Modeling Shortfall Risk versus Inflation – What a Good Hedge Looks Like
When people ask me about hedging inflation, they aren’t always asking what they think they’re asking. There are two approaches to addressing inflation in your portfolio so that the portfolio grows in real terms. One of the approaches is to try to simply outrun inflation: “If inflation averages 3%, and I have an investment that averages 5%, I’ve succeeded.” This mode of thinking derives, I think, from the fact that all of our education has been in nominal space and in most financial modeling problems inflation is just assumed rather than modeled as a random variable. It turns out to be a lot harder than it sounds to find an asset class or collection of asset classes that dependably beat inflation over moderate (10+ year) periods, because there is significant (inverse) correlation between inflation and the performance of many asset classes. Most obvious here are stocks and bonds, so if you build a 60-40 portfolio that “should” return 5% over the long term and figure that will beat inflation, you’ll be right…as long as inflation stays low. If inflation goes up, you won’t only lose purchasing power but you’ll lose actual nominal value, since equities and bonds both tend to decline when inflation goes up. Let’s put that aside for a second but I will come back to it.
The other approach to addressing inflation is to try to hedge inflation: exceed inflation by a little bit, but all the time, so that your returns go up when inflation goes up and your returns go down when inflation goes down, but you always are experiencing some positive real return.
The difference between the first approach and the second approach can be summarized by thinking about shortfall risk. As an investor, you care about the upside (in real terms) but most of us are risk-averse meaning that we care more about the downside. Ask most people whether they’d risk a 25% loss in their portfolio purchasing power to have a similar risk of gaining 25%, and they will experience a strong preference to avoid that coin flip. Risk aversion isn’t linear, so investors treat small gains and losses differently from large gains and losses, and of course it matters whether you’re barely covering your goals or easily exceeding them so that you’re ‘playing with house money.’ Many things, in other words, affect risk preferences. But the bottom line is that if you are trying to ‘hedge’ inflation, you care about your shortfall risk over some horizon. What is the probability that you underperform inflation – that is, lose value in real terms – by some given amount between now and a stated horizon?
Now we are going to get a little mathy, but for those who aren’t so mathy I will try to explain in English as well.
If you want to evaluate the probability of asset B underperforming asset A by some given amount over some period, of course you need an estimate of the expected returns of A and B, or how they’re expected to drift relative to one another. That determines your jumping off point. Let’s suppose that A and B have the same expected return. The next thing that determines the frequency and severity of a shortfall of B versus A is the volatility of the spread between them, which is driven by (a) how correlated A and B are, and (b) how volatile each of them is. If they are highly correlated but B is far more volatile than A, you can have a large shortfall if B just has a bad day. If they aren’t very correlated, then when B happens to zig lower as A zags higher, you’ll get a shortfall even if they have similar volatilities. Essentially, we are valuing a spread or Margrabe option and like any option, we need a volatility parameter. In this case, it’s the volatility of the spread we care about, so we can evaluate “what’s the likelihood that the B-A spread is negative.”
If “SA” is the value of an inflation index (or an indexed token like USDi), and “SB” is the value of the hedging asset, then if distributions of A and B are approximately normal,[1] the option value is
C = SA N(d1) – SB N(d2), where
and
and, crucially, is the volatility of the ratio of A to B, which is a formula that will be familiar to travelers in traditional finance and depends on the individual asset volatilities and the correlation () between them:
For this ‘shortfall’ option to be as small as possible, assets A and B should have small volatilities () and a high correlation () between them.
In plain English terms: imagine two drunk guys walking down the boardwalk. What determines how far away they are from each other at any given time? Assuming no drift, it will depend on how much they’re weaving (volatility) and how much they’re weaving in the same pattern (correlation). If they’re holding hands (imposing high correlation), they’ll never get too far away from each other. And if neither one is very drunk (low volatility) they also won’t stray very far from each other. On the other hand, if both are wildly drunk and they don’t know each other, the spread between them will be wildly variable.
We aren’t trying to evaluate the spread between drunks, though. Let’s take this thought process and apply it to the inflation-hedging problem with an example. Suppose you are considering which of two assets is a better ‘hedge’ for inflation: the “INFL” ETF, or a mystery fund – let’s call it “EUSIT.”[2] Here is relevant data for these two assets, and for CPI. These are 3-year returns, volatilities, and month/month correlations, ending November 2025:
Using this data, we can see that the spread volatility (the result of the last formula listed above) for INFL versus CPI is 15.2%, while the spread volatility for EUSIT vs CPI is 1.1%. The Mystery Private Fund is the drunk holding hands with the other drunk, with neither of them that drunk; but INFL is really smashed (14.9% vol) and tending to zig when the CPI drunk zags (negative correlation).
Let’s extend this out one year, assume that INFL, EUSIT, and CPI all have the same expected returns, volatilities, and correlations. Practical question: What is the probability that your investment in INFL or EUSIT underperforms inflation?
For INFL: based on prior returns, it is expected to outperform CPI by 8.99% (11.97% – 2.98%). With a spread volatility of 15.2%, underperforming inflation (a spread of 0% or less) would mean an outcome that is 0.59 standard deviations below the mean. The probability of a draw from a normal distribution being 0.59 standard deviations below the mean is about 33.5%, which means that if you hedge your inflation exposure with INFL, you’ll underperform inflation about one year in three. Your chances of underperforming inflation by 10% or more in a given year is about 18%.
For EUSIT: based on prior returns, it is expected to outperform CPI by 3.15% (6.13% – 2.98%). With a spread volatility of 1.1%, underperforming inflation (a spread of 0% or less) would mean an outcome that is 2.86 standard deviations below the mean. The probability of a draw from a normal distribution being 2.86 standard deviations below the mean is about 0.66%, which means that if you hedge your inflation exposure with EUSIT, you’ll underperform inflation for a full year about once every 151 years. Your chances of underperforming inflation by 10%…even by 5% for that matter…is essentially zero.
Put a star by this paragraph: the assumptions here are key and I am making no claims about either of these strategies having those same characteristics going forward. This is only to illustrate the point that if you want an inflation hedge, meaning that you want to minimize shortfall risk, then it is very important to look at the volatility and correlation to CPI of your intended hedge. Having a better return is important, but less important than you think it is: at a 5-year horizon, the INFL ETF would be expected to outperform inflation (if we think 12% and 3% are decent long-term projections too) by about 60% compounded, but the spread standard deviation is now 15.2% times the square root of 5 years, so you’re only about 1.76 standard deviations above zero and thus you still have an 8% chance of underperforming inflation at the 5-year horizon! On the other hand, your chance of outperforming inflation by a huge amount, if you use the Mystery Fund, is also very small while that possibility exists if you use INFL. That’s what a hedge does: you give up the possibility of big outperformance to ‘buy back’ the chance of underperformance. If you are risk averse, that is a good trade because you’re giving up the less-salient part of your gains (big outperformance) to protect against the more-salient part (big underperformance).
So getting back to answering the question that we started with: what does a good inflation hedge look like?
- It has highly positive correlation to inflation at whatever horizon you’re focused on
- It has low volatility
- It outperforms, or at least doesn’t underperform, inflation over time
To this, I’ll add a fourth characteristic. It’s almost humorous, because hedges that fit those three characteristics are themselves quite rare. But the fourth one I would add is that it has convexity to higher inflation; that is, it does better at an increasing rate, the higher inflation gets. An inflation option, in other words.
Most of us should be happy with three! But at least now you’ll know how to evaluate whether you’re really getting a hedge, or something that will hopefully perform so well that you won’t care that it isn’t a hedge.
[1] I also conveniently wave away some complexities like the relative growth rates and the time value of money to make the math clearer with respect to volatility and correlation, which is my point here.
[2] Mystery fund is a private 3(c)1 fund available to verified accredited investors via a subscription agreement.
Mamdani’s Effect on the CPI
Surprising no one, and yet shocking many, avowed socialist Zohran Mamdani won the election yesterday to become Mayor of the largest city in the United States.[1]
Probably the main reason for Mamdani’s victory is that he pursued the tried-and-true method of giving out free stuff, and a whole generation of Americans who have systematically been poorly educated in history and economics said “that sounds awesome.” So, now we will see whether socialism will work for the first time ever.
