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Inflation Guy’s CPI Summary (Apr 2024)
The CPI for April came in pretty close to expectations. CPI came in at 0.31% m/m, and 0.29% on core, versus a priori expectations for 0.37% and 0.30%. This relative accuracy does not necessarily mean that economists now know exactly what is going on in this index, only that all of the misses canceled out. But the misses are interesting, and worth looking at, and we will do that here. Ultimately, reports like this mostly create an opportunity for framing the debate on whichever side you are on. But to my mind, this report does not meaningfully move the ball towards ‘price stability’ and leaves the Fed – if they’re being honest – still in a bind between slowing growth and sticky inflation.
Not all parts of the CPI were sticky, and that’s the point here. Actually, that has been the point for quite a while, but it was very stark in today’s report. Here’s the distribution of y/y changes in bottom-level components in the CPI. Today, the left hand stuff got lefter, the right-hand stuff got a little righter, and the middle stuff stayed about the same.
I don’t usually lead with the distribution, but it is important to keep this in mind. Inflation is not, especially at lowish levels (say, less than 5-8%), a smooth process. I used to liken this to the process of popcorn popping in a bag; the bag inflates but not because all of the kernels popped at once. The good news is that the popping is slowing, as the Fed has removed some of the heat from the bag, but the pops are still happening.
Now, here’s the good news. Thanks to core CPI being on target, the 3-month, 6-month, 9-month (well, never mind that one), and 12-month averages all decelerated.
Median inflation won’t be out for a couple of hours, but my estimate this month is 0.348% m/m, essentially unchanged from last month. That’s sort of the bad news – the y/y median CPI should be stable this month at 4.5%.
So, I think the bold type for the top line is this: inflation is decelerating, but slowly, and in a sticky fashion. The markets loved that answer and stocks and bonds leapt on the report. But that’s all framing. The debate coming into today was never about whether inflation was declining – it has been, for a while, and is expected to (even by me, and I’m on the high side of Street expectations by a fair amount) until at least Q3 and probably into Q4. That wasn’t the question – we have known since the middle of last year that 2024 would see decelerating inflation. The question is whether the deceleration will continue after that, and whether it is decelerating to 3.75%-4.25% or 1.75%-2.25%. There is as yet no sign of the latter and all signs still point to the former, because the sticky stuff is not yet unstuck.
And that continues to boil down to this: deceleration is still being driven by core goods, and resistance to that deceleration by core services.
Core goods fell to -1.3% y/y this month. I have been saying that we’ve squeezed about all we can out of core goods, and then it drops from -0.7% to -1.3%, the lowest y/y figure in 20 years! This happened even though Apparel rose 1.2% m/m. As usual, the main culprits were autos with Used Cars -1.38% m/m after -1.11% last month, and New Cars -0.45% m/m. Ironically, I think the continued softness in autos is due partly to the continued rise in motor vehicle insurance costs (which were +1.4% m/m again). We hear a lot about the affordability of housing, but you gotta have housing. You don’t gotta update your car.
The softness in core goods is welcome, naturally, but that’s the volatile part of CPI. And such low levels are only sustainable if the dollar continues to strengthen.
On the other hand, core services only softened to 5.3% y/y from 5.4%. A lot of that is housing, with OER +0.42% m/m (was +0.44% last month) and Primary Rents slowing to 0.35% from 0.41%. But outside that, ‘super core’ (core services less rent of shelter) is actually still bouncing higher. It’s 4.91% y/y – below the 6.5% it got to in late 2022, but well above the lows from October (3.75%).
Some people will like the fact that the m/m Supercore was “only” 0.42% or so, which is down from recent months. But that’s a little deceiving. Airfares were -0.81% m/m, car/truck rental -4.6%, and the monthly health insurance bump has run its course and is back to a more normal m/m change (positive, but at a 3.5% annualized rate). Longer-term, we still have to worry about the continued acceleration in, say, hospital services, which is +7.7% y/y. I pointed this out last month, and the picture is no prettier this month.
One other comment/update on rents. It is proceeding according to expectations, although I expect a slightly faster rate of deceleration for the next quarter or so. But then, all the signs are that rents are going to re-accelerate. Even those terrible indicators that inflation dummies (this includes Yellen and most of the Fed) relied on to forecast that rents would be in deflation this year…even those indicators are showing a bounce to come. Home prices are accelerating again. And none of this is surprising given that landlords are facing higher costs and increasing demand (6 million immigrants need roofs). And this is why the inflation dummies are inflation dummies – there was never, never, a good argument for why rents should be in free fall, if you just spent 10 minutes talking to an actual landlord. Get your heads out of your models and look around occasionally, dummies.
Okay, so that was a little strident but I am getting a little tired of asking potential clients how they are addressing inflation and hearing them tell me about their economist. Inflation hedging ≠ economists. Come on, people.
Let’s take this around to what we care about, and that’s policy. The Administration is trying to help the inflation figures by delaying the refilling of the Strategic Petroleum Reserve if prices go up, but is also implementing new tariffs on Chinese goods. That answers the first WWJD question (what will Joe do) – in an election year, actions which cause inflation next year are fine…just not anything which causes inflation this year. The other WWJD question (what will Jerome do) is still interesting. Growth is indeed slowing, and has been slowing for some time. Consumers are looking a bit tired, and unemployment is rising slowly. But inflation is not behaving. Median inflation won’t get below 4% until September at the earliest, and even optimistically won’t get to 3% before it starts to bounce. Before, the Fed could pretend that the new rent indicators showing widespread deflation gave it some latitude to move before the rent decreases actually arrived, but that isn’t a plausible argument any more.
