Archive
Summary of My Post-CPI Tweets (February 2023)
Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy, but subscribers to @InflGuyPlus get the tweets in real time and a conference call wrapping it all up by about the time the stock market opens. Subscribe by going to the shop at https://inflationguy.blog/shop/ , where you can also subscribe to the Enduring Investments Quarterly Inflation Outlook. Sign up for email updates to my occasional articles here. Individual and institutional investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments! Check out the Inflation Guy podcast!
- Welcome to the #CPI #inflation walkup! To be sure, the importance of this data point in the short run is much less than it was a week ago, but it would be a mistake to lose sight of inflation now that the Fed is likely moving from QT to QE again.
- A reminder to subscribers of the tweet schedule: At 8:30ET, when the data drops, I will post a number of charts and numbers, in fairly rapid-fire succession. Then I will retweet some of those charts with comments attached. Then I’ll run some other charts.
- Afterwards (recently it’s been 9:30ish) I will have a private conference call for subscribers where I’ll quickly summarize the numbers.
- After my comments on the number, I will post a partial summary at https://inflationguy.blog and later will podcast a summary at inflationguy.podbean.com .
- I am also going to try and record the conference call for later. I think I’ve figured out how to do that. If I’m successful, I’ll tweet that later also.
- Thanks again for subscribing! And now for the walkup.
- This picture of the last month has changed quite a bit over the last few days! Suddenly, rates have reversed and the nominal curve is steepening. The inflation market readings are…of sketchy quality at the moment.
- Now, the swap market has also re-priced the inflation trough: instead of 2.65% in June (was in low 2s not long ago), the infl swap market now has y/y bottoming at 3.34% b/c of base effects before bouncing to 3.7% & then down to 3.15% by year-end. I think that’s pretty unlikely.
- Let’s remember that Median CPI reached a new high JUST LAST MONTH, contrary to expectations (including mine). The disturbing inflation trend is what had persuaded investors…until late last week…that the Fed might abruptly lurch back to a 50bp hike.
- These are real trends…so I’m not sure why economists are acting as if they are still certain that inflation is decelerating. The evidence that it is, so far at least, is sparse.
- Also, this month not only did the Manheim used car index rise again, but Black Book (historically a better fit although BLS has changed their sampling source so we’re not sure) also did. I have that adding 0.04%-0.05% to core.
- But maybe this is a good time to step back a bit, because of the diminished importance of this report (to be sure, if we get a clean 0.5%, it’s going to be very problematic for the Fed which means it should also be problematic for equity investors).
- Over the last few days we’ve read a lot about how banks are seeing deposits leave for higher-yielding opportunities. This is completely expected: as interest rates rise, the demand for real cash balances declines.
- You may have heard me say that before. But it’s really Friedman who said that first: velocity is the inverse of the demand for real cash balances. DEPOSITS LEAVING FOR HIGHER YIELDS IS EXACTLY WHAT HIGHER VELOCITY MEANS.
- And it is the reason for the very high correlation of velocity with interest rates.
- So the backdrop is this: money may be declining slightly but velocity is rebounding hard. Exactly as we should expect. Our model is shown here – it’s heavily influenced by interest rates (but not only interest rates).
- And if the Fed is going to move from its modest QT to QE, especially if they don’t ALSO slash rates back towards zero, then the inflationary impulse has little reason to fade.
- You know, I said back when the Fed started hiking that they would stop once the market forced them to. What has been amazing is that there were no accidents until now, so the market let them go for it. And in the long run this is good news – rates nearer neutral.
- But we have now had some bumps (and to be fair, I said no accidents until now but of course if the FDIC and Fed had been doing their job and monitoring duration gaps…this accident started many many months ago).
- With respect to how the Fed responds to this number: it is important to remember that the IMPACT ON INFLATION of an incremental 25bps or 50bps is almost zero. Especially in the short run. It might even be precisely zero.
- But the impact of 25bps or 50bps on attitudes, on deposit flight, and on liquidity hoarding could be severe, in the short run. On the other hand, if the Fed stands pat and does nothing but end QT, it might smack of panic.
- If I were at the Fed, I’d be deciding between 25bps and 0bps. And the only decent argument for 25bps is that it evinces a “business as usual” air. It won’t affect 2023 inflation at all (even using the Fed’s models which assume rates affect inflation).
- Here are the forecasts I have for the number – I tweeted this yesterday too. I’m a full 0.1% higher on core than the Street economists, market, and Kalshi. But I’m in-line on headline. So obviously as noted above I see the risks as higher.