This is an inflation blog, so I want to review briefly the effects of price controls on inflation – and indirectly, on inflation instruments. It’s interesting because we actually have some direct and recent experience with what were effectively price controls: the Biden Administration’s ‘eviction moratorium’ during COVID, that prevented landlords from tossing out renters who weren’t paying their rent. Really, it’s a pretty amazing thing that says a lot about Americans that the vast majority of renters continued to pay rent anyway.[2] An ancillary effect, though, was that landlords had no leverage to raise rents and therefore, rents stopped going up. Unsurprisingly (and here is where the lesson should have been learned), when the eviction moratorium was lifted rents re-accelerated. In the chart below, note how in 2021 effective rents declined while asking rents went up – but the red line eventually rebounded and exceeded the prior trend.
I actually haven’t looked at that chart in a little while. It’s fascinating to me that ‘asking rents’ (which come from the Census department) have maintained their divergence from ‘effective rents’ (sourced from Reis Inc). I wonder if some of that is the effect of the LA wildfires. In any case, not today’s article. The point is that the effective price controls on rents did have an effect on measured rents, but it didn’t change the economics and eventually prices caught up.
Back in 2022, I produced an excellent podcast episode entitled Ep. 37: Bad Idea of the Year – Wage and Price Controls. In it, I discussed some of the trial balloons that had been floated by the Administration and some of the really bad economics that was being used to support the idea. This is a part of the transcript (from Turboscribe.ai), and I still love the analogy:
“But the basics of how it works are very simple to visualize. Price is a teeter-totter, okay? It’s a seesaw. On one side of the seesaw sits all of the buyers. On the other side sits all of the sellers. If there are lots more buyers jumping onto one side, then the teeter-totter drops on that side, and the fulcrum, in order to make everything balance, the fulcrum has to move. And if you move the fulcrum, then you can get that to balance even with more buyers and fewer sellers.
It just means that the fulcrum, which is price, has to move in one direction. If then people, those buyers drop off, then the fulcrum moves back the other direction. If more sellers jump onto the teeter-totter, the fulcrum moves the other direction as well.
So it’s a simple way to visualize it…and yes, there are all kinds of complexities in the real world. There’s behavioral, there’s stickiness that happens, but that’s the fundamental theory of price, is what I’ve just given you, is that price is the fulcrum that balances the buyers and sellers.
So what price controls say is that, well, we don’t like where this balanced. We have too many buyers, not enough sellers, and the fulcrum has moved way over to one side and we don’t think it should be there. So we’re going to take the fulcrum and we’re going to move it to where we like it. And guess what happens? There’s no balance. All of a sudden, if you move the fulcrum away, then all of a sudden, the side with all the buyers goes down and goes thunk on the ground. There’s no balance.
“How do you then balance it? If you say that the fulcrum has to be in this location, how do you balance the teeter-totter? Well, you have to take buyers away. And you take buyers away by making a shortage. And so those buyers can’t buy anything. And then voila. So if you force the price, then the quantity has to change. And if you let both things happen, then it will magically go and balance. If it’s truly a free market and there’s good information and all that stuff.
“So does this solve the problem to push the fulcrum to one side and say, oh, there’s no inflation and to make it balanced, we shove everybody off the teeter-totter by creating a shortage? It doesn’t solve the problem. And furthermore, the people that you’ve pushed off the teeter-totter who can’t get access to the thing anymore are pretty upset. They should be upset because before they had a way to get what they wanted and what they were willing to pay for. And now they can’t because you’ve shoved them off the teeter-totter. You’ve created a shortage.”
That was a public service announcement, just to remind you why price controls don’t work. That doesn’t mean they aren’t really good politics, especially if you can leave the removal of the controls to the next guy who ‘causes’ the inflation when they come off. And it’s the politics, not the economics, that leads to this dumb idea being tried over and over despite a roughly 0% record of success.[3]
Because can price controls affect price indices? You betcha. If you make it illegal to move prices, then at least official prices will not move. So let’s consider the potential impact of Mamdani freezing rents and grocery prices, for example.
New York City is about 7% of the CPI sample. Technically, it’s New York-Newark-Jersey City but we know most of that is NYC. In the New York consumption basket, Rent of Primary Residence is about 11%, 28% is Owners’ Equivalent Rent, and 8% is Food at Home. So, if rents and grocery prices were frozen, about 19% of the NY CPI would go to zero month/month right away (at least officially – the best tomatoes will be sold on the black market for a premium of course and the best catch of the day will be sold in NJ…[4]) And since OER is based on a survey of primary rents, eventually 47% or so of the NY CPI basket will go to zero price change. I’m ignoring the quality adjustments in the housing stock, which have the effect of increasing OER inflation slightly.[5]
The effect of this on the national CPI: if 47% of the NY basket goes from, say, 4% inflation to 0%, and NY is 7% of the national CPI, then the really-rough effect on the US CPI would be 47% x -4% x 7% = -13bps per year. Obviously that’s extremely rough, but I’m just aiming for an order of magnitude calculation. 13bps is small, but noticeable. Probably not tradeable.
But here is something that’s interesting and potentially tradeable. New York City is about 30% of the Case-Shiller 10-City Home Price Index. Let’s suppose that home prices in New York over the next year drop, say, 10%.[6] That move would cause the nationwide Case-Shiller (10-city) index to drop 3%, or to rise 3% less than it otherwise would. Here’s what is interesting. The chart below shows the February 2027 NYC Metro Case-Shiller futures contract, which trades on the CME (and settles to the index for December 2026, which is released in February 2027).
There has been exactly zero price effect of the Mamdani victory. To be sure, open interest in the NYC contract – in all of the Case-Shiller contracts, for that matter – is extremely low but there is an active market-maker and the current price as I write this is 344.40 bid/351.60 offer. The last print of the S&P Cotality Case-Shiller New York Home Price NSA Index, for August 2025, was 334.08. On the bid side, then, the market is paying 3.1% higher prices than the current index. That seems sporty to me. Why would home prices rise if rents are frozen? Why would they rise if people are leaving the city?
As always, my musings here are not trade recommendations; do your own research. Disclosure: I do not currently have a position either long or short in any housing futures contract, nor does any account or fund that I or Enduring Investments manages, nor do I currently have plans to initiate any position.
[1] New York, at least for now.
[2] At the time, we worried about what would happen with the CPI since a renter paying zero rent is not skipped but the rent goes into the calculation as a zero. So you could in theory have had 10% of the basket going to zero, which would have destroyed the inflation market.
[3] If you listen to the episode: I also love my thermometer analogy.
[4] Also, though rents will stop rising the quality of the apartments will deteriorate since landlords will skimp on maintenance. Mamdani has a plan for that, though – he has said the city will order maintenance to be done and if it isn’t, the city will seize the property. Just in case there was any question who really owns any property that you can’t pick up and transport elsewhere.
[5] N.b. – the increase in the CPI nationally from the owned-housing quality adjustment almost exactly cancels the decrease from quality/hedonic adjustments in other parts of the CPI. Yet another reason that the whining about hedonic adjustment being used to ‘manipulate CPI lower’ makes no sense.
[6] You can easily make a case for a much steeper drop if the city increases property taxes to make up for declining income tax collections, not to mention if the exodus from the city looks anything like the 9% of the population who claim they’d move if Mamdani won, or if the finance industry continues to relocate to Dallas and Miami.
Inflation Guy’s CPI Summary (September 2025)
Well, it seems like it’s been a while since the last CPI update! Thanks to the government shutdown, it has been since this data is a week and a half later than it was scheduled to be. The importance of the CPI release is obvious, but it was reinforced by the fact it’s the only one the government is calling people back to release. It isn’t that we don’t have reasonably-accurate alternative ways to measure price pressures, though – it’s because unlike Payrolls and most other government releases that are important touchpoints for economists, the CPI is an important legal touchpoint for contracts, bonds, and legal obligations of the federal government. In this case, September’s data is a crucial number needed to calculate COLA adjustments for Social Security for next year. If this had been October’s data? I’m not sure they call back workers to release it. But that’s next month’s problem.