However, the FOMC has started to lean more dovish. The significant decrease in the rate of taper that was announced at the last meeting clearly shows which way they are leaning. The case for a rate cut later in the summer (absent some financial crack-up that needs to be addressed) would be based on the Committee members’ sense that the current policy rate is above neutral and can be moved back towards neutral as the risks become ‘more balanced.’ Additionally, doves could argue that they don’t want to be seen easing right before the election so an ease at the end of July is a ‘down payment’ on looser policy later. The inflation data don’t support that, but the Fed doesn’t care only about inflation data. If I was on the Committee, I would not vote to loosen the taper or lower rates, but I would not be surprised to see a token ease at the end-of-July meeting. It would be cavalier, and possibly political, and not supported by the data we currently have in hand…but it wouldn’t surprise me.
One final administrative notice to those of you who subscribe to the Quarterly Inflation Outlook. The Q2 issue is expected to be published this Sunday, so look for it! (And subscribe, if you haven’t).
Bounce in Money Growth is Good News and Bad News
The monthly money supply numbers are out. I have bad news and good news.
The bad news is that the contraction in the money supply appears to be over. That’s not bad news per se (see below), but it’s bad in that the anti-inflationary work that was happening is coming to an end before it’s quite finished. Although I would be reluctant to annualize any one month’s change in M2, the $92bln increase in M2 in March was the largest increase since 2021. It only annualizes to 5.5%, so it isn’t exactly running away from us – but it’s positive. The 3-month and 6-month changes are also positive, and the highest since early 2022 in each case. Again, we’re only 0.72% above the ding-dong lows of last October, but the sign is now positive.
With the money supply figures now in, and with the advance Q1 GDP report due this week, we can revisit our chart of “how much more inflation ‘potential energy’ remains.” (see “Where Inflation Stands in the Cycle,” November 2023). As that article (and this chart) illustrates, if M2 doesn’t go down then this gets more difficult. M2 in Q1 rose at a 1.24% annualized rate over Q4. GDP is expected to rise 2.5% annualized. So M/Q…barely moves, as the chart shows.
We will eventually get back to the line, unless velocity is permanently impaired. Despite all of the crazy people who told you it was, there’s no evidence of that. M2 velocity will rise about 1% (not annualized), if the GDP forecasts are on point. That will be the smallest q/q change in several years, and velocity will be getting very close to the 2020Q1 dropping-off point. But there frankly is no reason for velocity to stop there; higher interest rates imply higher money velocity. However, we are getting close.
(Incidentally, if you’re curious how we can be almost back to the dropping-off point of velocity and yet still be 5% below the line in the first chart above, it’s because I’m using core inflation. With food and energy, we’re a little closer to the line and have used up more of the ‘potential energy.’ But food and energy are of course volatile and so while a good spike in energy prices would look like we’ve used up all of the potential energy, that could just be a one-off effect.)
Either way, we aren’t too far away from getting back to home base and that’s good news. Yes, prices by the time we are done will have risen 25% since the end of 2019, and that can’t really be characterized as a ‘win.’ Let’s go Brandon. But we are getting closer.
The good news about the new rise in M2 is that it’s timely. Markets and the economy were starting to show signs of money getting a little tight; losing a little lubrication in the machinery. An economy does need money to run, and while the only way we can get back to the old price level is to have money supply continue to decrease, that’s also a painful process. In the long run, we would have price stability if the change in M was approximately equal to the change in GDP. If we want 2% inflation, then we need M to grow about 2% faster than GDP. Vacillating velocity means that it isn’t purely mechanical like that – the steady decline in velocity since 1997 is the only reason that inflation stayed tame despite too-fast money growth over that period – but the long downtrend in velocity is likely finished since the long decline in rates is finished. Thus, if we get money supply growth back to the neighborhood of 4%, we can get our 2-2.5% growth with restrained inflation over time.
I am not super optimistic that all of that will work out so nice and cleanly like we draw it up on the chalkboard, but I am more optimistic about it than I was two years ago. We still have some sticky inflation ahead of us, but if the Fed keeps reducing its balance sheet then eventually we will get inflation below the sticky zone and back towards ‘target’ (even though there isn’t a target per se any more).
Inflation Guy’s CPI Summary (Mar 2024)
After a week when the NY/NJ area saw an earthquake, an eclipse, and a gorgeous 75-degree spring day, it is time to get back to work.
Today’s CPI report was not expected to be particularly great. In fact, one of the biggest conundrums of market behavior recently has been the question of why investors seemed to remain very confident that the Fed will cut rates several times this year, even as forecasts for the path of inflation have backed off of what they were last year (when most forecasters had core CPI returning placidly and obediently to the neighborhood of 2% this year). The a priori consensus forecasts for today’s CPI figure were +0.28% m/m on core and +0.33% m/m on headline. The Kalshi market was in line with that, although CPI swaps were a touch lower on headline at +0.29% (seasonally adjusted, but CPI swaps trade NSA CPI). That’s not wonderful: 0.28% on core would annualize to 3.4% y/y.
