E-piphany

Summary of My Post-CPI Tweets (February 2023)

March 14, 2023 Michael Ashton 1 comment

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy, but subscribers to @InflGuyPlus get the tweets in real time and a conference call wrapping it all up by about the time the stock market opens. Subscribe by going to the shop at https://inflationguy.blog/shop/ , where you can also subscribe to the Enduring Investments Quarterly Inflation Outlook. Sign up for email updates to my occasional articles here. Individual and institutional investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments! Check out the Inflation Guy podcast!

Welcome to the #CPI #inflation walkup! To be sure, the importance of this data point in the short run is much less than it was a week ago, but it would be a mistake to lose sight of inflation now that the Fed is likely moving from QT to QE again.
A reminder to subscribers of the tweet schedule: At 8:30ET, when the data drops, I will post a number of charts and numbers, in fairly rapid-fire succession. Then I will retweet some of those charts with comments attached. Then I’ll run some other charts.
Afterwards (recently it’s been 9:30ish) I will have a private conference call for subscribers where I’ll quickly summarize the numbers.
After my comments on the number, I will post a partial summary at https://inflationguy.blog and later will podcast a summary at inflationguy.podbean.com .
I am also going to try and record the conference call for later. I think I’ve figured out how to do that. If I’m successful, I’ll tweet that later also.
Thanks again for subscribing! And now for the walkup.
This picture of the last month has changed quite a bit over the last few days! Suddenly, rates have reversed and the nominal curve is steepening. The inflation market readings are…of sketchy quality at the moment.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Just sayin’.

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

The Powell of Positive Thinking

March 8, 2023 Michael Ashton 7 comments

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

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

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

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

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

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

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

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

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

Is Inflation Mean-Reverting?

February 28, 2023 Michael Ashton 2 comments

Over the last couple of decades, the assumption that inflation is mean-reverting to something approximating the Fed’s target level (or to where inflation expectations are supposedly – without any evidence advanced to support the notion – ‘anchored’) has become a key component of most economists’ models. I’ve pointed out a number of times in podcasts (including my own Inflation Guy Podcast as well as numerous others) and in articles that after a quarter-century of having low and stable inflation any model which did not assume mean-reversion has been discarded because it made bad predictions over that period compared to one which did.

A critical follow-up question is whether a model should assume mean reversion in inflation. My observation implicitly says that it should not. If I’m wrong, and inflation in fact is mean-reverting, then the right models won and there’s no real problem.

So, did the right models win?

There are many sophisticated ways to test for mean reversion, but an intuitive one is this: for a given current level of inflation, which is a better guess: (a) inflation will be closer to the ‘mean’ in the next period; (b) inflation will be about the same distance from the mean (homeostasis), neither pulling towards the mean nor pushing away from the mean; or (c) inflation will be further away from the mean, such that deviations from mean get amplified over time. In case (b) we would say that inflation itself has momentum; in case (c) we would say the acceleration of inflation has momentum. The latter case seems an unlikely case of extreme instability: it says that once prices move away from equilibrium, the economy either enters into an inflationary spiral or a deflationary spiral with no clear end. While this clearly can eventually happen in the hyperinflation case, those cases seem to have other causes that tend to amplify the swings (notably, an accelerating loss of faith in the currency itself).

Let’s consider case (a) and (b), and look at some historical data.

The chart below shows the period 1957-2022. The x-axis indicates the current level of inflation, (I collapse the range from -0.5% to +0.5% and call it 0%, +0.5% to +1.5% and call it 1%, etc), and the y-axis shows the average inflation over the subsequent one year. So, the point that is at [2%, 2.3%] shows that between 1957 and 2022, if inflation was between 1.5% and 2.5% then the average inflation over the ensuing 12 months was 2.3%.

I’ve drawn a line that indicates inflation at the same level at the point of observation and subsequently (x=y). Notice that for any number below x=2%, y tends towards 2%. This shows that when the current reading is very low inflation or deflation, the subsequent year we tend to get something close to 2%. Notice that at higher rates of inflation, the dots are below the line – meaning that if inflation is high, the following year tends to see inflation closer to the target. So, this is what we would think mean reversion would look like (and FWIW, it is more pronounced if you choose a longer historical period but because the next chart I am showing is core CPI and we only have data to 1957, I wanted to use the same range).