Speaking of next month’s problem: the government shutdown did not affect data gathering for this month’s number; they had to recall the people to collate the data and publish it but not the collectors. So the quality of the data should be fine. The data-quality question is much murkier when we look forward to next month, but since much less of the data collection is done by guys with clipboards these days, it might not be as bad as you think. Still, that will be the concern for the October CPI released next month. Like I said: next month’s problem!
Heading into the release, consensus was for +0.37% on headline CPI (SA) and +0.29% on core. I have to admit that I was confiding to people that this seemed sporty because the prior month had seen a surprising acceleration in rents that could be reversed, indications are that Used Cars would be a drag, and Food at Home also looked soft (I was right on 2 out of 3 – Food at Home was an add). That told us going in that if we were going to get to +0.29% core, either I had to be wrong on most of that or core goods ex-used cars was going to have to be pretty strong. Tariffs definitely are helping to push that narrow group of the consumption basket higher. But is that enough? Let’s see.
The backdrop going into the data was that rates have been generally softening, and the inflation swaps curve has been steepening (lessening its inversion, with near-term inflation pricing dropping more than longer-term inflation expectations). That’s consistent with a return to normalcy…but it’s really happening because energy prices have dropped quite a bit until the last couple of weeks, and that has a more immediate impact on the front of the inflation curve. The mean reversion time for energy prices is something like 15 months, so by the time you’ve gotten a few years out the curve today’s lower gasoline prices shouldn’t much affect your expectations of inflation forwards. But it affects inflation spot, which propagates through the forwards.
Actual print: SA CPI +0.31%; SA Core +0.227%. Softer than expected, and it took only a moment to see that a big part of that was due to a sharp deceleration in Owners’ Equivalent Rent (see chart). Some of that was the give-back I expected, but it was more than that and so we should put this in the back of our minds for next month – we’re probably due a reversal in the other direction over the next month or two.
Interestingly, even with the miss the Core CPI time series doesn’t look terribly weak. I mean, +0.227%, repeated for a year, still gives you 2.7% core CPI. And we won’t get downside drags from cars and housing every month.
Interesting jump in apparel this month. It’s a small category and always volatile, but since we also import almost all of our apparel it’s one place I look for tariff effects. But note the y/y numbers are still very low and in fact decelerated with this jump, implying last year’s bump in September was even larger. That’s a seasonally-adjusted figure, but I wonder if the problem here is that seasonal adjustment is failing us. Maybe pre-holiday mark-ups (from which we can show great discounts in a month!) are happening earlier. In any event it’s only 2.5% of the CPI so probably not worth too much computational cycles.
Core goods inflation rose slightly to +1.54% y/y, and core services declined to 3.47% y/y. The latter is mostly and maybe entirely due to housing, which is a core service. The former is interesting because Used Cars/Trucks was -0.41% m/m. That was expected, but it means that other core goods were more buoyant.
So here are OER and Primary Rents. 3.76% y/y (only +0.13% m/m) and 3.4% y/y (only +0.2% m/m). You can’t really tell a lot about the miss today from this chart – I showed the m/m series earlier, and the bottom line is that this continues to level out. I think the flattening is going to be more dramatic over the next 3-6 months but we’ll see. Lodging Away from Home rose again, +1.3% m/m, and is now flat y/y.
At this point, I’m thinking: with rents a downside surprise and Used Cars a downside surprise, this isn’t that bad a miss. In other words, if you’d told me we were going to get those numbers from rents and cars I would have thought core would be a lot weaker than +0.23% m/m.
Earlier I showed the last 12 Core CPIs. My guess at Median looks better, but that’s mostly because the median category is West Urban OER and even split up, an aberration in OER – and that’s what I think this is – is enough to sway Median CPI. It also means my estimate of median, +0.213% m/m, might be off because the Cleveland Fed separately estimates the seasonals for the regional OERs and so I have to guess at that part. My guess will take y/y Median CPI to 3.5% from 3.6%. And the Fed is easing. Hmm.
Here are the four-pieces charts. Food and Energy +2.99% y/y. Core Commodities +1.54%. Core Services less Rent of Shelter (Supercore) +3.37%. Rent of Shelter +3.53%. These are the four pieces that add up to CPI. None of them looks terrible except for Core Goods, and there’s limited upside to that – and it has a short period, so in a year it’s likely to be lower. I do think that going forward, core goods remains positive instead of the steady deflation it was in for decades, but not big positive. However, you need it to be negative if you want inflation at 2%, unless you get core-services-ex-rents a lot lower (but that’s highly wage-driven, and reversing illegal immigration helps support that piece somewhat) or rent of shelter a lot lower. The latter is certainly receding but it’s not going to go a lot lower.
I don’t usually spend a lot of time talking about energy, because that’s a hedgeable piece (largely – gasoline is a big part of energy and that’s easy to hedge with a little lag; electricity is harder). This month, Energy was +0.12% NSA. But next month, we’ll see a decent drag because of the sharp drop in gasoline over the last few weeks. That’s a little early compared to the usual seasonal, and it may mean we get the usual December drop in gasoline in October CPI.
Except…that I think the White House has teased that we might not get October CPI at all, just skip it, because of the difficulty gathering data. If that is true, the fallback mechanisms will kick in. See my piece on what that means, here, but the bigger point is that you wouldn’t get my scintillating commentary. I guess again that’s not this month’s problem.
Now, I have to show this almost by habit, and because the economists expecting housing deflation will be dancing in the streets. Take pictures, and show them again next year. They never learn. Housing inflation is slowing but there is no sign rents are going to come anywhere near deflation. Except maybe on a weighted basis if Mamdani gets elected Mayor of New York City and freezes rents. But then we’ll have to start looking rents ex-NYC.
How disinflationary a period are we in? Wellllll…of the item categories in the median CPI calculation, there were zero core categories that decelerated faster than 10% annualized over the last month (-0.833% or faster). On the plus side, there were Personal Care Services (+11.9% m/m annualized), Footwear (+12.0%), Motor Vehicle Fees (+14.2%), Tenants’ and Household Insurance (+15.2%), Lodging Away from Home (+17.5%), Miscellaneous Personal Goods (+17.9%), Men’s and Boys’ Apparel (+19.3%), and Public Transportation (+21.5%). These are small categories for the most part – but not all import goods and interesting in that the tails are all to the upside. That’s not the way a disinflationary economy usually looks, although I don’t want to overstate the importance of a single month!
Here’s the observation about long tails compressed into a single number, the Enduring Investments’ Inflation Diffusion Index. It’s signaling upward pressure.
Below is a chart of the overall distribution. The two big spikes in the middle are mainly rents and OER. But take those away and you can see there’s not a lot of categories in the 1-3% range, and a decent weight in the 5-6% range. This doesn’t really look like a price system settling back down placidly to 2%.
Now, the stock market clearly loves this, which makes sense. The Fed is going to ease, probably twice more this year. But that was already baked into the cake in my mind, because the Fed no longer targets 2% inflation. Remember that in the most-recent change to the 5-year operating framework the Fed, in Chairman Powell’s words, “…returned to a framework of flexible inflation targeting and eliminated the ‘makeup’ strategy.” I talk more about that here: https://inflationguy.blog/2025/09/02/the-fate-of-fait-was-fated/ Ergo, the Fed doesn’t really care if we get to 2%. They’d prefer to not see inflation head higher, but they can spin a story to themselves that even though median inflation is in the mid-to-high 3s, “the process of inflation anchoring is underway” or somesuch nonsense. As long as it’s not hitting them in the face that inflation is going up, they’ll keep relying on their models that say it should be going down. N.b., those are the same models that said inflation shouldn’t have gone up that much to begin with, and should have been transitory, but we all know “Ph.D.” stands for “Pile it higher and Deeper.”