The assumption has been that even if in March we are annualizing to 3.4%, the coming deceleration in rents will push everything back down to where it needs to be. The problem with this has always been (a) the strongly-held belief that rents would slip into deflation this year were never based on good analysis, and more importantly (b) this assumed that nothing unforeseen would happen in the other direction. It is characteristic of inflationary periods, of course, that bad things happen on the upside. So this was always sort of assuming a can opener,[1] but at least forecasts for the current data were reflecting that these things had not happened yet. To be fair, the consensus on core has been low relative to the actual print for four months in a row, but at least folks are forecasting mid-3s, rather than 2.0.
Now, let’s review one other thing before we look at some charts. The recent story boils down to this: sticky rents, sticky wages. While core goods has been pulling down core inflation, that game was running out of room. The next part of core deceleration relies on un-sticking the sticky rents, and sticky wages.
So here we are. Today’s figure +0.36% on core CPI, +0.38% on headline (seasonally adjusted on both). This makes the last 3 core CPIs 0.39%, 0.36%, and 0.36%. The chart below of the m/m core CPI figures does not really give the impression of a decelerating trend.
We always look these days first at rents, because that is so important to the disinflation story. Rent of Primary Residence was +0.41% m/m, down from 0.46% last month. Owners’ Equivalent Rent was steady, at +0.44%. Remember that there had been some alarm two months ago, when OER for January jumped to 0.56%, that this was due to a new survey method or coverage and it was going to be repeated going forward. That was always pretty unlikely, but now we have had two months basically back at the old level and the January figure appears to be an outlier. 0.41% on Primary and 0.44% on OER is not hot, just sticky. It isn’t going up; it’s just not going down very fast.
Rents will continue to decline. But the failure of rents to slip into deflation is a source…maybe the source…of the big forecast error made by economists about 2024 CPI. Our cost-based model for primary rents, which never got even vaguely close to deflation, has now definitively hooked higher with the low coming in November. Rents haven’t been decelerating as fast as our model had them, but if anything that’s a source for concern on the high side.
Outside of rents, core inflation ex-housing rose to 2.38% y/y. That sounds like “most of the economy is on target,” but that’s not how inflation works. There’s a distribution, and if the ‘rents’ part of the distribution is going to be higher than the target then everything else needs to average something below the target. We aren’t there. And, as I noted above, we’ve squeezed out just about everything we can from core goods. Actually, y/y core goods dropped to -0.7% thanks partly to continued declines in Used Cars (-1.1% m/m) and some decline this month in New Cars (-0.2%). I think the latter might partially reflect discounts on the EV part of the fleet, where cars for sale have been piling up as manufacturers under political pressure have been producing far more of them than people want.
Note that core services, even with the decline in y/y rents, moved higher this month to 5.4% from 5.2% y/y. Some of that was medical care, which was +0.49% m/m driven by another jump (+0.98% m/m) in Hospital Services. The y/y rise in Hospital Services is now up to 7.55% – the highest since October 2010.
Partly driven by hospital services, the ‘super core’ (core services ex-rents) continues to re-accelerate.
Again, this is not what the Fed wanted to see; and it’s driven partly by the stickiness in wages. The Atlanta Fed’s Wage Growth Tracker has decelerated but is still at 5.0% y/y. That’s not the stuff that 2% core inflation is made of.
Let’s take one moment to look at a piece of good news from the report. My estimate of median CPI, which is my forecast variable because it is not subject to outliers like Core CPI, is +0.32% for this month. Because I have to estimate seasonals for the regional housing numbers, actual Median might be a teensy bit higher or lower but in any event the chart of Median CPI is much less alarming than the chart of Core CPI.
I should observe that the news there is not completely good, since a signature of inflationary environments is that tails are to the upside – that is, core is persistently above median. That was true during the upswing, but during the moderation core has gone back below median. But this bears watching, and if core starts to routinely print above median it will be a negative sign. For now, though, the Median CPI is good news. Relatively.
So let’s talk policy.
The Administration always seems to be confused about why, despite strong jobs numbers, consumers consistently report dissatisfaction with the economic situation. There really shouldn’t be any confusion. Consumers, especially those not in the upper classes, hate taxes. And in addition to a high direct take from the government in explicit taxes, consumers are also facing persistent inflation that the Administration says isn’t there. Inflation is a tax, and it sucks worse than direct taxation because you can’t rearrange your consumption very well to avoid it. (You can rearrange your investment portfolio, but a strikingly small number of people seem to have actually done that even three years into this inflation episode. If you’re curious about how, you really should visit Enduring Investments and ask.)
On the other question of policy, and that’s the Fed: I can’t see any rational argument for cutting rates in June. Actually, on the data we have in hand I can’t see an argument for cutting rates in 2024, except for the one the Fed doesn’t consider and that’s that interest rates don’t affect inflation. To cut the overnight rate, the Fed would have to rely on forecasts that inflation is going to get better. And to do that now, when forecasts have been persistently wrong (and not by just a little bit but about the whole trajectory) since 2020, would be incredibly cavalier. The FOMC still consists of human beings, so never say never. And the inflation data should improve as the year goes along and rents moderate. I just don’t see any sign that it’s going to moderate enough to say ‘we’ve reached price stability.’ Sticky in the high-3s, low-4s is still where I think we’re coming out of this.