Case closed! Inflation mean reverts!

Well, not exactly. This is headline inflation. We already know that food and energy tend to mean-revert; that is, after all, why economists exclude food and energy – because we know that high energy readings lead to high inflation prints, and we don’t want monetary policy to overreact to inflation that isn’t really persistent. So, let’s look at core instead.

This chart looks different in key aspects. Except for very high core readings (with comparatively few observations that happen to coincide with when Volcker was aggressively tightening policy), the best estimate for core inflation over the next 12 months is not something closer to the assumed mean; the best estimate is the same level as what we have right now.

What that means – and it is super important – is that inflation has momentum. Keep in mind that during most of the period shown here, the Federal Reserve was actively trying to make inflation mean-revert. And they didn’t succeed, at least on a one-year basis.

Well, monetary policy works with long and variable lags, right? How about core inflation over the period 12-24 months from now? Surely then we should see some mean reversion?

The answer, at least for core inflation, is decidedly no…except for very high current readings of inflation.

Two takeaways:

Inflation has momentum. This means that forecasting core inflation to return to the target level, just because we think it should, is a bad forecasting approach.
Monetary policy seems to have had, at least over this period, very little effect. Generously, it didn’t have effect on average…so perhaps sometimes the Fed overshot and other times it didn’t do enough. There is indeed a range. For example: starting from 5% y/y core inflation (between 4.5% and 5.5%), the 10^th percentile of the 1y CPI outcomes after that was 3.5% and the 90^th percentile was 6.0%. Starting from 7%, the 10^th percentile was 3.1% and the 90^th was 9.6%. So the average includes some times when inflation kept going up and some times when it was going back down.

The corollary to the second takeaway…call it takeaway 2a…is this: by the same token, there’s not a lot of reason for the Fed to be super aggressive raising rates to rein in inflation. We know that they can do harm. It’s less clear that they can do a whole lot of good!

Categories: CPI, Economics Tags: core cpi, core inflation, economy, Fed, inflation

Airline Loyalty Miles Have Become Money, not Tokens

February 22, 2023 Michael Ashton 1 comment

I noticed something recently about the many, many airline loyalty miles that my family has accumulated over the years.

Loyalty miles began as a way for airlines to induce brand loyalty in a market that was very fractured post-deregulation (the U.S. airline industry was deregulated in 1978; the American Airlines and United Airlines loyalty programs were created in 1981…although Texas International Airlines is credited with creating the first loyalty program in 1979). In the Old Days, miles worked something like the punch card at the ice cream store, but instead of getting a free scoop of ice cream after ten purchases, it was a free trip after so many segments flown. Because airlines get compensated basically by the number of passenger-miles they create, the loyalty programs were tied to how many miles you flew. Fly more miles, get more miles. But the redemption was fixed: originally, 20,000 miles got you one round-trip domestic coach ticket anywhere the airline flew.

When you get your free scoop of ice cream, it isn’t the scooper’s decision what flavor you get. It’s yours. With ice cream, that’s no big deal; one flavor costs the ice cream parlor about the same amount to deliver to you as another. But with airlines, the problem is somewhat bigger.

Quantitative aside: experienced rates traders may see an echo of the bond-contract structure where it is the seller of the contract who gets to decide which bond to deliver. This optionality is worth something to the seller, and costs something to the buyer, so the bond contract trades at a lower price than it would if there were no delivery options. In this case, it is the buyer who gets to choose what product the seller must deliver (with limitations, of course). So it is very clear that loyalty programs, at least in the traditional structure where the price of the benefit was fixed at 20k or 25k miles, were very valuable to the customer. So did the customer pay more for a fare than he/she otherwise would, to get miles? We may never know.