- Market reactions? If we get my number or higher, it creates an obvious dilemma for the Fed and that means bad things for the market no matter how the Fed resolves that. Do they ignore inflation or ignore market stability?
- If we get lower than the economists’ expectation (on core), then it’s good news for the market because MAYBE it means the Fed isn’t in quite such a bad box and can do more to support liquidity (read: support the mo mo stock guys).
- So – maybe this report is important after all! Good luck today. I will be back live at 8:31ET.
- Well, headline was below core!
- Waiting for database to update but on a glance this doesn’t look good. Core was an upside surprise slightly and that was with used cars a DRAG.
- m/m CPI: 0.37% m/m Core CPI: 0.452%
- Last 12 core CPI figures
- So this to me looks like bad news. I don’t see the deceleration that everyone was looking for. We will look at some of the breakdown in a minute.
- M/M, Y/Y, and prior Y/Y for 8 major subgroups
- Standing out a couple of things: Apparel (small weight) jumps again…surprising. And Medical Care is back to a drag…some of that is insurance adjustment (-4.07% m/m, pretty normal) and some is Doctors Services (-0.52% m/m), while Pharma (0.14%) only a small add.
- Core Goods: 1.03% y/y Core Services: 7.26% y/y
- We start to see the problem here: any drag continues to be in core goods. Core goods does not have unlimited downside especially with the USD on the back foot. Core services…no sign of slowing.
- Primary Rents: 8.76% y/y OER: 8.01% y/y
- And rents…still accelerating y/y.
- Further: Primary Rents 0.76% M/M, 8.76% Y/Y (8.56% last) OER 0.7% M/M, 8.01% Y/Y (7.76% last) Lodging Away From Home 2.3% M/M, 6.7% Y/Y (7.7% last)
- Last month, OER and Primary Rents had slipped a bit and econs assumed that was the start of the deceleration. Maybe, but they re-accelerated a bit this month. Lodging away from home a decent m/m jump, but actually declined y/y so you can see that’s seasonal.
- Some ‘COVID’ Categories: Airfares 6.38% M/M (-2.15% Last) Lodging Away from Home 2.26% M/M (1.2% Last) Used Cars/Trucks -2.77% M/M (-1.94% Last) New Cars/Trucks 0.18% M/M (0.23% Last)
- FINALLY we see the rise in airfares that has been long overdue. I expected this to add 0.01% to core; it actually added 0.05%. Those who want to say this is a good number will screech “outlier!” but really it’s just catching up. The outlier is used cars.
- Both the Manheim and Black Book surveys clearly showed an increase in used car prices. But the BLS has recently changed methodologies on autos. Not clear what they’re using. Maybe it’s just timing and used will add back next month. We will see.
- Here is my early and automated guess at Median CPI for this month: 0.634%
- Now, the caveat to this chart is that I was off last month (the actual figure reported is shown), but that was January. I think I’ll be better on February. I have the median category as Food Away from Home. This chart is bad news for the deceleration crowd, and for the Fed.
- Piece 1: Food & Energy: 7.97% y/y
- OK, Food and Energy is decelerating, but both still contributed high rates of change. Energy will oscillate. It is uncomfortable that Food is still adding.
- Piece 2: Core Commodities: 1.03% y/y
- This is the reason headline was lower than expected. Core goods – in this case largely Used Cars, which I thought would add 0.05% and instead subtracted 0.09% from core. That’s a -14bps swing. +5bps from airfares, but health insurance was a drag…and we were still >consensus.
- Piece 3: Core Services less Rent of Shelter: 5.96% y/y
- …and this is the engine that NEEDS to be heading sharply lower if we’re going to get to 3.15% by end of year. It’s drooping, but not hard.
- Piece 4: Rent of Shelter: 8.18% y/y
- …and I already talked about this. No deceleration evident. As an aside, it’s not clear why we would see one with rising landlord costs, a shortage of housing, and robust wage gains, but…it’s an article of faith out there.
- Core inflation ex-shelter decelerated from 3.94% y/y to 3.74% y/y. That’s good news, although mainly it serves to amplify Used Cars…but look, even if you take out the big add from sticky shelter, we’re still not anywhere near target.
- Equity investors seem to love this figure. Be kind. They’re not thinking clearly these days. It’s a bad number that makes the Fed’s job really difficult.
- Note that Nick Timiraos didn’t signal anything yesterday…that means the Fed hasn’t decided yet. Which means they cared about this number. Which means to me that we’re likely getting 25bps, not 0bps. Now, maybe they just wanted to watch banking for another few days, but…
- …the inflation news isn’t good. As I said up top, 25bps doesn’t mean anything to inflation, but if they skip then it means we are back in QE and hold onto your hats because inflation is going to be a problem for a while.