Eventually, inflation going up probably will hit them in the face. But that’s such a 2026 problem.
Does Crypto Expand the Money Supply?
We live in interesting times, and let’s face it: mostly, in a good way. It doesn’t have to stay that way, naturally, and it won’t stay that way naturally.
This has always been the weak spot in any system that insists on centralized management of certain functions. Of course, that’s the fundamental flaw and conceit of socialism: it relies on the active intercession of omniscient beings to order activities better than the masses of private actors can. Usually, “better” means “less volatile” to the policymakers who set up the committees of omniscient beings (personally, I would say “better” means “less fragile,” which is the opposite of “less volatile”).
The best argument for using the collective wisdom of the anointed few is to prevent the tragedy of the commons, where individuals making private decisions can impact the use of public goods. And that brings us to money.
I think it is a fascinating question whether ‘money’ is a public good, which should be regulated and controlled. Or is a particular currency, such as the US Dollar, the public good which should be regulated and controlled? The argument the Federal Reserve would make is that, absent the control of the Federal Open Market Committee, the money supply would grow or shrink in dangerous and random ways. Or at least, that would be the argument they would make, if they cared about the stock of money any more.
There is no plausible argument in my mind that “interest rates”, which is what the Fed now works to control, is a public good that is better managed by the Smart Guys. So, weirdly, the Fed now manages something which they don’t have any knowledge about that should supersede private market actors (rates), but does not purport to manage something they could plausibly argue is a common good that no one directly controls (money).
** Separate question: are the Cognoscenti at the Fed any good at it? Chairman Powell said yesterday that the Fed is likely to stop running down its balance sheet soon. With the balance sheet still at 22% of GDP, compared with the pre-GFC normal of about 6% – see chart – “Until the job is done” has apparently become “until it’s time for my smoke break, and then you’re on your own.” What’s the matter with kids today?
So the answer to this ‘separate question’, as inflation remains at the highest level of this millennium and is now headed higher, is “of course they’re not. Why are we even asking that question?”
I actually want to go slightly further. The Fed no longer tries to control the money supply, which at least they might have an argument for doing, in preference to managing interest rates against the market-clearing actions of private actors. But over time (and accompanied by the whining and moaning of central bankers), the concept of money has gotten squishier and squishier. One of the reasons that central bankers want to control crypto is that they fear the power of money loose in the wild (ironically, given that they stopped worrying about money a long time ago), untamed by the Anointed Stewards of Money.
The question is, does crypto expand the money supply? For the purposes of this question, let’s ignore the official definitions of money, M1, M2, M3, etc and just focus on ‘spendable balances.’
If you give me a dollar, in exchange for something that feels like a dollar and that you can spend (say, a stablecoin like USDC), have we increased the money supply? The answer depends on what I do with that dollar. If it is deployed to a vault, then obviously the number of ‘dollarish’ units in circulation haven’t changed. You have minted $1000 USDC, but there are now $1000 USD that are sequestered in a vault and not spendable. The amount of spendable money hasn’t changed. If instead that $1000 goes to buy a Treasury bill from the government, then it is going to the government to spend. Normally, buying Treasuries doesn’t change the amount of spendable dollars, because in buying a Tbill I am deferring my decision to spend (instead, I hold securities) and delegating that decision to spend to the government. I exchange my future spending for the government’s current spending, and in the future that transaction is reversed when the Tbill matures. Some people think that means that Treasury issuance increases inflation because it increases money, but it doesn’t. The Treasury bill is just a token representing my deferral of spending into the future.
But if I was able to buy that Tbill because I issued a USDC token, which you can spend, and then gave the fiat money I received from you to the government in exchange for a Tbill, then I have doubled the number of spendable dollars in circulation: $1000 in the form of USDC, and $1000 in the form of dollars sent to the Treasury which will be spent. Essentially, what has happened is zero-reserve banking. If I were a bank and you deposited $1000, I could lend out only, say, $900 of that (“fractional reserve banking) and in principle the Fed can control that multiplier by changing the reserve requirement.[1] But now you’ve deposited $1000 and I am lending 100% of that to the government. Stablecoin manufacturers in this way are basically banks issuing their own currencies. Now, a lot of that money is going abroad, but it looks like money to me.
Worse are the vaporware crypto issuers who simply create supply out of thin air. If people accept bitcoin as money, rather than as a speculative chip to trade around, then I have created money with no reserves whatsoever, and no limit on how much ‘money’ I can so create.
If this is true, then the irony is that crypto – which was inspired originally by the desire to remove money from the ministrations of the Very Smart Bankers who could ruin money by creating too much of it – could be the very tool that creates the inflation its originators wanted to protect against. In that kind of world, I really don’t understand the use of a nominally-anchored stablecoin. If the overall money supply growth is unbounded and now essentially uncontrollable (once the size of the crypto world gets sufficiently big), then holding something that is pegged to the sinking ship seems counterintuitive to me.
While I didn’t start this article with the intention of pointing out that our USDi coin is a raft rather than an anchor (like stablecoins), it does seem to be relevant here to mention that you can now mint USDi directly from our website: https://usdicoin.com/coin . And, while the increase of USDi will contribute to the overall money supply – at least it has a built-in defense!
[1] …but it doesn’t really work like that any more. The Fed still has a dial to turn that limits how much lending can happen on a given depository base but it isn’t as clean as it was when there was a simple reserve requirement. This is well beyond the point of this article.
The Fault, Dear Brutus, is in R*
I want to say something briefly about the “neutral rate of interest,” which has recently become grist for financial television because of new Trump-appointed Fed Governor Stephen Miran’s speech a couple of days ago in which he opined that the neutral rate of interest is much lower than the Fed believes it is, and that therefore the Fed funds target should be more like 2%-2.25% right now instead of 4.25%.
Cue the usual media clowns screaming that this is evidence of how Trump appointees do not properly respect the academic work of their presumed betters.
If that was all this is, then I would wholeheartedly support Miran’s suggestion. Most of the academic work in monetary finance is just plain wrong, or worse it’s the wrong answer to the wrong question being asked. And that’s what we have here. Anyone who thinks that Miran is an economic-denialist should read the speech. It is mostly a well-reasoned argument about all the reasons that the neutral rate may be lower now than it has been in the past. And I applaud him when he comments “I don’t want to imply more precision than I think it possible in economics.” Indeed, if we were to be honest about the degree of precision with which we measure the economy in real time and the precision of the models (even assuming they’re parameterized properly, which is questionable), the Fed would almost never be able to decisively reject the null hypothesis that nothing important has changed and therefore no rate change is required!
I can’t say that I agree with Miran’s argument though. Not because it’s wrong, but because it’s completely irrelevant.
Sometimes I think that geeks with their models is just another form of ‘boys with their toys.’ And that is what is happening here. The “neutral rate of interest” is a concept that is cousin to NAIRU, the non-accelerating-inflation rate of unemployment. The neutral rate, often called ‘r-star’ r* (which is your clue that we’re arguing about models), is the theoretical interest rate that represents perfect balance, where the economy will neither tend to generate inflation, nor tend to generate unemployment. Like I said, it’s just like NAIRU which is a level of unemployment below which inflation accelerates. And they have something else in common: they are totally unobservable.
Now, lots of things are unobservable. For example, gravity is unobservable. Yet we have a very precise estimate of the gravitational constant[1] because we can make lots of really precise measurements and work it out. Economists would love for you to think that what they’re doing with r* is similar to calibrating our estimate of the gravitational constant. It’s not remotely similar, for (at least) two enormous reasons:
- Measuring the gravitational constant is only possible because we know (as much as anything can be known) what the formula is that we are calibrating. Fg=Gm1m2/r2. So all we have to do is measure the masses, measure the distance between the centers of gravity, and infer the force from something else.[2] Then we can back into G, the gravitational constant. Here’s the thing. The theory of how interest rates affect inflation and growth, despite being ensconced in literally-weighty economics tomes, is just a theory. Actually, several different theories. And, by the way, a theory with a terrible record of actually working. To calibrate r*, the hand-waving that is being done is ‘assume that interest rates affect the economy through a James and Bartles equilibrium…’ or something like that. It is an assumption that we shouldn’t accept. And if we don’t accept it, calibrating r* is just masturbation via mathematics.[3]
- With the gravitational constant, every subsequent measurement and experiment confirms the original measurement. Every use of the model and the constant in real life, say by sending a spacecraft slingshotting around Jupiter to visit Pluto, works with ridiculous precision. On the other hand, r* has approximately a zero percent success rate in forecasting actual outcomes with anything like useful precision, and every person who measures r* gets something totally different. And r* – if it is even a real thing, which I don’t think it is – evidently moves all the time, and no one knows how. Which is Miran’s point, but the upshot is really that monetary economists should stop pretending that they know what they’re doing.
