy, Federal Reserve Tags: average inflation, inflation targeting

And Now Their Watch is Ended

August 3, 2020 Michael Ashton 3 comments

At one time, fiscal deficits mattered. There was a time when the bond market was anthropomorphized as a deficit-loathing scold who would push interest rates higher if asked to absorb too much new debt from the federal government. The ‘bond vigilantes’ were never an actual group, but as a whole (it was thought) the market would punish fiscal recklessness.

Of course, any article mentioning the bond vigilantes must include the classic account by Bob Woodward, describing how then-President Bill Clinton reacted to being told that running too-large deficits would cause interest rates to rise and tank the economy: “Clinton’s face turned red with anger and disbelief. ‘You mean to tell me that the success of the program and my re-election hinges on the Federal Reserve and a bunch of ****** bond traders?’”

Truth be told, this was always a bit of a crock in the big scheme of things. Although the bond market occasionally threw a tantrum when Big Government programs were announced, the bond traders have always been there when the actual paper hit the street. The chart below shows 10-year yields versus the rolling 12-month federal deficit. Far from being deficit scolds, bond market investors have always behaved more as if bonds were Giffen goods (whose price gets higher when there is more supply, and lower when there is less supply, in the opposite manner from ‘normal’ microeconomic dynamics). I guess so long as we are doing a walk down economic history lane, we could also say that the bond market followed a financial version of Say’s law: that supply creates its own demand…

Well, if ever there was a time for the market to get concerned about deficits, now is surely it. While the Fed continues to buy massive quantities of paper (to “ensure the smooth functioning of the markets”, as it surely does since if they were not buying such quantities the adjustment may be anything but smooth), there is still an enormous amount of Treasury debt in private hands. And it all yields far less than the rate of inflation. Clearly, these private investors are not alarmed by the three-trillion-dollar deficit, nor of the effect that the Fed buying a large chunk of it could have on the price level.

If investors are not alarmed by a $3T deficit – and, aside from market action being so benign, consider whether you’ve read any such alarm in the financial press – then it’s probably fair to say that there isn’t a deficit amount that would alarm them. Always before, if the market absorbed an extra-large deficit there was always at least the concern that it might choke on all that paper. Or, if it didn’t, that surely we were at the upper level of what could be absorbed. I don’t sense anything like the unease we’ve seen in prior deficit spikes. And that’s what alarms me. Because, as I tell my kids: a rule without enforcement means there isn’t a rule. Investors are not putting any limitation on the federal balance; ergo there is no limit.

Well, perhaps by itself that’s not a big deal. Heck, maybe deficits really don’t matter. But what bothers me is that the risk to that possibility is one-sided. If deficits don’t matter, then no biggie. But if they do matter, and the bond vigilantes are dead so that there is no push-back, no enforcement of that rule, then it follows that the only speed limit that will be enforced is when the car hits the tree. That is, if there is no alarm that causes the market to discipline the government spenders before there’s a crack-up, then eventually there will be a crack-up with 100% probability (again, assuming that deficits do matter at some level, and maybe they don’t).

While the vigilantes kept watch, there was scant worry that a government auction would fail. Although, as I’ve pointed out, the vigilantes weren’t macro-enforcers there were sometimes micro-aggressions: sudden interest rate adjustments where yields would jump 100bps in six weeks, say. This doesn’t happen any longer. So, while there’s plenty of money floating about right now to buy this zero-yielding debt, the larger the bond market gets the more of that money it will be sucking up. Unless, that is, the amount of money expands faster than the amount of debt (so that the debt shrinks in real terms), which is another way to say that the price level rises sharply. In that case, in order to keep the markets “orderly” the Federal Reserve will have to take more and more of that zero-yielding debt out of the market, replacing it with cash. It’s easy to see how that could spiral out of control quickly, as well.

I am not sure how close we are to such a crack-up. It could be years away; it could be weeks. But without the bond vigilantes, there’s no law in this town at all.

Categories: Bond Market, Federal Reserve, Government

Half-Mast Isn’t Half Bad

April 28, 2020 Michael Ashton 1 comment

As I watch the stock market, implausibly, rise to levels no one expected so soon after the crash, I am also sickened by the cheerleading from those whose fortunes – not to mention egos – are wrapped up in the level at which the Dow trades. Stock market fetishism always fascinates me as much as it repels me. Although my experience as a trader (and a short-term options trader, at that) would seem to suggest otherwise, my makeup is as a long-term investor. I want to buy value, and the mathematics of investing for me is that I want (a) high intrinsic value at (b) a low price. While people who are buy-and-hold investors of a certain age clearly benefit from higher prices, young investors clearly benefit from lower prices since they’re going to be net buyers for a long time. And the price at which you acquire intrinsic value matters. So does the price at which you sell, but not until you sell.