When the award was “any flight [other than some blackout dates]” and the cost was “20,000 miles”, the strategy was fairly clear. You wanted to wait until you had to buy a high-priced ticket, and buy that ticket with miles instead. In fact, spending the miles on a $400 ticket had a potential opportunity cost because then you wouldn’t be able to spend them on a subsequent ticket that cost $500. So the strategy was to wait, because the option had value. Moreover, inflation worked in your favor as tickets over time rose. There was no realize cost of carry to penalize not spending the miles…so the strategy was to wait. Your loyalty miles were an inflation-linked bond, whose value was linked to airline fares. Actually, an option on an inflation-linked bond…but I digress.

This has changed.

A few years ago, airlines started varying the amount of miles needed to book certain tickets. Tickets on high-load-factor flights started to cost more. In a way, this was not terrible because it meant that some tickets were available at a higher cost, that previously would have been blacked out. So your 25,000-mile award wouldn’t buy the ticket, but you could get it for 50,000. This was successful, and over time what happened is that ever-finer gradations of mile-award-amounts-needed began to show up.

I took an hour this morning and went on United’s website. I priced economy, non-stop, round-trip tickets for EWR-LAX, EWR-ORD, EWR-DFW, EWR-IAD, EWR-BOS, and MIA-SEA(one stop as there were no directs), for March 24-March 26. I collected the price for each departure time. Then I collected the mileage required to buy the ticket in lieu of cash. The chart of this little experiment is below. The x-axis is the miles needed; the y-axis is the dollar cost, and each dot represents one fare pair.

You may notice that the blue dots are arranged in a surprisingly linear way, at least until 32,500 where it seems there is a cap of sorts. In fact, a linear regression line run through the points produces an r-squared of 0.88, and you can get it to 0.95 or so if you use an exponential curve. But the linear line is instructive because the slope of the line indicates that one airline mile on United is worth almost exactly 2.5 cents. As an aside, I didn’t check other loyalty programs but I would be surprised if the slope of American’s line or Delta’s line was meaningfully different.

The red line is where the old 25,000 award would be. If that was still the cost of a ticket, a buyer would not waste it on the tickets to the left of the line and would only use it on those to the right of the line.[1]

So, let’s call a spade a spade: one airline mile on United is 2.5 cents. When airfares go up, your pile of miles becomes less valuable in real terms. Loyalty miles are now indistinguishable from money, in the air travel marketplace.

Here’s the interesting part. Because loyalty miles are now money, the strategy that you the customer should take completely changes. Before, your best strategy was to wait, allow miles to accumulate, and only use them when prices spiked. Now, because miles are money, your best strategy is to spend them as quickly as you can. They don’t earn interest, so they are a wasting asset in real space. It doesn’t matter if you buy one $800 ticket for 32,000 miles, or two $400 tickets for 16,000 miles each. The value is exactly the same.[2] Ergo, they’re money. Not only that, they’re money that can only be spent on airline tickets, and they have a credit component because if the company goes out of business *poof* there go your miles.

Actually, they can be spent on other things, but the optimal way to spend them is probably on airline tickets. I looked at how many miles I would have to exchange to rent various car sizes from Avis in Newark, for two days starting March 24. I added these dots to the chart below.

So the final moral to this story is: don’t rent cars with airline miles!

[1] Class exam question: draw the consumer surplus that the airline reclaimed by changing the pricing structure.

[2] A small caveat to this would be if the current apparent cap at 32,500 for a coach economy class ticket is fixed, because over time more and more tickets would be pricey enough to be capped. However, I think it is unlikely airlines will hold a cap in that way.

Categories: Uncategorized Tags: airfares, loyalty miles, Money

Summary of My Post-CPI Tweets (January 2023)

February 14, 2023 Michael Ashton 2 comments

We get the first CPI of 2023 this morning! A fair number of things are changing, but I don’t think the net result is going to be all that large.
A reminder to subscribers of the path here: At 8:30ET, when the data drops, I’ll be pulling that in and will post a number of charts and numbers, in fairly rapid-fire succession. Then I will retweet some of those charts with comments attached. Then I’ll run some other charts.
Afterwards (recently it’s been 9:30ish) I will have a private conference call for subscribers where I’ll quickly summarize the numbers.
After my comments on the number, I will post a partial summary at https://inflationguy.blog and later will podcast a summary at inflationguy.podbean.com .
Thanks again for subscribing! And now for the walkup.
First, let’s look at what the market has done over the last month. The front of the curve has gone from incorporating disinflation down to 2%, to disinflation down to 2.65%. Nominal and real yields are both higher as well.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

I mean…this is improving? But not crashing.