[1] A physicist, an engineer, and an economist are stranded on the desert island with nothing but a crate of canned food. “How are we going to get the food that is inside of these cans?” asked one. The physicist says “well, we could heat the cans, carefully, in a crucible we make from ocean clays. Eventually the heat will cause the can to burst and we can get the food inside.” The engineer says “that will take too long. What we need to do is take some of these coconuts, raise them up to a great height with a series of ropes I will design, and allow them to smash down onto the cans, breaking them open.” The economist says “I have a solution that is far easier than what you fellows are doing. Here is how we do this. First, assume a can opener….”
Inflation Guy’s CPI Summary (Jan 2024)
This is the reason that serious people don’t choose a trend length that happens to fit with their narrative. For the last few months, supposedly-serious economists have crowed about how the 3-month average of seasonally-adjusted CPI was at a new post-COVID low. (Most of those same economists, only a few months ago, were focused on the 6-month average, but when that started crawling higher they switched to the 3-month average.) And indeed, it was exciting. Headline CPI was down to 1.89% on a seasonally-adjusted-three-month-average; core CPI was at 3.30%. Victory over inflation was proclaimed! Inflation was back at target, even a bit below, so the Fed should start easing policy forthwith.
Fortunately, and maybe surprisingly, Chairman Powell is built of stronger stuff.
As a ‘Cliff’s Notes’ guide to what you’re going to read: all of those folks who loved the 3-month average when it was 1.89%, aren’t going to be as vocal about it now that it’s at 2.80%. Core, on a 3-month average basis, is at 3.92%. The 6-month averages also rose.
Now, this doesn’t mean that inflation is necessarily headed back higher yet. I’ll get to that in a bit, but I will allow as how the picture of m/m core CPI, below, might be perceived by some as discouraging.
Prior to this figure, consensus was for a fairly strong report, 0.16% on headline and 0.28% on core. I thought it would be softer, because rents on the basis of my model should start to decelerate soon. But, as I said in my podcast, if rents were high then you should look past rents. They’re going to decelerate over the next 6 months or so, to around 3% y/y, and then re-accelerate. That’s all baked in the cake, and it will flatter the inflation data. But it hasn’t happened yet! OER was a massive +0.56% m/m. Primary Rents were more in line with what I was looking for, with a small deceleration to +0.36% m/m from +0.39% last month. The indices are still decelerating…just not as rapidly as I think anyone (myself included now!) expected.
Lodging Away from Home was +1.78%, which was a big m/m figure and contributed to the overall housing subindex being +0.62% m/m at a time when shelter should be decelerating.
But as I said, if this surprise was all OER then we can look past it.
Core Goods was weak, which was a downside surprise. Used Cars fell -3.37% m/m, which is far worse than any surveys saw this month…but as I pointed out last month, Used Cars had been surprisingly strong compared to the private surveys so this is partly a make-up and it contributed to the weakness in Core Goods.
Medicinal Drugs was also weak, -0.54% m/m, and that’s also in Core Goods. Overall, Core Goods – which had shown some signs of life – dropped back to deflation y/y this month.
Going forward, I don’t think core goods will stay in deflation. Partly, that’s because supply chains are being stressed again due to drought in the Panama Canal and the effective shutting of the Red Sea to container traffic, but it’s also partly because there is continued interest in ‘nearshoring’ which will raise costs (after all, it was to lower costs that firms offshored stuff in the first place. And then there’s also this, for the medium term. To be sure, this level of growth in Personal Consumption in the past was consistent with mild deflation – but that was pre-nearshoring. The direction is what I’m interested in, but I also think that for a given amount of PCE growth, we will see more core goods inflation in the future.
So now we turn to the really interesting part of the report, and that’s core services ex-shelter. I’ve been saying for a while that this category was going to be a sticky wicket because wages are still rising at a 5% y/y pace. And indeed, the wicket is sticky. This month, airfares rose +1.4% (this may have been related to jet fuel tightness on the east coast), but also again we saw a continued acceleration to Hospital Services, which rose to the highest y/y rate (+6.7%) since 2011.
Overall, core services ex-shelter (so-called “Supercore”) rose +0.85% m/m, the biggest rise in a couple of years, and the y/y measure is in an upswing.
Overall, this report is deflating…pun absolutely, 100% intended…for those who thought that inflation is settling gently back to target and that the Fed therefore can lower interest rates back to where we have a God-Given Right to have them, 2% or so. Not so fast! Median, by the way, was also a scintillating +0.53% m/m, the highest since last February. Thanks to base effects, the y/y Median CPI was essentially flat, at 4.90% y/y.
Because of the deceleration in housing I expect, I continue to see Median slowing to the high-3s, low-4s over the middle of this year. But it is going to have a hard time getting lower than that. In the short-term, we have saucy performance from core services ex-shelter. In the short- and medium-term, core goods is going to get out of deflation (although I don’t expect it to rise very far). And then housing should re-accelerate, though not back to the old highs. In short, inflation is a long way from being beaten. I am sure that somehow, that’s bullish for stonks, but I can’t figure out why. (I hear the 3-month moving average of the last four months of CPI, dropping the highest month, looks good.)