So to me, there’s nothing great about a price that’s high relative to intrinsic value, unless I am preparing to sell. In a broader sense, the idea that we should cheer for higher prices (as opposed to higher intrinsic values) is not only unseemly, but destructive and I’ll explain why in a minute. I will note that the fascination with watching prices ticking every second goes back a long ways: you can read in Reminiscences of a Stock Operator about the bucket shops of the early 1900s where speculators would watch and trade the stock market tape. The general increase in investor twitchiness and short-termism that has accompanied the growth of financial news TV, online investing, and the development of ETFs to trade broad market exposures intraday certainly adds numbers to the cheerleading crowd. But it isn’t new. Depressing, but not new.

The most fascinating example of this belief in the (non-intuitive, to me) connection between the value of the stock market and the value of ‘Merica was presented to me in the aftermath of 9/11. When we first trudged back to lower Manhattan, there were people handing out these cards:

Fight Osama! Buy Cisco! I never did see the connection, and it seemed to me at the time either delusional (the terrorists win if my investment in Lucent goes down) or nakedly self-serving. Certainly the way I feel about my country has nothing to do with where I’m able to buy or sell eBay today. And actually, they really weren’t coming for our 401(k)s, they were coming for our lives. But I digress.

The point I actually want to make is that when the Fed works to stabilize market prices, they’re having a negative effect by destabilizing economic variables. An analogy from manufacturing might be an entry point to this explanation: a truism in manufacturing is that you can stabilize inventory, or you can stabilize production, but you can’t stabilize both (unless your customers are accommodating and provide very smooth demand). If you want to stabilize inventory levels, then you need to produce more when business is high and less when business is low, so you’re on the production roller-coaster. If you want to keep production level, then inventory will be low when business is high and high when business is low, so you’re on the inventory roller-coaster. Only if business itself is stable – which is rare – can you do both.

A similar thing happens in capital markets. You can stabilize the cost of capital, but then you destabilize growth rates. Or you can stabilize growth rates, and the cost of capital (stock and bond prices) will fluctuate. This is true unless you can do away with the business cycle. If you choose, as the Fed has in recent years, to try and stabilize market prices at very high levels (stabilizing the cost of capital at very low levels), then when underlying activity is strong you’ll get a ton of speculative investment in capacity, new ventures that depend on the availability of cheap capital, and strong growth. And then when economic activity heads lower, you’ll find that lots of businesses go bust and the recession is deeper. In fact, it’s not just the speculative businesses that go bust, but the overbuilding in the expansion can cause even prudent enterprises to have more difficulties in the downturn.

The Fed’s historical response to this has been to let the speculative activity happen when the cost of capital is held too low, but not let companies go bust when economic activity wanes…so they lower the cost of capital even further.

I’m obviously not the first person to point out that the Fed’s constant intervention has deleterious effects and tends to increase the amplitude of boom and bust. And, for what it’s worth, I’m not blaming the current recession on the Fed. Clearly, the proximate cause of this recession was COVID-19 and the global economic shutdown. What made it worse was that the Fed, by holding down the cost of capital, had previously precipitated the development and preserved the success of many more speculative enterprises. And the fetishism about stock prices, and about how important it is to have lots of money “working for you” in the stock market, is also one of the reason that people don’t save enough.

Of course, right now is probably not the time for the Fed and Congress to pull back and let huge numbers of people and companies go bankrupt. There’s a case to be made for the sort of government response we are having in this episode, in which personal income is being replaced by money creation while workers are ordered to stay home. There will be a piper to pay for that policy – a loss of price stability which is a consequence of trying to preserve output stability, but a consequence that it’s arguably acceptable to pay. Afterwards, though, I hope that central banks can start to let natural rhythms replace the autocratic ones. I am not hugely optimistic on that score, but one place to start is this: stop lowering the bar for central banks to intervene in markets. Stop targeting equity prices and interest rates. It’s okay to let the Dow trade at half-mast, and the bull will come back without the Fed’s help.

In fact, if we don’t keep trying to artificially increase the length of the mast, the Dow might never need to trade down to half-mast in the first place. Certainly, intrinsic values don’t retrace 50% in a recession!

Categories: Analogy, Behavioral, Economy, Federal Reserve, Government, Stock Market

Last Time Was Different

April 4, 2020 Michael Ashton 7 comments

They say that the four most dangerous words in investing/finance/economics are “This time it’s different.”