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

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

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

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

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

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

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

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

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

We Are All Bond Traders Now

February 6, 2023 Michael Ashton 3 comments

When I started working in the financial markets, bond traders were the cool kids. The equity guys drove Maseratis and acted like buffoons, but the bond guys drove sensible style like Mercedes and cared about things like deficits and credit. The authoritative word on this subject came from the book Liar’s Poker by Michael Lewis, about 1980s Salomon Brothers, where the trainees dreaded being assigned to do Equities in Dallas.

Back then, equities guys worried about earnings, the quality of management and the balance sheet, and the really boring ones worried about a margin of safety and investing at the right price. That seems Victorian now, but I guess so does the idea that sober institutions should only own bonds.

Down the list of concerns, but still on it, were interest rates. Ol’ Marty Zweig used to have a commercial in which he said “if you can spot meaningful changes (not just zig-zags) in interest rates and momentum, you’ll be mostly in stocks during major advances and out during major declines.” The reason that interest rates matter at all to a stock jockey is that the present value of any series of cash flows, such as dividends, depends on the interest rate used to discount those cash flows.

In general, if the discount curve (yield curve) is flat, then the present value of a series of cash flows is the sum of the present values of each cash flow:

…where r is the interest rate.

As a special case, if all of the cash flows are equal and go on forever, then we have a perpetuity where PV = CF/r. Note also that if all of the cash flows have the same real value and are only adjusted for inflation, and the denominator is a real interest rate, then you get the same answer to the perpetuity problem.[1]

I should say right now that the point of this article is not to go into the derivation of the Gordon Growth Model, or argue about how you should price something where the growth rate is above the discount rate, or how you treat negative rates in a way that doesn’t make one’s head explode. The point of this article is merely to demonstrate how the sensitivity of that present value to the numerator and the denominator changes when interest rates change.

The sensitivity to the numerator is easy. PV is linear with respect to CF. That is, if the cash flow increases $1 per period, then the present value of the whole series increases the same amount regardless of whether we are increasing from $2 to $3 or $200 to $201. In the table below, the left two columns represent the value of a $5 perpetuity versus a $6 perpetuity at various interest rates; the right two columns represents the value of a $101 perpetuity versus a $102 perpetuity. You can see that in each case, the value of the perpetuity increases the same amount going left to right in the green columns as it does going left to right in the blue columns. For example, if the interest rate is 5%, then an increase in $1 increases the total value by $20 whether it’s from $5 to $6 or $100 to $101.

However, the effect of the same-sized movement in the denominator is very different. We call this sensitivity to interest rates duration, and in one of its forms that sensitivity is defined as the change in the price for a 1% change in the yield.[2] Moving from 1% to 2% cuts the value of the annuity (in every case) by 50%, but moving from 4% to 5% cuts the value by only 20%.

What this means is that if interest rates are low, you care a great deal about the interest rate. Any change to your numerator is easily wiped out by a small change in the interest rate you are discounting at. But when interest rates are higher, this is less important and you can focus more on the numerator. Of course, in this case we are assuming the numerator does not change, but suppose it does? The importance of a change in the numerator depends not on the numerator, but on the denominator. And for a given numerator, any change in the denominator gets more important at low rates.

So, where am I going with this?

Let’s think about the stock market. For many years now, the stock market has acted as if what the Fed does is far more important than what the businesses themselves do. And you know what? Investors were probably being rational by doing so. At low interest rates, the change in the discount rate was far more important – especially for companies that don’t pay dividends, so they’re valued on some future harvest far in the future – than changes in company fortunes.