Inflation Guy’s CPI Summary (Dec 2023)
You can follow me on X at @inflation_guy. 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!
I’m changing the way I do the monthly CPI analysis. Doing it live for an audience was always stressful, especially with the inevitable data issues from time to time. Of course, as an inflation investor/trader I’ll still do it live; I just don’t have an audience. The nice part about doing it live was that the monthly report had a very similar structure to it with the same charts all of the time, and that will change. But it also means that I can lead with the important stuff sometimes, like this month. So I’m going to start today’s discussion of the slightly above-consensus CPI report (+0.31% on core, vs expectations for +0.25%) by saying the quiet part out loud:
Rents aren’t collapsing. They are decelerating, and they will continue to do so, but they are not going into deflation. Everyone today seems to be acting as if this is some huge shock, but it really isn’t. The only reason to ever have thought there would be rental deflation in an environment of housing shortage was that some of the high-frequency rent indices (which are not designed to be high-quality data; they’re data derived from a business that have been packaged as if it is high-quality data) suggested declines in rents, and an influential article – I talked about it in episode 74 of the Inflation Guy podcast – popularized the notion that you could get more information from the BLS by looking at less data. But the cost side has never improved for landlords – in fact, it keeps getting worse – so it was hard to see how there would be a general decline in rents. In some parts of the country, from which people are migrating away, e.g. perhaps inner cities, rents may fall. But those people have to go somewhere. Big migration means the housing stock is now all in the wrong places, and rents go up when there’s a shortage faster than they fall when there’s a glut.
Anyway, both my costs-based rents model above and my old rents model below suggest the same destination for rents – middle of this year or just afterwards, y/y rents should get to around 2-3%. That’s a lot lower than the current run rate for rents, of +0.47% m/m for OER and +0.42% for Primary rents this month, but it’s also far above what the general expectation has been for this large part of the consumption basket. Moreover, it appears that the longer-term pressures are for that part of inflation to scoop back higher, not lower.
So, today’s rents number was a little surprising, but not that surprising. Some are attributing the miss today to ‘just rents,’ as if it’s okay for the largest part of the CPI to have a trajectory that’s confounding many forecasts, but it wasn’t just rents. Median inflation was +0.42% m/m, keeping the y/y number above 5%. And three of the last four figures have been in that zone. Median should keep decelerating too, but it is not collapsing.
Now, I’ll note that Used Car prices were weird, again. They rose +0.49% m/m, when I (and most folks) had expected a decline. They’ve been a bit squirrelly for a while, with official inflation printing higher than the private surveys fairly persistently for 6-9 months. But on the other hand, airline fares have been persistently squirrelly lower compared to jet fuel, so these two things were ‘errors’ in the opposite direction. This month, airfares also rose, by about 1% m/m – but that was right about where it should have been given the change in fuel prices and not a surprise.
Now, the diffusion stuff is looking better, and supports the idea that median inflation will continue to decelerate.
Such a deceleration has been and continues to be my forecast. I expect median inflation to settle in the high 3%s, low 4%s, and be hard to push much below that. In the near-term, meaning maybe by early H2 of this year, we could get some numbers a little below that as the rent deceleration continues. But then the hook happens. It will be hard to get inflation below 3% for very long, especially if the Fed decides to stop shrinking its balance sheet and money supply growth recovers.
So the system is normalizing after COVID (and more relevantly, after the spastic and dramatic fiscal and monetary response to COVID). But normal is no longer sub-2%. Core services ex-shelter (so-called “supercore”) abstracts both from the deceleration in housing and the sharp drop in core goods, and it is hooking higher (this is partly because Health Insurance had been artificially depressing it and that effect is waning).
Supercore is unlikely to really plunge either. Wages remain robust. The Atlanta Fed just released its Wage Growth Tracker, at 5.2% for the fourth month in a row. The spread between median wages and median inflation, which had been stable around 1% for a long while, is heading back there (see chart). So again, we’re looking at something around 4% for median inflation unless wages start to decelerate…and there’s as yet no sign of that.
The bottom line is that while this number was only a little bit surprising, it was surprising for all the wrong reasons. There is nothing in this figure that suggests the Fed can comfortably abandon a tight-money policy and think about easing soon, and I don’t expect them to do so.
Summary of My Post-CPI Tweets (Nov 2023)
Below is a summary of my post-CPI tweets. You can follow me on X at @inflation_guy. 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 for December (November’s figure). This is the last month I’ll be doing this live!
- Thanks to all of you who have subscribed, voting with your dollars that this was useful. I’ve suspended all renewals so you will no longer be charged after today. I’m deeply grateful that you participated in this experiment. Thank you!!
- As in the past, if you miss the live tweets, you can find a summary later at https://inflationguy.blog and I will podcast a summary at inflationguy.podbean.com . Those will continue in 2024 after the live tweeting stops.
- For this month, I’m on top of the consensus economists’ forecasts for core, but higher for headline. I left Cleveland Fed out because it’s routinely the worst.
- Here’s a rough sketch of where I get my core. Average of the last 3 core numbers is 0.28%; average of the last 6 is 0.26% but that includes a couple of outliers. Average of the last 6 median CPIs is 0.34%. Roughly, overall trend core is about 0.28%.