- Even if they hike, they will probably arrest QT – and that was the only part of policy that was helping. Higher rates was just accelerating velocity. But I digress. Point is, this is a bad print for a Fed hoping for an all-clear hint.
- The only core categories with annualized monthly changes lower than -10% was Used Cars and Trucks (-29%). Core categories ABOVE +10% annualized monthly: Public Transport (+46%), Lodging AFH (+31%), Jewelry/Watches (+20%), Misc Personal Svcs (+17.7%), Footwear (+18%), >>>
- Women’s/Girls’ Apparel (+15%), Tobacco and Smoking Products (+13%), Recreation (+11%), Motor Vehicle Insurance (+11%), Infants’/Toddlers’ Apparel (+11%), and Misc Personal Goods (+10%). Although I also have South Urban OER at +10%, using my seasonality estimate.
- On the Medical Care piece, we really should keep in mind this steady drag from the crazy Health Insurance plug estimate for this year. It’ll almost certainly be an add next year. Imagine where we’d be on core if that was merely flat rather than in unprecedented deflation.
- Let’s go back to median for a bit. The m/m Median was 0.63% (my estimate), which is right in line with last month. The caveat is that the median category was Food Away from Home but that was surrounded by a couple of OER categories which are the ones I have to estimate. [Corrected from original tweet, which cited 0.55% as my median estimate]
- I can’t re-emphasize this enough. Inflation still hasn’t PEAKED, much less started to decline.
- One place we had seen some improvement was in narrowing BREADTH of inflation. Still broad, but narrower. However, this month it broadened again just a bit and the EIIDI ticked higher. Higher median, broader inflation…and that’s with Used Cars a strange drag.
- Stocks still don’t get it, but breakevens do. The 10y BEI is +7bps today. ESH3 is +49 points though!
- We’ll stop it there for now. Conference call will be at 9:30ET (10 minutes). (518) [redacted] Access Code [redacted]. I will be trying to record this one for playback for subscribers who can’t tune in then.
- The conference call recording seemed to go well. If you want to listen to it, you can call the playback number at (757) 841-1077, access code 736735. The recording is about 12 minutes long.
In retrospect, my forecast of 0.4% on seasonally-adjusted headline and 0.5% on core looks pretty good…but that’s only because we got significant downward one-offs, notably from Used Cars. If Used Cars had come in where I was expecting (+1.4%) instead of where it actually came in (-2.8%), and the rest of the report had been the same, then core inflation would have been 0.6% and we would be having a very different discussion right now.
As it is, this is not the number that the Fed needed. Inflation has not yet peaked, and that’s with Health Insurance providing a 4-5bps drag every month. That’s with Used Cars showing a drag instead of the contribution I expected. The “transitory” folks will be pointing to rents and saying that it seems ridiculous, and ‘clearly must decline,’ but that’s not as clear to me. Landlords are facing increased costs for maintenance, financing, energy, taxes; there is a shortage of housing so there is a line of tenants waiting to rent, and wage growth remains robust so these tenants can pay. Why should rents decelerate or even (as some people have been declaring) decline?
Apparel was also a surprising add. Its weight is low but the strength is surprising. A chart of the apparel index is below. Clothing prices now are higher than they’ve been since 2000. The USA imports almost all of its apparel. This is a picture of the effect of deglobalization, perhaps.
So all of this isn’t what the Fed wanted to see. A nice, soft inflation report would have allowed the Fed to gracefully turn to supporting markets and banks, and put the inflation fight on hold at least temporarily. But the water is still boiling and the pot needs to be attended. I think it would be difficult for the Fed to eschew any rate hike at all, given this context. However, I do believe they’ll stop QT – selling bonds will only make the mark-to-market of bank securities holdings worse.
But in the bigger picture, the FOMC at some point needs to address the question of why nearly 500bps of rate hikes have had no measurable effect on inflation. Are the lags just much longer than they thought, and longer than in the past? That seems a difficult argument. But it may be more palatable to them than considering whether increasing interest rates by fiat while maintaining huge quantities of excess reserves is a strategy that – as monetarists would say and have been saying – should not have a significant effect on inflation. The Fed models of monetary policy transmission have been terribly inaccurate. The right thing to do is to go back to first principles and ask whether the models are wrong, especially since there is a cogent alternative theory that could be considered.