However, as interest rates rise this becomes less true. As interest rates rise, investors should start to care more and more about company developments. I don’t know that there is any magic about the 5% crossover that I have in that chart (the y-axis, by the way, is logarithmic because otherwise the orange line gets vertical as we get to the left edge!). But it suggests to me that stock-picking when interest rates are low is probably pointless, while stock-picking when interest rates are higher is probably fairly valuable. What does an earnings miss mean when interest rates are at zero? Much less than missing on the Fed call. But at 5%, the earnings miss is a big deal.

Perhaps this article, then, is mistitled. It isn’t that we are all bond traders now. It’s that, until recently, we all were bond traders…but this is less and less true.

And it is more and more true that forecasts of weak earnings growth for this year and next – are much more important than the same forecasts would have been, two years ago.

But the bond traders are still the cool kids.

[1] I should also note that r > 0, which is something we never had to say in the past. In nominal space, anyway, it would be an absurdity to have a perpetually negative interest rate, implying that future cash flows are worth more and more…and the perpetuity has infinite value.

[2] Purists will note that the duration at 2% is neither the change in value from 1% to 2% nor from 2% to 3%, but rather the instantaneous change at 2%, scaled by 100bps. But again, I’m not trying to get to fine bond math here and just trying to make a bigger point.

Categories: Bond Market, Investing, Stock Market, Theory

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

January 31, 2023 Michael Ashton 6 comments

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The Quintillion-Dollar Coin

January 25, 2023 Michael Ashton 3 comments

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

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

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

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

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

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

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

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

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

The Monetary Policy Revolution in Three Charts

January 18, 2023 Michael Ashton Leave a comment

Over the last few years, I’ve pointed out exhaustively how the current operating approach at the Fed towards monetary policy is distinctly different from past tightening cycles. In fact, it is basically a humongous experiment, and if the Fed succeeds in bringing inflation gently back down to target it will be either a monumental accomplishment or, more likely, monumentally lucky. My goal in this blog post is to explain the difference, and illustrate the challenge, in just a few straightforward charts. There are doubtless other people who have a far more complex way of illustrating this, but these charts capture the essence of the dynamic.

Let me start first with the basic ‘free market’ interest rate chart. Here, I am showing the quantity of bank lending on the x-axis, and the ‘price’ of the loan – the interest rate – on the y-axis. If we assume for the moment that inflation is stable (don’t worry, the fact that it isn’t will come into play later) then whether the y-axis is in nominal or real terms is irrelevant. So we have a basic supply and demand chart. Demand for loans slopes downward: as the interest rate declines, borrowers want to borrow more. The supply curve slopes upward: banks want to lend more money as the interest rate increases.

An important realization here is that the supply curve at some point turns vertical. There is some quantity of loans, more than which banks cannot lend. There are two main limits on the quantity of bank lending: the quantity of reserves, since a bank needs to hold reserves against its lending, and the amount of capital. These are both particular to a bank and to the banking sector as a whole, especially reserves because they are easily traded. Anyway, once aggregate lending is high enough that there are no more reserves available for a bank to acquire to support the lending, then the bank (and banks in aggregate) cannot lend any more at any interest rate – at least, in principle, and ignoring the non-bank lenders / loan sharks. We’re talking about the Fed’s actions here and the Fed does not directly control the leverage available to loan sharks.

Now, traditionally when the Fed tightened policy, it did so by reducing the aggregate quantity of reserves in the system. This had the effect of making the supply curve go vertical further to the left than it had. In this chart, the tightening shows as a movement from S to S’. Note that the equilibrium point involves fewer total loans (we moved left on the x axis), which is the intent of the policy: reduce the supply of money (or, in the dynamic case, its growth) by restraining reserves. Purely as a byproduct, and not very important at that, the interest rate rises. How much it rises depends on the shape of the demand curve – how elastic demand for loans is.