- But we have to add 1bp for Health Insurance; and I’m writing in -1% m/m for Used Cars which is a 3bp drag. That’s an abbreviated version of how I get 0.26%, but it’s pretty close.
- A quick word on Used Cars, which I have as a drag but some of the big shops have as a +. Black Book fell about 3.7%, seasonally adjusted, last month. The seasonals are an add back, but the add back is much less than the decline. I might be wrong on this, but I don’t see the add.
- That said, there were several months recently that SHOULD have been an add, and were a subtraction, so maybe some economists are expecting a correction. Or maybe my model is just bad.
- What I am NOT including is any drag from airfares. If you’ve followed these tweets in the past you know that airfares have been quite low for the level of jet fuel prices (see chart, red dot is end-of-Nov fuel and end-of-Oct SA fares)
- This month, jet fuel prices plunged, so I think some people have penciled in a decline in airfares. And it could happen. But all this really does is move fares back in line with the current jet fuel (yellow triangle, if NSA fares were unchanged).
- FWIW, there is no strong seasonal adjustment from Oct to Nov in airfares. They tend to drop in December, but that shouldn’t be in this report.
- Previously, I’d been assuming a boost from airfares moving back in the direction of the trendline. That hasn’t happened. If again the dots move just parallel to the line, the jet fuel drop implies about a -3.3% decline in airfares, which is worth 2.5bps on core.
- So if we get a low number like that, the first place I’m looking is shelter (just because it’s big); the second place is airfares.
- Obviously we’re still going to watch shelter. OER was +0.41% m/m and Primary Rents +0.50% last month. I expect both of those to be lower. On the other hand, Lodging Away from Home should swing in the other direction, so shelter overall should be similar to last month.
- Fair disclosure that my Primary Rents model starts to drop fairly rapidly now, so if I take the number naively then I’d be penciling in 0.32% m/m for Primary Rents. That would be much lower than anything we’ve seen m/m yet. And, anecdotally, I don’t see that yet.
- Finally – my headline ‘forecast’ is higher than others’. And that’s because of piped gas, and because I don’t get fired if I miss. Natural Gas spiked in October; given usual lags that SHOULD mean ‘Piped Gas’ is higher this month.
- That would add 7bps, while gasoline drags about 22bps. But subsequent to that, Nat Gas has dropped sharply. And I don’t think most people want to forecast HIGHER gas and try to catch the zig-zag. Safer to just forecast flat.
- If it’s flat, then my headline is exactly in line w/ CPI swaps: -0.21% m/m NSA, +0.10% SA headline. But if I’m taking the mechanical drag from gasoline then I’m taking the mechanical bump from Natty. (Although to be fair, gasoline passes into CPI directly and Natty doesn’t.)
- Turning to markets. Market movements this month are all lower, as the massive bond rally can be seen in real rates and in breakevens.
- Let’s not lose sight of the fact that the monetary metrics are continued good news. M2 is still negative y/y and q/q. And bank loan growth is also very soft (a lot of that is mortgages though).
- Now, you can kinda think of the ‘potential energy’ as the amount the line moved above some trend…say 5%, 6% money growth or loan growth…and it needs to ‘absorb’ that by being below by a certain amount (or the price level will be permanently higher, which is likely the case).
- How long can money growth be below 0? I’ve already been surprised! But if the market is right about the substantial Fed easing in 2024, then money growth will not stay low enough, for long enough, to get inflation back to where everyone wants it.
- OK, bottom line is that everyone is forecasting a SOFT 0.3% on core, meaning that it will round up and barely keep y/y rounding to 4.0%. If shelter comes in soft or airfares moves with jet fuel, it will be a downside surprise.
- But stocks are already on the roof and bonds are 75bps off the high yields. I am not sure an 0.23% or 0.24% on core will be greeted with a tremendous market rally. But 0.31%…or heaven forbid an 0.34% that turns Core CPI up a tick? That would be ugly.
- Ergo I think a downside surprise is the bigger chance, but the smaller effect. I’d sell the initial pop. An upside surprise: I wouldn’t try to catch the knife. Especially in illiquid year-end conditions.
- So that’s a wrap. Good luck today, and thanks again for your persistent support!
- Humorously, it looks like Twitter changed its authorization hooks again. So the auto chart will be manual again. Wish it could have been smooth for this last month! I’ll do it pretty quickly though.
- Well, +0.097% on SA headline, and +0.285% on SA Core. Higher than expectations, but not by much.
- Immediately jumping out is OER at +0.50%, higher than last month’s +0.41%. Primary Rents +0.48%, down slightly from last month but still wayy above my model. And my model is higher than what the Street has, which has been projecting deflation next year in rents.
- Used Cars was in fact an add. +1.58%, despite a 4% fall in (NSA) retail prices. The BLS seasonals just don’t have that much of a drop off, so it must be that some other survey was showing higher retail used car prices.
Some charts in a minute. BLS blocked everything for a bit.
- Airfares was -0.39%; recall I’d assumed flat despite a large decline in jet fuel. Feel good about that one. But Lodging Away from Home was -0.9% m/m.
- Last 12 Core CPI. The downside momentum is less evident now.
- Major subgroups. I will come back to this. Medical Care was an outlier compared to recent trends. Doctors’ Services rose more than 1% m/m. As I said I’ll come back to that.