And so why worry, the thinking goes, about massive quantitative easing and profound fiscal stimulus? “After all, we did it during the Global Financial Crisis and it didn’t stoke inflation. Why would you think that it is different this time? You shouldn’t: it didn’t cause inflation last time, and it won’t this time. This time is not different.”

That line of thinking, at some level, is right. This time is not different. There is not, indeed, any reason to think we will not get the same effects from massive stimulus and monetary accommodation that we have gotten every other time similar things have happened in history. Well, almost every time. You see, it isn’t this time that is different. It is last time that was different.

In 2008-10, many observers thought that the Fed’s unlimited QE would surely stoke massive inflation. The explosion in the monetary base was taken by many (including many in the tinfoil hat brigade) as a reason that we would shortly become Zimbabwe. I wasn’t one of those, because there were some really unique circumstances about that crisis.[1]

The Global Financial Crisis (GFC hereafter) was, as the name suggests, a financial crisis. The crisis began, ended, and ran through the banks and shadow banking system which was overlevered and undercapitalized. The housing crisis, and the garden-variety recession it may have brought in normal times, was the precipitating factor…but the fall of Bear Stearns and Lehman, IndyMac, and WaMu, and the near-misses by AIG, Fannie Mae, Freddie Mac, Merrill, Goldman, Morgan Stanley, RBS (and I am missing many) were all tied to high leverage, low capital, and a fragile financial infrastructure. All of which has been exhaustively examined elsewhere and I won’t re-hash the events. But the reaction of Congress, the Administration, and especially the Federal Reserve were targeted largely to shoring up the banks and fixing the plumbing.

So the Federal Reserve took an unusual step early on and started paying Interest on Excess Reserves (IOER; it now is called simply Interest on Reserves or IOR in lots of places but I can’t break the IOER habit) as they undertook QE. That always seemed like an incredibly weird step to me if the purpose of QE was to get money into the economy: the Fed was paying banks to not lend, essentially. Notionally, what they were doing was shipping big boxes of money to banks and saying “we will pay you to not open these boxes.” Banks at the time were not only liquidity-constrained, they were capital-constrained, and so it made much more sense for them to take the riskless return from IOER rather than lending on the back of those reserves for modest incremental interest but a lot more risk. And so, M2 money supply never grew much faster than 10% y/y despite a massive increase in the Fed’s balance sheet. A 10% rate of money growth would have produced inflation, except for the precipitous fall in money velocity. As I’ve written a bunch of times (e.g. here, but if you just search for “velocity” or “real cash balances” on my blog you’ll get a wide sample), velocity is driven in the medium-term by interest rates, not by some ephemeral fear against which people hold precautionary money balances – which is why velocity plunged with interest rates during the GFC and remained low well after the GFC was over. The purpose of the QE in the Global Financial Crisis, that is, was banking-system focused rather than economy-focused. In effect, it forcibly de-levered the banks.

That was different. We hadn’t seen a general banking run in this country since the Great Depression, and while there weren’t generally lines of people waiting to take money out of their savings accounts, thanks to the promise of the FDIC, there were lines of companies looking to move deposits to safer banks or to hold Treasury Bills instead (Tbills traded to negative interest rates as a result). We had seen many recessions, some of them severe; we had seen market crashes and near-market crashes and failures of brokerage houses[2]; we even had the Savings and Loan crisis in the 1980s (and indeed, the post-mortem of that episode may have informed the Fed’s reaction to the GFC). But we never, at least since the Great Depression, had the world’s biggest banks teetering on total collapse.

I would argue then that last time was different. Of course every crisis is different in some way, and the massive GDP holiday being taken around the world right now is of course unprecedented in its rapidity if not its severity. It will likely be much more severe than the GFC but much shorter – kind of like a kick in the groin that makes you bend over but goes away in a few minutes.

But there is no banking crisis evident. Consequently the Fed’s massive balance sheet expansion, coupled with a relaxing of capital rules (e.g. see here, here and here), has immediately produced a huge spike in transactional money growth. M2 has grown at a 64% annualized rate over the last month, 25% annualized over the last 13 weeks, and 12.6% annualized over the last 52 weeks. As the chart shows, y/y money growth rates are already higher than they ever got during the GFC, larger than they got in the exceptional (but very short-term) liquidity provision after 9/11, and near the sorts of numbers we had in the early 1980s. And they’re just getting started.