As an aside, we are assuming here that the secondary constraint – bank capital – is not binding. That is, if reserves were plentiful, the S curve would go vertical much farther to the right. In the Global Financial Crisis, that is part of what happened and was the reason that vastly increase reserves did not lead to massive inflation, nor to a powerful recovery: banks were capital-constrained, so that the Fed’s addition of more reserves did not help. Banks were lending all that they could, given their capital.

Manipulating the aggregate quantity of reserves was the way the Fed used to conduct monetary policy. No longer. Now, the Fed merely moves interest rates. Let’s see what effect that would have. Let’s assume for now that the interest rate is a hard floor, and that banks cannot lend at less than the floor rate. This isn’t true, but for ease of illustration. If the Fed institutes a higher floor on interest rates then what happens to the quantity of loans?

This looks like we have achieved the same result, more simply! We merely define the quantity of loans we want, pick the interest rate that will generate the demand for those loans, and voila, we can add as many reserves as we want and still get the loan production we need. The arrows in this third chart show the same movements as the arrows in the prior chart. The quantity of loans is really determined entirely by the demand curve – at the prescribed interest rate, there is a demand for “X” loans, and since banks are not reserve-constrained they are able to supply those loans.

However, it’s really important to notice a few things. The prior statement is true if and only if we know what the demand curve looks like, and if the floor is enforced. Then, a given interest rate maps perfectly into Q. But:

D is not known with precision. And it moves. What is more, it moves for reasons that have nothing to do with interest rates: for example, general expectations about business opportunities or the availability of work.
Moreover, D is really mapped against real rates, while the Fed is setting nominal rates. So, for a given level of a nominal floor, in real space it bucks up and down based on the expected inflation rate.
Also, the floor is not a hard floor. At any given interest rate where the floor would be binding, the desire of banks to lend (the location of the S curve) exceeds the demand for loans (by the amount of the ?? segment in the chart above). The short-term interest rate still affects the cost to banks of that lending, but we would still expect competition among lenders. This should manifest in more aggressive lending practices – tighter credit spreads, for example, or non-rate competition such as looser documentary requirements.

In the second chart I showed, the Fed directly controlled the quantity of reserves and therefore loans. So these little problems didn’t manifest.

Now, there is one advantage to setting interest rates rather than setting the available quantity of reserves as a way of reducing lending activity. Only the banking sector is reserve-constrained. If there is an adequate non-bank lending network, then the setting of interest rates to control the demand for loans will affect the non-bank lenders as well while reserve constraint would not. So this is somewhat “fairer” for banks. But this only means that non-bank lenders will also be competing to fill the reduced demand for loans, and the non-bank lending sector is less-vigorously regulated than the banking sector. More-aggressive lending practices from unregulated lenders is not, it seems to me, something we should be encouraging but what do I know? The banks aren’t lobbying me to help level the playing field against the unregulated.

Hopefully this helps illuminate what I have been saying. I think the final chart above would be a lovely final exam question for an economics class, but a bad way to run a central bank. Reality is not so easily charted.

Categories: Bond Market, Federal Reserve, Theory Tags: loans, monetary policy, Money

Summary of My Post-CPI Tweets (December 2022)

January 12, 2023 Michael Ashton 1 comment

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

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

Where would those surprises come from? Wage growth is strong, and that pushes up on prices in hospitality, domestic manufacturing, food away from home, and even shelter.

I also don’t think that airfares will be the drag that’s implied by jet fuel. Here’s the regression that would make you think they WOULD.

But here’s the one that makes you think maybe not. Airlines tend to push prices higher when there are spikes in jet fuel costs, but they don’t necessarily lower them very fast when jet fuel prices decline. And did I mention wage pressures? Airlines feel them.

I do think that used car prices will drag again, although the CPI has been falling a little faster than the Black Book and Mannheim indices would suggest they should. But I don’t see a strong argument for New Car prices to decline.
New Cars are in black in this chart, while Used are in blue. New car prices are up 20%, while used are up 40%, since the end of 2019. And the money supply is up around 40%. That doesn’t mean new car prices won’t decline, but it doesn’t look like a slam dunk to me.