In short, we are arguing about an unmeasurable mental construct that has no useful track record of success, and we are using that mental construct to argue about whether policy rates should be at 2% or 4%. Actually, even worse, Miran says that the market rate he looks at is the 5y, 5y forward real interest rate extracted from TIPS. The Fed has nothing to do with that rate. But if that’s what he is looking at why are we arguing about overnight rates?
I should say that if there is such a thing as a ‘neutral rate’ that neither stimulates nor dampens output and inflation, I would prefer to get there by first principles. It makes sense to me that the neutral long-term real rate should be something like the long-run real growth rate of the economy. And if that’s true, then Miran is probably at least directionally accurate because as our working population levels off and shrinks, the economy’s natural growth rate declines (unless productivity conveniently surges) since output is just the product of the number of hours worked times the output per hour. But I can’t imagine that the economy ‘cares’ (if I may anthropomorphize the economy) about a 1% change in the long-run real or nominal interest rate, at least on any time scale that a monetary policymaker can operate at.
The best answer here is that whether Miran is right or not, the Fed should just pick a level of interest rates…I’m good with 3-4% at the short end…and then change its meeting schedule to once every other year.
[1] Which may in fact not be constant, but that’s a topic for someone else’s blog.
[2] In the first experiment to measure gravity, which yours truly replicated for a science fair project in high school, Henry Cavendish in 1797 figured the force in this equation by measuring the torsion force exerted by the string from which his two-mass barbell was suspended, with one of those masses attracted to another nearby mass.
[3] Yeah, I said it.
Inflation Guy’s CPI Summary (August 2025)
Before I begin talking about today’s CPI, a quick word about the 24th anniversary of the terrorist attacks of 9/11. As someone who worked 1 block from the Towers, I can tell you it’s a day I will never forget and filled with images I can never erase. But I also remember that in the weeks that followed, the country was unified in a way I’d never seen. Rudy Giuliani was “America’s Mayor” for his courage and steady hand during the disaster and in the period that followed. When I traveled to the Midwest, menus were filled with ‘Freedom Fries’ and strangers asked with concern about my family and friends when they heard I was from New York. It seems crazy to me that only 24 years removed from that, the country is divided in a way I’ve never seen. Everyone said “we will never forget.” And then they forgot.
But I do not forget. I give prayers and thanks for the brave first responders I saw that day and for the families of those who didn’t return. And you should too.
All of which makes the monthly CPI report seem very small. In truth, it is small all of a sudden. From being one of the most-important releases for a couple of years because of the Fed’s assumed reaction function, it has abruptly been pushed to the back. This is partly because of the weak Employment data and the massive downward revisions to the prior data but that point is reinforced by the Fed’s recent adjustment to the inflation targeting framework, in which they removed any imperative to make up for periods of high inflation by engineering lower inflation so that the reaction function is basically one way. (See my writeup on this at https://inflationguy.blog/2025/09/02/the-fate-of-fait-was-fated/.) I guess there’s an ironic parallelism here. After the inflationary 1970s and the pain of bringing inflation back down, the Fed said “we will never forget.” And then they forgot.
But I do not forget. And neither should you. An investor’s nominal returns are irrelevant (except to the IRS). What matters is real returns, and a period of higher and less-stable inflation has historically resulted in lower asset prices since the most important indicator of future returns over normal investing horizons is starting price. If markets need to adjust to higher inflation to give higher nominal returns, the easiest way to do that is to lower the starting price. So whether the Fed cares, we should.
And with that – we came into today with real yields having fallen some 20bps this month, but with inflation expectations having not declined much at all. Obviously, that’s the market’s reaction to the presumed tilt of the Fed.
The CPI report was slightly above expectations, which were already somewhat higher than in prior months. So when people tell you this was a ‘small miss higher,’ that’s mainly because economists adjusted their expectations, not because the number was similar to prior months. Month/month headline inflation (seasonally adjusted) was +0.382% (expectations were +0.33%), with core at +0.346% (expectations were +0.31%). Markets have not reacted poorly to this figure, but I wonder if core had been slightly higher and rounded to +0.4% if we’d have seen more introspection.
But as I said, this is a ‘small miss’ but that does not mean it was a small number. Indeed, with the exception of the jump in January associated with tariff noise, this is the highest core figure in 17 months.
There were a number of upside categories, but one of them was not Medical Care. Some people had been looking for a move higher here, and Doctor’s Services rose a bit, but Medicinal Drugs fell -0.372% m/m and is now down year/year. That surprises me, but there are a lot of pressures on the drug industry right now and it is going to take a while to see how it shakes out.
Core goods prices continued to accelerate. On a y/y basis, core goods are +1.54%. With the exception of the COVID spike, this is the highest level of core goods inflation since 2012. Some of that is definitely due to tariffs, and that will trickle in for a while. But the long-wave concern is that deglobalization/re-onshoring of production means that it will be very hard to get core goods inflation back to the persistent mild deflation we had enjoyed for a very long time. And without that, it is very hard to get core inflation to 2%, especially if core services (+3.59% y/y) stops improving as the chart sort of hints it might.
One surprise you will hear a lot about is Owners Equivalent Rent, which was +0.38% m/m. Primary Rents were +0.30% m/m. Both of those are higher than the recent figures, but this looks like some residual seasonal-adjustment issues to me. The y/y for both continues to decline, albeit at a slowing rate, which means that the number we dropped off from last year was higher than the upside surprise of today.
Rents are on schedule.
We also saw another jump from airfares, +5.87% m/m, and Lodging Away from Home (+2.92% m/m) finally rebounded after months of weakness. Used cars were +1.04% m/m, and new cars +0.28%. When you look at all of the pieces, it adds up to Median CPI being almost the same as last month: my early guess is +0.276% m/m.
Turn that picture any way you want to. I don’t see a downtrend.
When we break down inflation into the four main pieces, none of them is in deflation and none seems to be an overt drag or pulling everything else up. Food and Energy is +2.16% y/y. Core goods is +1.54% y/y. Core services less rents (aka Supercore, chart below) is +3.56% y/y. And Rent of Shelter is +3.61%. How do you want to get inflation to 2% from those pieces?
Long-time readers will know this does not surprise me. Median CPI will be around 3.6% y/y again. That’s where we are. We overshot my ‘high 3s, low 4s’ target to the downside a bit, but we’re back up in the mid-to-high 3s. I’ll take that as a win.
I want to share the money supply chart. On an annualized basis, we’re near 6% y/y over the last six months. That is back to pre-COVID levels, and is too fast in this environment. You can’t get 2% inflation with deglobalization and sour demographics if you’re running the monetary playbook from when you had globalization and positive or neutral demographics.
And finally, we now know USDi’s price through the end of October.
So what does all of this mean for policy? Well, see what I said above about inflation targeting and the change of the Fed’s operating framework. The most important things to the FOMC right now are, in order:
- Employment
- Politics, and jockeying for position to be named next Fed Chair
- Internal modeling about tariffs, inflation expectations, rents, etc.
- Actual inflation numbers, like CPI
35th or so in importance is “the quantity of money,” if it’s on the list at all. You can probably glean from my list that I think the Fed is likely to ease. Let me make clear that I do not think that a wise Fed chair would even consider easing with median inflation steadying around 3.6%, and a 50bps cut would be laughable. However, this is not a wise Fed chairman, and this one is going to ease. In my gut, I think the Fed will cut 25bps but with several dissents for 50bps. I would not be shocked with a 50bps ease even though it is completely boneheaded to do it with inflation still running hot with no clear path for it to decline to what used to be the target.