Moreover, interest rates at the beginning of the GFC were higher (5y rates around 3%, depending when you look) and so there was plenty of room for rates, and hence money velocity, to decline. Right now we are already at all-time lows for M2 velocity and it is hard to imagine interest rates and velocity falling appreciably further (in the short-term there may be precautionary cash hoarding but this won’t last as long as the M2 will). And instead of incentivizing banks to cling to their reserves, the Fed is actively using moral suasion to push banks to make loans (e.g. see here and here), and the federal government is putting money directly in the hands of consumers and small businesses. Here’s the thing: the banking system is working as intended. That’s the part that’s not at all different this time. It’s what was different last time.

As I said, there are lots of things that are unique about this crisis. But the fundamental plumbing is working, and that’s why I think that the provision of extraordinary liquidity and massive fiscal spending (essentially, the back-door Modern Monetary Theory that we all laughed about when it was mooted in the last couple of years, because it was absurd) seems to be causing the sorts of effects, and likely will cause the sort of effect on medium-term inflation, that will not be different this time.

[1] I thought that the real test would be when interest rates normalized after the crisis…which they never did. You can read about that thesis in my book, “What’s Wrong with Money,” whose predictions are now mostly moot.

[2] I especially liked “The Go-Go Years” by John Brooks, about the hard end to the 1960s. There’s a wonderful recounting in that book about how Ross Perot stepped in to save a cascading failure among stock brokerage houses.

Categories: Banks/Wall Street, Causes of Inflation, CPI, Federal Reserve, Liquidity

Summary of My Post-CPI Tweets (February 2020)

February 13, 2020 Michael Ashton 1 comment

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy. Or, sign up for email updates to my occasional articles here. Investors with interests in this area be sure to stop by Enduring Investments (updated site coming soon). Plus…buy my book about money and inflation. The title of the book is What’s Wrong with Money? The Biggest Bubble of All; order from Amazon here.

Welcome to CPI day! Before we get started, note that at about 9:15ET I will be on @TDANetwork with @OJRenick to discuss the inflation figures etc. Tune in!
In leading up to today, let’s first remember that last month we saw a very weak +0.11% on core CPI. The drag didn’t seem to come from any one huge effect, but from a number of smaller effects.
The question of whether there was something odd with the holiday selling calendar, or something else, starts to be answered today (although I always admonish not to put TOO much weight on any single economic data point).
Consensus expectations call for +0.2% on core, but a downtick in y/y to 2.2% from 2.3%. That’s not wildly pessimistic b/c we are rolling off +0.24% from last January.
Next month, we have much easier comparisons on the y/y for a few months, so if we DO drop to 2.2% y/y on core today that will probably be the low for a little while. Feb 2019 was +0.11%, March was +0.15%, April was +0.14%, and May was +0.11%.
So this month we are looking to see if we get corrections of any of last month’s weakness. Are they one-offs? We are also going to specifically watch Medical Care, which has started to rise ominously.
One eye also on core goods, though this should stay under pressure from Used Cars more recent surveys have shown some life there. Possible upside surprise because low bar. Don’t expect Chinese virus effect yet, but will look for signs of it.
That’s all for now…good luck with the number!
Small upside surprise this month…core +0.24%, and y/y went up to 2.3% (2.27% actually).
We have changes in seasonal adjustment factors and annual and benchmark revisions to consumption weights this month…so numbers are rolling out slowly.
Well, core goods plunged to -0.3% y/y. A good chunk of that was because Used Cars dropped -1.2% this month, down -1.97% y/y.
Core services actually upticked to 3.1% y/y. So the breakdown here is going to be interesting.
Small bounce in Lodging Away from Home, which was -1.37% m/m last month. This month +0.18%, so no big effect. But Owners Equivalent Rent jumped +0.34% m/m, to 3.35% y/y from 3.27%. Primary Rents +0.36%, 3.76% y/y vs 3.69%. So that’s your increase in core services.
Medical Care +0.18% m/m, 4.5% y/y, roughly unchanged. Pharma fell -0.29% m/m after +1.25% last month, and y/y ebbed to 1.8% from 2.5%. That goes the other way on core goods. Also soft was doctors’ services, -0.38% m/m. But Hospital Services +0.75% m/m.
Apparel had an interesting-looking +0.66% m/m jump. But the y/y still decelerated to -1.26% from -1.12%.
Here is the updated Used Cars vs Black Book chart. You can see that the decline y/y is right on model. But should reverse some soon.

here is medicinal drugs y/y. You can see the small deceleration isn’t really a trend change.

Hospital Services…

Primary Rents…now, this and OER are worth watching. It had been looking like shelter costs were flattening out and possibly even decelerating a bit (not plunging into deflation though, never fear). This month is a wrinkle.