Finally, a point I’ve been making recently on a longer-term horizon viewpoint. Markets are fully priced for inflation to totally and almost immediately mean-revert. Large declines in breakevens, especially short BEI. Some of that is the gasoline slide. Not all of it.

The short end of the inflation swap curve has NSA inflation at -0.38% m/m in December, +0.37% in Jan, +0.33% in Feb, and 0.30% in March. And that’s the last 0.3% print we see. According to inflation swaps, y/y inflation will be at 2% in June.
Even if I am wrong about inflation staying around 4-5%, you have a 2% cushion to bet that way. (I think I used an unfortunate analogy a few days ago saying that if you give me 21 points I’ll take TCU over Georgia, but you get my point.)
Ergo, for choice I’d be long breakevens going into this number.
The response in the stock market will be interesting. If the number is as-expected or better, I would think stocks will try and scream higher on the theory that the Fed can back off. The problem is that folks are already long for that, I sense.
So I’d probably sell that pop, especially because earnings may be a hurdle in the near future, though you have to be cognizant of the 200-day moving average in the S&P. The mo-mo crowd will try to get some prints above that so I’d be cautious.
What about on a strong CPI? Few seem to be thinking/talking of that, which means to me that folks are a little naked there. Do I think it would change the Fed trajectory? Not from what the Fed is SAYING they’re doing, but from what the market is pricing – yes.
As I said, this is the interesting part of the inflation cycle. Buckle up.
At 8:30ET, I’ll be pulling the data in & will post charts and #s – then retweet some of those charts w/ comments plus other charts. Around 9:30ish, I will have a private conference call for subscribers where I’ll quickly summarize the numbers.
Pre-release, both stocks and bonds are loving this number! May be that some are reading into the fact Biden has a speech this morn including inflation as a topic, and perhaps he wouldn’t if the number was bad. But even if it is, he can focus on y/y so not sure that means much…
That’s all for now. Good luck!

m/m CPI: -0.0794% m/m Core CPI: 0.303%
Last 12 core CPI figures

Overall, highest core number in 3 months, but clearly in a down trend. I think lots of people would be DELIGHTED with 3.6% annualized compared with where we have been, but that’s closer to what I am expecting than what the market/Fed is looking for.
M/M, Y/Y, and prior Y/Y for 8 major subgroups

Interesting thing is apparel, up for the second month in a row. Apparel is an almost pure import, so if it’s up then either (a) the recent dollar weakness is already affecting prices or more likely (b) there is pricing power at retail, and the markdowns for Christmas were lower.
Core Goods: 2.15% y/y Core Services: 7.05% y/y

The story continues to be bifurcated and we will look further at the four-pieces. More important than the fact that services are trending and goods are deflating, is whether the services part was all rents.
Here is my early and automated guess at Median CPI for this month: 0.378%

Clearly good news! Lowest median m/m in quite some time. So core was higher, but median lower. THIS is positive. And as I said, this is the interesting part now: inflation is decelerating, but why and how fast and how far? Median clearly shows it is.
Primary Rents: 8.35% y/y OER: 7.53% y/y

Further: Primary Rents 0.79% M/M, 8.35% Y/Y (7.91% last) OER 0.78% M/M, 7.53% Y/Y (7.13% last) Lodging Away From Home 1.5% M/M, 3.2% Y/Y (3.2% last)
Although the rent data is clearly bad news, there has been a strong campaign against this data to weaken its importance by claiming it’s just really lagged. That’s partly true but the recent research on the subject has enormous error bars for short-term forecasts so…
Some ‘COVID’ Categories: Airfares -3.12% M/M (-3.02% Last) *** Lodging Away from Home 1.47% M/M (-0.71% Last) *** Used Cars/Trucks -2.55% M/M (-2.95% Last) *** New Cars/Trucks -0.06% M/M (0.04% Last)
So, I was ‘on’ core even though I was wrong on airfares (it was weak, despite the fact that every fare I saw in December was about 2x normal). Used cars was the predicted drag, and New cars was not…but I was low on rents. That’s the ‘away from mean surprise’.
Incidentally, Lodging Away from Home was quite strong – and is one of those core-services-ex-rents that is driven a lot by wages.
Piece 1: Food & Energy: 9.31% y/y