Back when I wrote What’s Wrong With Money?, my prescription for unwinding the extraordinary largesse of the global financial crisis – never mind the orders-of-magnitude larger QE of COVID policy response – was exactly the opposite. I said the Fed should decrease the money supply, while holding interest rates down (since, if interest rates rise, velocity should be expected to rise as well and this will exacerbate the problem in the short-term). The Fed has done the opposite, and seem so far to be getting the exact opposite result than they want.
Just sayin’.
The Powell of Positive Thinking
Yes: Federal Reserve Chairman Powell was very hawkish at his Congressional testimony on Tuesday and Wednesday. He clearly signaled (again) that once Fed overnight policy rates reach a peak, they would not be declining for a while. He additionally signaled that the peak probably will be higher than previously signaled (I’ve been saying and thinking 5% for a while, but it’s going to be higher), and even signaled the increasing likelihood of a return to 50bp hikes after the recent deceleration to 25bps.
This latter point, in my view, is the least likely since all of the reasons for the step down to 25bps remain valid: whether the peak is 5% or 6%, it is relatively nearby and the confidence that we should have that rates have not risen enough should therefore be decreasing rapidly. Moreover, since monetary policy works with a lag and there has been very little lag since the aggressive tightening campaign began, it would be reasonable to slow down or stop to assess the effect that prior hikes have had.
But here is the bigger point, and one that Powell did not broach. There is really not much evidence at all that the Fed’s hikes to date have affected inflation. It is completely an article of faith that they surely will, but this is not the same as saying that they have. Consider for a moment: in what way could we plausibly argue that rate hikes so far have been responsible for the decline in inflation? The decline in inflation has been entirely from the goods sector, and a good portion of that has been from used cars returning to a normal level (meaning, in line with the growth in money) after having overshot. How exactly has monetary policy driven down the prices of goods?
This is not to say that higher interest rates have not affected economic activity, and this (to me) is the real surprise: given the amount of leverage extant in the corporate world, it amazes me that we haven’t seen a more-serious retrenchment. Some of this is pent-up demand that still needs to be satisfied, for example in housing where significant rate hikes would normally dampen housing demand substantially and seems to have. However, there is a severe shortage of housing in the country and so construction continues (and home prices, while they have fallen slightly, show no signs of the collapse that so many have forecast). Higher rates are also rippling through the commercial MBS market, as many commercial landlords have inexplicably financed their projects with floating rate debt and where the cost of leverage can make or break the project.
Higher interest rates, on the other hand, tend to support residential rents, at least until unemployment eventually rises appreciably. I think perhaps that not many economists are landlords, but higher costs tend to not result in a desire to charge lower rents. On the commercial side, leases are for longer and turnover is more costly, but the average residential landlord these days is not facing a shortage of demand.
So where have rate hikes caused inflation to decline? Judging from the fact that Median CPI just set a new high, I think the answer is pretty plain: they haven’t. And yet, the Fed believes that if they keep hiking, inflation will fall into place. Where else can we more plainly see at work the maxim that “if a piece doesn’t fit, you’re not using a big enough hammer?” Or maybe, this is just a reflection of the notion that if you want something bad enough, the wanting itself will cause the thing to happen. [N.B. this is really more in line with the prescription from Napoleon Hill’s classic book “Think and Grow Rich”, but the title of Peale’s equally-classic “The Power of Positive Thinking” suggested a catchier title for this article. Consider it poetic license.]
Moreover, what we have seen is that higher interest rates have had the predicted effect on money velocity. Although I have elsewhere noted that part of the rebound in money velocity so far is due to the ‘spring force’ effect, there is substantial evidence that one of the main drivers of money velocity is the interest rate earned on non-cash balances. Enough so, in fact, that I wrote about the connection in June 2022 in a piece entitled “The Coming Rise in Money Velocity,” before the recent surge in velocity began. [I’d also call your attention to a recently-published article by Samuel Reynard of the Swiss National Bank, “Central bank balance sheet, money, and inflation,” where he incorporates money velocity into his adjusted money supply growth figure. Reynard is one of the last monetarists extant in central banking circles.]
Now, nothing that I have just written is going to deter Powell & Co from continuing to hike rates until demand is finally crushed and, according to their faith but in the absence of evidence to date, inflation will decelerate back to where they want it. But with long-term inflation breakevens priced at levels mirroring that faith, it is worth questioning whether there is some value in being apostate.
The Coming Rise in Money Velocity
As M2 money growth soared throughout the COVID and post-COVID period of direct stimulus check-writing funded by massive quantitative easing (QE), monetarism novices thought that this would not result in inflation because money velocity simultaneously collapsed. Consequently, they argued, M*V was not growing at an outrageous rate.