- Core goods inflation got to 0, but core services inflation stayed at 5.1% y/y. I continue to think core goods inflation is just about done declining, but Used Cars keeps pulling it slowly lower.
- OER and Primary rents. Yes, they’re decelerating. But wayyyyyyyy less than people expected. 0.50% on OER m/m, and 0.48% on Primary Rents. Lodging Away from Home was the only drag on shelter.
- Some ‘COVID’ Categories:
Airfares -0.39% M/M (-0.91% Last)
Lodging Away from Home -0.93% M/M (-2.45% Last)
Used Cars/Trucks 1.58% M/M (-0.8% Last)
New Cars/Trucks -0.06% M/M (-0.09% Last)
- My early guess on Median CPI is a rise to +0.434%, above 0.4%. As with core, the downside momentum here isn’t clear any more. Leveling out in the mid 0.3s gets us 4.25% or so y/y. Not good enough.
- Piece 1: Food and energy was a bit of a drag. HOWEVER, Piped Gas was +4.05% m/m, which added 0.04% to headline inflation – that’s the main source of the headline miss. I should note, I pointed this out…overall, Energy was a -0.23% drag.
- Piece 2: core goods, back to flat.
- Piece 3: the most disturbing piece, because it’s ‘supercore’ and now hooking higher. This is medical and I’ll come back to it.
- Piece 4 rent of shelter. A loooooooong way to go before deflation!
- Food was +0.22% m/m (SA), after +0.30% last month. Food at home was softer thanks to declining shipping, packaging, and commodities costs: +0.11% SA m/m vs 0.26% last. Food Away from Home remains bubbly thanks to wages: +0.43% SA m/m vs +0.37% last.
- Doctors’ services jumped 0.55% m/m. Y/y, it’s still -0.7%, but this jump contributed to the surprise in core and in ‘supercore’. It’s mostly a payback for the -1% surprise plunge last month.
- Medicinal Drugs was +0.45% m/m vs 0.6% prior. But Prescription Drugs jumped to 3.77% y/y. Have no fear: the Biden Administration just threatened to seize patents for any drug increasing prices too much. https://inflationguy.blog/2023/12/07/beware-the-price-controller/
- Core inflation ex-housing rose to 2.13% y/y, the first sequential acceleration since March. Not alarming at 2.13%, but prior to COVID this was in the low 1s.
- Biggest m/m declines were Mens/Boys Apparel (-26% annualized), Car/Truck Rental (-24%), Infants/Toddlers Apparel (-15%), Womens/Girls Apparel (-13%), Motor Vehicle Fees (-13%), and Lodging Away from Home (-11%). The Apparel decline is seasonal holiday discounting.
- Biggest annualized m/m core increases: Used Cars & Trucks (+21%), Tobacco & Smoking Products (+15%), Public Transportation (+13%), and Motor Vehicle Insurance (+12%).
- I love it when a plan comes together.
- Glancing at the markets, I must say I haven’t the slightest idea why we rallied hard in both stocks and bonds on this data. This is not bullish data.
- Have to point out the inflation swap market nailed the headline figure. You can’t trade core in size, but the Kalshi market going in had it at +0.32%. That always seemed high to me.
- Overall, this was fairly close to expectations but the fact that it was shelter holding it up – which is why Median was high, also – is bad news. The entire mainstream thesis on inflation going back to target DEPENDS on something close to deflation in housing.
- …well, deflation in housing OR calamity elsewhere in services. Thanks to the lags in housing, core inflation is going to drip somewhat lower, but it won’t get below 3% before it is hooking higher UNLESS housing really does belly flop. No sign of that at all.
- I guess the counterargument is “but it’s ONLY housing holding it up.” That’s not really true, though. Actually the far left tail of goods in deflation is getting bigger – but that’s the short-cycle stuff (e.g. core goods) that will rotate back up. Services, housing still high.
- I shouldn’t obscure the good news, which is that the breadth of inflation is narrowing. And the decline in the monetary aggregates is promising. The problem is that we have just SO FAR TO GO and the market anyway is expecting the Fed to take its eye off the ball.
- In conclusion – yes, Virginia, this IS the hard part. Core and Median will drip lower thanks to shelter. That takes us from 4% to what, 3-3.25% in 2024 – before shelter’s disinflation is complete. Then what?
- I continue to expect inflation to settle in the high 3s, low 4s, although continued decline in the aggregates will have me push that a little lower. Maybe we’re mid-3s to high-3s in the medium term now, with cycle bottom around 3%. Is that good enough? Doesn’t feel like it.
- That’s all for today. And all for @InflGuyPlus! Thanks again for subscribing to this channel. Be sure to subscribe to the blog at https://inflationguy.blog and follow the podcast at https://inflationguy.podbean.com or your favorite podcast app – so we’ll stay in touch. Merry Christmas!
This number was a little bit above expectations, led by shelter, Used Cars, and Physicians’ Services. There weren’t a lot of large surprises (Physicians’ Services was an unexpected jump but last month it had an unexpected decline so this is best viewed as a give-back), which helps explain the relatively placid market response. Ultimately, how you feel about inflation these days comes mostly down to shelter although it is worth pointing out that ‘super core’ (core services ex-rent of shelter) hooked slightly higher too.