But that’s the point I suppose. Is there even a target, if the Fed doesn’t mind missing it?
One final announcement. If you’re an investor in cryptocurrencies (in particular, stable or flatcoins) and have a Telegram account, consider joining the read-only USDi_Coin room https://t.me/USDi_Coin where the USDi Coin price is updated every four hours or so…and where many of these charts are also posted shortly after CPI just as I used to do on Twitter.
The Fate of FAIT was Fated
Growth in the US is ebbing, and it is likely only the AI boom that is keeping us from recording a small recession. Unemployment is still rising, although slowly, and credit delinquencies are rising. Because the services sector and the goods sector are still asynchronous – a holdover from the COVID period – we haven’t seen an aggregate contraction, but it will happen eventually. That doesn’t concern me. Recessions happen. It is only worrisome because equity markets are so ‘fully valued’ that an adjustment to a recession could be rough. On the other hand, all signs point to the Federal Reserve starting to ease, and this may support stocks. I would go so far as to say that investors are counting on that.
That is a rather ordinary problem. The bigger problem has not yet been realized by equity markets, but as we look at long maturities on the yield curve we see that yields are near the highs of the year even with the Fed expected to ease. That is not normal. When the Fed eases the curve tends to steepen, because however long the period of lower short rates, it will be a larger proportion of a shorter-maturity instrument. But long rates still decline in that case, normally.
You can insert your favorite story here, about how foreign investors hate Trump, or people are worried about inflation, or the credit profile of the United States. My preferred explanation (see “The Twin Deficits – One Out of Two IS Bad”) is that if you reduce the trade deficit sharply but do not reduce the budget deficit equally sharply, then the balance must be made up by domestic savers and that implies a higher rate of interest.
There’s also some reason to be wary of the turn higher in inflation, even though that was entirely foreseen (see “Ep. 145: Beware the Coming Inflation Bounce”) and a good part due to base effects. There are, though, some signs of underlying secular rather than cyclical pressures on prices. For example thanks partly to AI electricity prices started accelerating higher in 2021 but unlike other parts of the CPI have continued to rise. The CPI for Electricity stands 35% above the level of year-end 2020, and well beyond the long-term trend. Beef prices are 41% higher and still rising.
Of course, there are always prices that are rising but there are two reasons I am more concerned about this now. The first is that the money supply has returned to a positive and rising growth rate and is at a level inconsistent with long-term price stability even before the Fed renews its easing campaign.
Five percent was once a nice level for M2 growth, when demographics and globalization were following winds. Now they are headwinds and we need to be lower. Still, I wouldn’t get panicky about 5%. Get to 8% and I’ll be more concerned. But the reason that might happen concerns changes happening at the central bank.
What gets the headlines is the continual pressure that the Trump Administration is putting on Fed Chairman Powell and others on the Federal Reserve Board, several of whom are jockeying to be dovish enough to be selected as the next Fed Chair. But the much more important development was the 5-year review of the Fed’s operating framework, which Powell discussed at his Jackson Hole speech. The significance of this was seeming lost on most investors, although 10-year breakevens have gradually risen and are up at 2.42%, and other than in the post-COVID surge they’ve not been much higher than that since 2012 or so.
These are 10-year breakevens, so this isn’t a tariff effect. What’s going on here? Not much, yet, but…there is the change in the Fed’s framework, which I think is important.
Five years ago, the Fed abandoned a specific inflation target in favor of “Flexible Average Inflation Targeting”, or FAIT, which basically said “we are targeting 2% inflation, but only over time. So when inflation is too low for a while, then it’s okay to let it run hot for a while later.” At the time, this was a clear sign that monetarists – who don’t necessarily believe there is a tradeoff between inflation and growth like the Keynesians do – were losing the battle. More flexibility to respond to inflation ‘tactically’ is not something that we needed, and it wasn’t clear how that would be a helpful change anyway.
But the current 5-year framework adjustment is worse. It basically abandoned the good part of FAIT, which was any kind of soft commitment to be hawkish in the future if necessary. In Powell’s words – and I’m not making this up – “…we returned to a framework of flexible inflation targeting and eliminated the ‘makeup’ strategy.”
Yep, that’s what he said.
There is a lot more in Powell’s explanation, but most of it all leans in the same direction. For all my historical criticism of former Chairman Greenspan, he deserves credit for this: he used to say that achieving low and stable inflation was key to achieving maximum stable employment over time. Thus, inflation was primary, not secondary, in achieving the dual mandate. Now, the Fed ostensibly wants to target a low level of inflation…because that’s what central banks are supposed to do…but recognizes that sometimes they’ll want to emphasize lower rates to help Employment – and the important part is that as I just noted, they won’t ‘make up’ for running too much liquidity now by running less liquidity later. Does anyone want to take the other side of the bet that the Fed will have an easier time lowering rates and keeping them low, than raising them and keeping them high? Accordingly, the long-term inflation outlook just got worse. I don’t think we are returning to the 1970s, but we aren’t returning to 2% any time soon – and the Fed is okay with that!
FAIT was never a very good idea, and I didn’t think it would survive the first time inflation ran too high and dictated an extended period of very tight money. It didn’t. I didn’t think they’d actively make it worse, and maybe the joke’s on me. They always make it worse.
How to Calculate USDi’s Current Value
I haven’t been writing a lot during August, nor have I done many podcast episodes. I feel like I make this apology almost every year, but it seems every year August just gets slower, and slower, and slower – and any content I push out gets less engagement during August than during any other full month (although the end of December, naturally, gets very thin as well. It’s really remarkable how August has changed during my career. In the 1990s, there were maybe a couple of weeks that were a little thin in the markets, but that has metastasized so that now it’s all of August and a week or two into July. I am speaking of the US markets – Europe has always been slow for the second half of the summer, at least in my experience, and I don’t know if there has been much change in that over the last few decades.
In any event, I’m more than happy as a writer to take a little time off and recharge. As an entrepreneur? Not so much.
This is, though, a good time for a ‘utility’ post. As readers know, a few months ago we launched USDi, the first CPI-linked cryptocurrency that’s fully backed by traditional finance assets. Because those assets for the most part reside in a private fund (which, because it’s a private fund issued under Reg D, I can’t talk much about on a public post so forgive my vagueness here about what the fund does and how), there is regularly confusion when potential buyers of USDi think that they are buying a share of the fund. They are not, for two reasons. The first is that a coin that represents a tokenized share of a traditional-finance fund would clearly be a security under US law, which creates lots of other complexities that we don’t want: for example just as I can’t tell you much about the fund, if the token was a security then I couldn’t tell you much about that, either! Which would make distribution difficult, to say the least.
The second reason that we didn’t want the coin to represent a tokenized share of the fund is that then the coin would not exactly track CPI. It is important that the coin be a zero-risk instrument, and I illustrate why that’s important in the post “USELESS Coin vs Very Useful Coin”. Accordingly, USDi’s value is entirely formulaic, and known in advance by at least a few weeks. It’s my purpose today to explain how the value of USDi is derived from CPI prints.
USDi, like TIPS and US CPI swaps, is linked to the Non-seasonally Adjusted Consumer Price Index for All Urban Consumers…the NSA CPI for short. The CPI that is released every month is related to this number – specifically, the ‘headline CPI’ is the month-on-month percentage change in the Seasonally-adjusted number. Here is where you find that number (rounded, of course) in the monthly BLS release found at https://www.bls.gov/news.release/cpi.nr0.htm:
The problem with using a seasonally-adjusted number is, you guessed it, that the seasonal adjustment factors can change. Consequently, all inflation derivatives rely on NSA numbers, which are almost never revised. In the same report linked above, the BLS notes the NSA number:
The highlighted number, 323.048 in this case, is the number that TIPS traders and inflation swaps traders care about. And, if you buy USDi, you will care about this number as well. This is the price index value defined relative to the base of 100.000 representing the average of the 1982-1984 price level. The index value of 323.048 tells you that the (quality-adjusted) price level has risen 223.048% since the early 1980s, slightly more than a tripling!