There was precedence for such optimism. In the Global Financial Crisis of 2008-09, money supply grew rapidly with the onset of QE and money velocity declined, never to recover. The chart below shows in a normalized fashion the rise in M, the decline in V, and the relative quiescence of MV/Q, which is of course P by definition as long as you choose your Ms, Vs, and Qs right.
A similar thing happened in this episode, so why would this be any different?
There are many reasons why these episodes are different. To name a few:
- The absolute scale of the rise in M2 was 2.5x the rise in 2007-2010, and that’s being generous since that measures the growth in 2007-2010 starting almost 2 years before the first QE in November 2008 compared to only 15 months in the second case.
- As I’ve written previously, QE in the first case was directed at banks; at the same time that the Federal Reserve was adding reserves it was also paying banks interest on reserves – because the point was to strengthen banks, not consumers.
- 5y interest rates came into 2008 at 3.44%; they came into 2020 at 1.69%. Since velocity is most highly correlated to interest rates, there was less room for this factor to be a lasting downward influence on velocity (after the crisis began in 2008, 5y Treasury rates never exceeded 3% again except for a few days in 2018).
- Bank credit growth never stopped in the 2020 crisis, while it contracted at a 5% rate in the 2008 crisis (see chart, source Board of Governors of the Fed).
The monetarist novices (you can tell they’re novices because they say things like “Friedman said velocity was constant,” which is false, or “velocity is just a plug number [true] and has no independent meaning of its own [false]”) insisted that velocity was in a permanently declining state and that there was no reason at all to expect it to ever “bounce.” After all, it bounced only slightly after the GFC; why should it do so now?
But after 2008, as I noted, interest rates bounced only briefly before declining again…with the added phenomenon that some global debt came to bear negative yields, calling into fair question whether there was in fact any natural “bottom” to velocity if interest rates are the main driver! And velocity, obediently, dripped lower as well.
There is at least one other big driver to money velocity, although it is rarely important and almost never for very long. And that is economic uncertainty, which creates a demand to carry excess cash balances (implying lower money velocity). A model driven (mainly) by rates and a measure of uncertainty has done a pretty good job at explaining velocity over time (see chart, source Enduring Investments), including explaining the collapse in velocity during the COVID crisis out-of-sample.
Now, explaining velocity is a helluva lot easier than predicting it, because it isn’t easy to predict interest rates. Nor is it easy to predict the precautionary demand for money – but at least we can count on that being somewhat mean-reverting. The latest point from the model shown above uses current data, and suggests (largely because of the rise in interest rates, but also because precautionary balances are declining) that money velocity should bounce. Not that the model predicts it will happen this week, but it should not be surprising when it does.
A rise in velocity would be a really bad thing, because the money supply is very unlikely to decline very far especially while bank credit growth continues to grow. The only reason we have been able to sustain 6% or 8% money growth for a very long time has been because we could count on velocity to keep declining with interest rates. If money growth ticks up at, say, a mere 6% while money velocity rises 5%, then nominal GDP is going to rise 11%…and most of that will be in prices.
Now, this is a very slow-moving story. I mention it now for one specific reason, and that is that we are almost certain to see a rise in velocity in Q2 when the GDP figures come out in late July. That’s because money growth for the quarter has been very slow so far. So far, the Q2 average M2 is 0.06% higher than the Q1 average. My best wild guess is that we will end up with an 0.5% annualized q/q growth rate. The Atlanta Fed GDPNow model estimates 0.25% GDP growth in Q2 (the Blue Chip Consensus is still at 3%). And if the inflation market is right, Q/Q inflation in Q2 will be about 11.7%. That’s CPI, so let’s be generous and say 9%. We don’t know all of these numbers, but we know 2/3 of all of them. Let’s use the Blue Chip consensus for GDP and assume M2 doesn’t spike next month and the price level doesn’t collapse. Then:
If that happened, the increase would be the largest quarterly jump in money velocity – absent the reactionary bounce in 2020Q3 after the 20% plunge in 2020Q2 – since 1981. And here’s the rub: because of the mathematics of declines and recoveries, that would still leave us with velocity that prior to 2020 would have been an all-time record low.
Does this matter? Not if you believe the monetarism dabblers, who will say this is a mechanical adjustment that will soon be reversed as velocity continues its long slide to oblivion. Nor will it matter to the Fed, who at best will take executive notice of the fact before ignoring it since they aren’t monetarists any longer. But for those who think that inflation comes from too much money chasing too few goods? It’s scary.