Piece 2: Core Commodities: 2.15% y/y

Piece 3: Core Services less Rent of Shelter: 6.34% y/y

…and here is the spoiler: it wasn’t all rents. Core services less rents still strong. I’ll drill down further in a bit.
Piece 4: Rent of Shelter: 7.59% y/y

So, the swap market gets closest-to-the-pin on headline (SA). -0.079% was the figure, a bit lower than consensus econs and a fair bit lower than me. On Core, econs and I were both pretty close as it was right around 0.3% (0.303%).
I had managed to talk myself into the idea that food and energy would be a bit less of a drag than my model said, but food wasn’t up as much as it has recently been. Ergo, right on core and off on headline.
Interesting story in Medical Care, which has been a drag recently because of the huge adjustment to insurance company margins (huge and unlikely, btw). Doctors’ Services is slowly reaccelerating a little. Hospital Services continues to have problems getting sufficient sample.
Overall, Medical Care was up 0.1% m/m, but that’s after the continuing ‘insurance’ drag. Y/Y it was at 3.96%, down from 4.15% but looking like it’s leveling out.
The median category in the Median CPI will be Food Away from Home, +4.63% annualized monthly number. And the y/y Median will decline very slightly again. Was 7.00% in Oct, 6.98% in Nov, 6.93% in Dec. But heading down.
Biggest upward m/m movements in core categories were in Jewelry/Watches (+48% annualized monthly), Mens/Boys Apparel (+22%), Lodging Away from Home (+20%), Motor Vehicle Maint/Repair (+13%), and South Urban OER.
• Biggest decliners were energy things, including Public Transportation, plus Used Cars (-27% annualized monthly figure), and Car/Truck Rental (-18%).
Core ex-shelter: this includes core goods decelerating rapidly and core services accelerating so perhaps isn’t as useful as sometimes: 4.48% y/y, down from 5.2% last month and the lowest since April 2021. But if it stayed there, then it’s hard to get core to 2%.

While I’m waiting for the diffusion stuff to calculate, a word on what this does to the Fed: nothing. The Fed is aiming for 5% and then will keep rates high for a while unless something breaks.
Do markets love this data today because it means they were worried about a more-hawkish Fed, with higher rates or higher-for-longer? Or do they think it means the Fed will in fact start easing this year as the curves impound?
In my view, the latter is really unlikely. I can see the Fed starting QE again if auctions start getting difficult, but in my view there’s no evidence here that we’re going right back to 2% inflation and the Fed has been loudly consistent about this.
To be sure, they can turn on a dime and they have previously, but…I just think market pricing is really optimistic.
This [chart below] is consistent with the good news from Median – for the first time, our diffusion index has declined smartly. It’s still above the highs of the last couple of inflation ‘spikes’ (which no longer look like spikes!), but moderating.

This chart is not quite as good. The mean CPI is falling more because some high outliers (cars e.g.) are coming back to the pack, and some are moving from low to the low tail, and less because the middle is shifting a lot. Look at how >5% is barely declining.

I mean, that’s not TERRIBLE news, but obviously we need to see the “<2%” get close to 50% if the Fed is going to be confident they’re back near their inflation target. • One more point and then I’ll prep for the call. A lot of the positive-news things are well along towards delivering what they’re going to deliver. Health ins won’t be a drag in 2024. Used cars won’t drop another 20%. And >>
>>the dollar has turned south so core goods won’t be in retreat forever. The case for inflation going back to 2% rests on rents turning, and on wages slackening. And while those are expected, there are scant signs of them yet. So hold off on the celebrations in the Eccles bldg.
OK, let’s wrap up and get to the call. Thanks for subscribing. at 9:35ET I’ll be on this call; join if you want to hear me say what I just tweeted. 🙂 [NUMBER REDACTED]

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

Two broad observations:

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

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

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

Categories: CPI, Tweet Summary Tags: core cpi, CPI, cpi report, Fed, inflation, sticky inflation

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