(As an aside, the BLS has an enormous number of NSA series for different subcomponents available. You can see and chart a lot of them here: https://data.bls.gov/dataQuery/find?fq=survey:%5Bcu%5D&s=popularity:D )
Now, the BLS reports this number just once a month, and in arrears. It was mid-August when they reported the July CPI referenced above. So we have two things we need to account for when we turn this into an index that USDi (or TIPS or inflation swaps) can track: 1. We have a monthly number, and we need a daily number – or in USDi’s case, one number every block, and 2. We have numbers for every month ending in July, but today isn’t July, so we need something for today. Let’s call the index value that we are going to construct, to use for TIPS/swaps/USDi, the “Reference CPI.”[1]
The second problem is handled in the simplest way possible: we just lag the data.[2]
So when we got the July data this month, we have the Ref CPI for October 1 (the 323.048 number I mentioned above). We already have the Ref CPI for September 1 (that was the June CPI, reported in July, 322.561). So now, we can straight-line interpolate the Ref CPI for any day in between those two dates, based on the number of calendar days in that month. So, the Ref CPI for September 2nd is:
1/30 * 323.048 + 29/30 * 322.561 = 322.57723
Voila, that’s just what the Treasury calculates for September 2nd, which isn’t surprising because that’s how math works.
Now, the only subtlety to USDi is that while TIPS and CPI swaps have one settlement per day USDi in principle is tradeable 24/7. That means that if we changed the Ref CPI for USDi just once per day, at 1 second before midnight every day you could buy USDi and then sell it at 1 second after midnight and get the entire day’s interest. That doesn’t seem fair. The blockchain is much closer to continuous settlement, so we have to interpolate not by day, but by block. On Ethereum (where USDi exists, initially), a block is roughly 10-15 seconds long, so USDi accrues interest basically every 10 seconds. The actual code for USDi looks at the block number and does the exact same calculation that we do above except that it is interpolating between the first block in September and the first block in October. You can get very close to the right answer by simply using spreadsheet NOW() functions, which in Google Sheets has 1-second precision. I do the approximate calculation for USDi on a Google Sheet here: https://docs.google.com/spreadsheets/d/1UnPzAu-U2zy5TEIcxgLBqkVP7QNtBJhwrwLnHt9EitM/edit?gid=0#gid=0
Let’s see, why did I want to calculate the Reference CPI? Oh, I remember: I want to find the price of USDi for a given time, in the past or present or any time up until (for now) the end of September. We have done all of the work except for the last step, which is to divide the current price level index – the Reference CPI – by the base price level index. For USDi, we defined the denominator as the December 2024 CPI. This is why we say that USDi is a dollar that preserves the purchasing power of a December 2024 dollar.
The December 2024 CPI was 315.605. Since the December 2024 CPI was also the Reference CPI for March 1st (see the handy drawing above), that means the value of USDi on March 1st was (drum roll) 315.605/315.605 = 1.000000. The value of USDi on October 1st will be 323.048/315.605 = $1.023583.
So the USDi coin is not a fund, nor a share of a fund. It is a time machine.
[1] The Reference CPI for TIPS and swaps is identical. The Treasury calculates them too, and reports them at https://treasurydirect.gov/auctions/announcements-data-results/tips-cpi-data/ (look for the PDF and XML files for the “Reference CPI Numbers and Daily Index Ratios Table.”)
[2] In principle, we could take the recent data trend and project to the current date, which would make it contemporaneous but lose accuracy…since when the inflation data is actually released, we will find out that method isn’t perfect. It would also be confusing, since on any given day in the past there would now be the actual CPI data and the previously-used projected-trend data. Since the importance of the exact timing of the price level diminishes with distance, while the two-index confusion would persist, the simple-lag method makes sense to me.
Inflation Guy’s CPI Summary (July 2025)
The inflation story and the employment story are about the only things rippling the still summer waters these days, it seems. The weak employment data in the most-recent report got equity investors very excited since every analyst worth his or her salt believes that lower rates are good for the companies he/she covers, but those companies will surely be able to avoid losing business in an economic slowdown. And, to be fair, because the goods and services sectors in the US (and global) economy are out-of-sync, any recession is likely to be fairly shallow (and being out-of-sync is probably why the recession has been so delayed – different sectors are having recessions at different times. I discussed this in last week’s podcast, Ep. 147: Out of Sync).
But the fly in the ointment would be if inflation heads higher, wouldn’t it?
Well, maybe not so much. In normal times, probably. But in today’s world there is a nice, built-in excuse for any inflation uptick: it’s the tariff effect! It is amazing how focused on tariffs everybody has been, when they forecast/analyze the CPI report. The core goods sector of the economy is about one-fifth of total consumption. Tariffs will (and finally are) driving this higher, but that story will eventually pass. Core goods will not be what keeps inflation high or sends it higher in 2026. But you know why everyone wants to focus on it? Because if you can blame the inflation uptick on tariffs, then you can argue that rate cuts still make sense. More on that later, but when you look at the monthly changes in real yields and inflation expectations you can see what is happening: yields are down, inflation expectations basically unchanged, over the last month. The best of all worlds!
Which brings us to today’s report. The consensus expectations were for +0.23% on headline CPI (seasonally-adjusted), +0.29% on core, pushing the y/y figures higher for both of them as we drop off soft data from last summer. The actual prints were +0.197% on headline (yay!) and +0.322% on core (boo!). That was the highest m/m core inflation figure since January, and the first time since then that core has been higher than consensus expectations. It also was the highest m/m core number, other than January’s tariff-related spike, since March 2024.
The category breakdown was interesting for a change because the top culprits were Medical Care, Recreation, and Other.
To be fair, housing would have contributed more except for another drop in Lodging Away from Home. Seasonally-adjusted prices for lodging away from home have now fallen 7.3% since January. I have been working on the assumption that this is a deportations story, or possibly a tourism story (I don’t really think ‘foreigners aren’t visiting the US because they hate Trump’ is really happening but in some quarters that’s the story they’re selling). But if you look at this chart and notice the times that hotel prices declined meaningfully, there’s an argument that it’s a recession story. Or that it could be, if it continues to slide.
Primary rents accelerated slightly m/m, +0.26% vs 0.23% last month, but Owners’ Equivalent Rent decelerated to +0.28% vs 0.30%. Both are playing to form, but it’s worth keeping an eye on Primary Rents here. Deportations as an inflation story would show up in Lodging Away from Home but it also could show up eventually in rents – but a recession wouldn’t be expected have any meaningful impact on rents. So how those two series behave might give us a clue. Or maybe not; perhaps I’m trying to read too much into this.
Core goods accelerated again. The bounce was totally expected, but now that we are over +1% (+1.17% y/y) we are clearly seeing some of the impact of tariffs. Core services is more interesting, though. Even with rents decelerating and Lodging Away from Home dropping again, Core services ticked higher.
Indeed, lumping core services and core goods together, but taking out shelter, and we can see that the underlying core dynamic looks like it had been bottoming anyway and might be heading higher.
A large jump in airfares (+4.04% m/m) is partly to blame this month…but in March airfares were -5.3% m/m and the worst since 2021 while today’s number was the highest since 2022. Since COVID, airfares have just been really unstable, or the seasonals have been unstable, or both. I am not worrying too much about this jump.
Airline fares are 0.9% of CPI, but this volatility has added to the overall volatility of the CPI. And before you say ‘this is a consequence of resource constraints at the BLS!’ you should realize that airfares are not collected by people with clipboards but by web scrapers. However this is yet another reminder that Median CPI is a better way to look the overall trend, so as not to be distracted by little categories. My early guess at Median this month is +0.276%, a bit better than last month. But there is nothing here that looks to me like a moderating trend to lower inflation.