Core ex-housing 1.53% versus 1.55% y/y…so no big change there. The upward pressure on core today is mostly housing.
Whoops, just remembered that I hadn’t shown the last-12 months’ chart on core CPI. Note that the next 4 months are pretty easy comps. We’re going to see core CPI accelerate from 2.3%.

So worst (core) categories on the month were Used Cars and Trucks and Medical Care Commodities, which we’ve already discussed. Interesting. Oddly West Urban OER looks like it was down m/m although my seasonal adjustment there is a bit rough.
Biggest gainers: Miscellaneous Personal Goods, +41% annualized! Also jewelry, footwear, car & truck rental, and infants/toddlers’ apparel.
Oddly, it looks like median cpi m/m will be BELOW core…my estimate is +0.22% m/m. That’s curious – it means the long tails are more on the upside for a change.
Now, we care about tails. If all the tails start to shift to the high side, that’s a sign that the basic process is changing.
One characteristic of disinflation and lowflation…how it happens…is that prices are mostly stable with occasional price cuts. If instead we go to mostly stable prices with occasional price hikes, that’s an inflationary process. WAY too early to say that’s what’s happening.
Appliances (0.2% of CPI, so no big effect) took another big drop. Now -2.08% y/y. Wonder if this is a correction from tariff stuff.
Gotta go get ready for air. Last thing I will leave you with is this: remember the Fed has said they are going to ignore inflation for a while, until it gets significantly high for a persistent period. We aren’t there yet. Nothing to worry about from the Fed.

Because I had to go to air (thanks @OJRenick and @TDAmeritrade for another fun time) I gave a little short shrift on this CPI report. So let me make up for that a little bit. First, here’s a chart of core goods. I was surprised at the -0.3% y/y change, but it actually looks like this isn’t too far off – maybe just a little early, based on core import prices (see chart). Still, there has been a lot of volatility in the supply chain, starting with tariffs and now with novel coronavirus, with a lot of focus on the growth effects but not so much on the price effects.

It does remain astonishing to me that we haven’t seen more of a price impact from the de-globalization trends. Maybe there is some kind of ‘anchored inflation expectations’ effect? To be sure, it’s a little early to have seen the effect from the virus because ships which left before the contagion got started are still showing up at ports of entry. But I have to think that even if tariffs didn’t encourage a shortening of supply chains, this will. It does take time to approve new suppliers. Still I thought we’d see this effect already.

Let’s look at the four pieces charts. As a reminder, this is just a shorthand quartering of the consumption basket into roughly equal parts. Food & Energy is 20.5%; Core Goods is 20.1%; Rent of Shelter is 32.8%; and Core services less rent of shelter is 26.6%. From least-stable to most:

We have discussed core goods. Core Services less RoS is one that I am keeping a careful eye on – this is where medical care services falls, and those indices have been turning higher. Seeing that move above 3% would be concerning. The bottom chart shows the very stable Rents component. And here the story is that we had expected that to start rolling over a little bit – not deflating, but even backing off to 3% would be a meaningful effect. That’s what our model was calling for (see chart). But our model has started to accelerate again, so there is a real chance we might have already seen the local lows for core CPI.

I am not making that big call…I’d expected to see the local highs in the first half of 2020, and that could still happen (although with easy comps with last year, it wouldn’t be much of a retreat until later in the year). I’m no longer sure that’s going to happen. One of the reasons is that housing is proving resilient. But another reason is that liquidity is really surging, so that even with money velocity dripping lower again it is going to be hard to see prices fall. M2 growth in the US is above 7% y/y, and M2 growth in the Eurozone is over 6%. Liquidity is at least partly fungible when you have global banks, so we can’t just ignore what other central banks are doing. Over the last decade, sometimes US M2 was rising and sometimes EZ M2 was rising, but the last time we saw US>7% and EZ>6% was September 2008-May 2009. Before that, it happened in 2001-2003. So central banks are providing liquidity as if they are in crisis mode. And we’re not even in crisis mode.

That is an out-of-expectation occurrence. In other words, I did not see it coming that central banks would start really stepping on the gas when global growth was slowing, but still distinctly positive. We have really defined “crisis” down, haven’t we? And this isn’t a response to the virus – this started long before people in China started getting sick.

So, while core CPI is currently off its highs, it will be over 2.5% by summertime. Core PCE will be running up on the Fed’s 2% target, too. If the Fed maintains its easy stance even then, we will know they are completely serious about letting ‘er rip. I can’t imagine bond yields can stay at 2% in that environment.

Categories: Bond Market, Causes of Inflation, China, CPI, ECB, Federal Reserve, Housing, Tweet Summary

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