In fact, median y/y ought to tick higher again this month to about 3.65%. It is stabilizing in the high-3s. The next few monthly figures to drop off will be 0.3s, so I don’t think we will see median y/y head back to the 4% level. But having said that, there is one development that bears watching.
Core services less rent-of-shelter, aka “Supercore”, rose +0.48% m/m. If higher tariffs and deportations lead to more domestic employment and higher wages – which they should, but it isn’t yet really in the data as employment looked weak and the Wage Growth Tracker ticked down to +4.1% y/y this month – then this part is what will keep inflation uncomfortably high even if rents continue to decline (I don’t see them declining lots further than this) and goods inflation eventually declines after the tariff effect passes through. That isn’t today’s story. But it might be a 2026 story. Stay tuned. At the tails of the distribution this month we had greater than -10% annualized monthly inflation from three non-core categories while greater than +10% from eight non-core categories – including motor vehicle parts and equipment and miscellaneous personal goods, which are tariff stories, but also tenants and household insurance, miscellaneous personal services, public transportation, and motor vehicle maintenance and repair. Those are all service stories. As is this one, although it’s also a goods story indirectly (I explain further in the Q3 Quarterly Inflation Outlook, due out tomorrow – subscribe at https://inflationguy.blog/shop).
Overall, the underlying trend is the same: we’re settling in the high-3s for median inflation. Last month, I said that unless the economy starts to soften more seriously there just isn’t a good argument right now for rate cuts and the optics of rising year/year inflation would make it more challenging for the FOMC to consider an ease. That is still true. If Fed credibility matters to inflation, then inflation should start heading up because we are clearly getting more doves. If tariffs matter, inflation should be heading up because the tariffs are now showing and will be an effect for a while. If money growth matters, inflation should be heading up because M2 growth is back to +4.5% and accelerating.
But the core question is whether the Fed cares about inflation right now. Listening to their public statements, it doesn’t appear they do. One might argue that they are just supremely confident that if the Unemployment Rate heads higher, inflation will head lower so they have some room to move. To be honest, “supremely confident” and “Fed official” are not phrases that should appear in the same paragraph except sardonically. Nevertheless, the Fed is likely to ease soon, and likely multiple times before the end of the year.
And they’re worried that President Trump is going to hurt Fed credibility! That’s a little like the streetwalker who is afraid that this skirt is going to make her look cheap. Honey, that ship has sailed.
One final announcement. If you’re an investor in cryptocurrencies (in particular, stable coins) and have a Telegram account, consider joining the read-only USDi_Coin room https://t.me/USDi_Coin where the USDi Coin price is updated every four hours or so…and where many of these charts are also posted shortly after CPI just as I used to do on Twitter.
An Update/Reminder on Rent Inflation
A subscriber to our Quarterly Inflation Outlook (you can subscribe here) wrote to me recently and asked about a research piece put out by a major sell-side investment house that discussed how private rental indices (such as Zillow) and the Fed’s NTRR (“New Tenant Rent Index”, as defined in a paper by the Cleveland Fed’s Randall Verbrugge a couple of years ago called “Disentangling Rent Index Differences: Data, Methods, and Scope”) were indicating that a decline in rent inflation was on the way. I felt like it was time for an update on this topic, since it has been a little while since the exact same arguments made the rounds a few years ago.
I even had a podcast (Ep. 74: Inflation Folk Remedies) in July 2023 in which I discussed (among other things) the NTRR issue. So the deceleration of Zillow and the other private rent indices, the NTRR which was forecasting sharply negative rent growth (before revisions!), the supply of new rental units – all of those are arguments from 2023!
Here are rents. The black line is the actual CPI for Primary Rents, y/y. In July of 2023, it was at 8%. You may notice that it never went negative in 2023 or 2024, and isn’t showing any signs of going negative in 2025.
Before I go any further, here is sufficient reason to ignore the NTRR, in addition to the other arguments I’ll make in a bit. Here is the chart of the NTRR from the 2023 paper.
And here is the updated NTRR from Bloomberg today. You will note that the 0% print in 2023Q1 from the 2023 paper has been revised up to around 4.5%. That’s even higher than the upper edge of the error range in the prior chart.
So forgive me if I don’t panic at the -2.2% current reading of the NTRR. Here’s the problem: the conviction among economists in 2023 (not just the Fed economists, but it was a general consensus at the time that rents were about to collapse) that the “stock” of rent inflation would eventually respond to the “flow” of new rents is just not how rents work. The new rents are not indicative of new conditions while the stock isn’t…those are two totally different populations.
There are people who turn over rents and move with some frequency, or who are moving now for one reason or another, and there is a stock of open units that landlords want to fill. But just because a landlord offers a low rent to fill his one open unit has nothing to do with his desire to cut rents on all of the units that aren’t turning over.
What is amazing is that the only reason this ever looked like it worked was because when both rates are very low, the noise outweighs the signal. So there’s no data for economists to really test the hypothesis on a period that matters because it’s similar to the current period of generally rising prices. But if economists just spoke to landlords, they would understand. That’s what I did, and the reason that in 2023 I switched my model from a top-down to a bottom-up (which is the dotted line in the first chart above…and that was not revised significantly). If costs are growing for landlords, they aren’t going to be cutting rents for their tenants even if they want to cut them for new tenants to fill a unit.
It should not be a surprise that the ‘faster’ NTRR has large error bars and large revisions. Essentially, the idea behind those indices is that they take the same rent data the BLS generates and squeeze out several different indices, some of which are “faster.” But basic information theory says you can’t get 3 bits of data from a pile that holds 1 bit, for free. What happens is those new indices are faster…but they have huge error bars that are huger the shorter the forecast length. Duh. Which means you can’t reject any null hypothesis about the near-term path. In the original paper they mention this and they show the data on the variance but they didn’t really explain it well. The short way to describe the problem is that you can’t get three pounds of crap out of a one pound bag. Period.
Now…having said all that I do entertain the possibility that rents could slow meaningfully further than here, even more than the mild softening that my model has. But my reasons for that are different:
- Rents in NYC will likely decline sharply if Mamdani wins, partly because jobs will absolutely flee the city but mainly because of his not-very-veiled-threat to seize property if they don’t. The smart landlords will dump their property at any price and get out, but some will try to ride out his term as Mayor. That’s unlikely to work but they’ll try. And NYC is a big part of the rent indices (by the way, one hedge for this is to sell the Shiller NYC property index, which futures trade (thinly, but they trade) on the CME. Combined with naturally slowing rent growth from some of the really hot but now getting overbuilt areas – like Miami – and you could get the overall indices to look better than the median would.
- (Offsetting this but probably nearer-term, LA rents will be buoyant for a while and maybe more sharply once the wildfires are further in the rear-view mirror so the claims of “profiteering” can be ignored. They bounced right after the fires destroyed a huge number of units but predictably people screamed at landlords so that stopped. But supply and demand, you know. There are fewer rental units in Los Angeles, and rents are going to go up faster as a result).
- If mass deportations really do turn into mass deportations, then what we are already seeing with Lodging Away from Home could become broader pressure on rents. The hotels were where the newest and biggest wave of illegal migrants were housed in the big cities. Elsewhere, they live in apartments and sometimes own homes when they have been here for a while. I can’t imagine the government will be able to deport more than say 1mm over the next year or two. That would be 2000-4000 per work day, and while the illegal immigrants generally walked in they generally have to be flown out. However, 1mm is still a big number and if enough other illegals ‘self-deported’ so that you’re talking about a million households then you’d have to consider a good chance of significant housing disinflation as the stock of rental units – currently just barely out of shortage – becomes a glut from the demand side.
But note that neither 1 nor 2 is currently something that you’d be able to detect with NTRR or Zillow or other rental indices. Maybe at the margin we could see deportations affecting rents in some of the ‘sanctuary cities’ where a lot of the deportations are concentrated, but I doubt it. Too soon.
In any event, my forecast for rents is not super-aggressive and I recognize there are mostly downside risks associated with those enumerated reasons. But right now? In the data? There is nothing that looks like it spells housing deflation.