To get inflation back to target in 2024, we would need one or more of the following to happen:
- Shelter inflation indeed goes negative, as the mainstream forecast expects (but I do not – I believe rents will level off around 3% y/y and then likely rise from there); or
- Core goods goes into hard deflation, of -2%ish. With Used Cars already having given up 17% or so off its highs, it is unlikely to be the driver of that. Apparel? Medicinal Drugs? (chart below shows the striking relationship between the growth in M2 since the end of 2019 and the contour of Used Car prices – driving home again how important a continued decline in the money supply is, if we want inflation to get tame again); or
- Core Services ex-Shelter decelerates markedly. For that to happen, we’d probably need to see wages decelerate a lot more. The chart below shows the Atlanta Fed wages measure (y/y) in black, and ‘supercore’ as Bloomberg calculates it in blue. If you want Supercore down to 2%, then you probably need wages at 3-4%. We have a long ways to go there.
To repeat my recent theme: while the inflation numbers are better, and will keep getting better for a while in 2024 because of easy comps and positive trends, we are into ‘the hard part.’ The current trends do not point to inflation placidly returning to 2-2.25% in 2024, or in 2025 unless the money supply continues to shrink.
And that’s where we run into the issue. The market is pricing in something like 125bps of eases over the course of 2024. While it’s possible that the Fed could cut rates while continuing to shrink the balance sheet (since the Fed funds rate is now just stated, rather than being managed through pressure on reserve balances), it would be very odd for the Fed to do something that looks like easing with one hand and tightening with the other. They’d come under a tremendous amount of criticism for that. While that’s actually my recommended strategy for them, I don’t give it much chance of happening.
So, if that’s not going to happen, then one of two things is going to happen:
- The Fed eases in 2024, and ceases shrinking the balance sheet. This is great for the bond market in the short term, but it would mean inflation probably wouldn’t even get back to 3% on core before re-accelerating. And no one will be able to blame the next increase (probably not a spike) on COVID.
- The Fed does not ease in 2024, in which case at some point the bond and stock markets are going to have to stop pricing loose money. That would of course be very bad for stocks and bonds.
There aren’t any easy ways out. Yes, that’s what “this is the hard part” means!
Summary of My Post-CPI Tweets (Oct 2023)
Below is a summary of my post-CPI tweets. You can follow me on X at @inflation_guy. 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 for November (October’s figure). This is the next-to-last month I will be doing this!
- If you miss the live tweets, you can find a summary later at https://inflationguy.blog and I will podcast a summary at inflationguy.podbean.com . Those will continue in 2024 after the live tweeting stops.
- Well, this report ought to be interesting. My forecasts are very different from the other forecasts out there. The Bloomberg consensus has +0.09% on SA headline, and 0.30% on core. The swap market, Kalshi, and Cleveland Fed are all in the same ballpark.
- I have 0.14% NSA, roughly 0.22% on headline, and 0.38% on core.
- It is a little wild to me that everyone else is so low, and it makes me concerned that I’m missing something. But I think it comes down to the fact that everyone must be expecting a big give-back on OER this month.
- Used car prices should add this month. Health care insurance pivots from an 0.04% drag to an 0.02% add. Even airfares could rise, despite sliding jet fuel, because fares are too low given the level of fuel.
- All of those are in my forecast (well, I conceded flat on airfares but it could go either way). I assume they’re in everyone’s forecast. So that leads me to believe that the assumption is a correction in OER is in store.
- OK, I see the chart too. It sure LOOKS like OER did something weird last month. If OER prints 0.45% m/m instead of 0.55%, then that takes 2.5bps off my forecast. That still doesn’t get there. You need an 0.35% or something.
- And oh by the way, I’d argue that the jump might just be payback for a too-rapid fall that happened earlier this year. There was no reason to expect monthlies to drop from 0.7% m/m in Feb to 0.48% in March. Rents are not collapsing and home prices are now going back up.
- I know that’s inconvenient to the deflation story but it’s right on par with where my model says it should be. (Our model is Primary Rents but OER is based on rents).
- So okay, I’ll drop my forecast 2.5bps on the assumption we go back to 0.45% m/m for OER. Now ya happy?!? But I’m not assuming any ‘payback’.
- Meanwhile, I haven’t even talked about the fact that I have +1% on Used Cars, but that might be too conservative given how strong auctions were in the latter part of September (not picked up in the last number).
- And I don’t have anything for New Cars – but thanks to the new wage agreement, car prices both New and Used are going to go up again.
- I’ve already spoken plenty about the reversal in Health Insurance; it shouldn’t take anyone by surprise this year.
- The change in method means that the shift from -0.04% to +0.02% per month should only last six months – it shortens the lag but this transition period increases the effect to synchronize.
- With all this, Core CPI should stay at 4.1% y/y, or rise (if my forecast is on point). As I said last month, getting it below 4% is going to be more of a challenge. And Median inflation will fall to probably around 5.25% this month, but again we’re in the hard part now.
- Breakevens have net slumped a bit this month, but that hides the fact that after last month’s CPI they spiked for a week or so. 10y breaks got to 2.50% in the bond market selloff before settling back.
- If the bond bear market continues (and the balance of large government budget deficits, smaller trade deficits, and a Fed in run-off means more pressure on rates to attract domestic savers), breakevens will go back up.
- Not sure that’s a good play in Q4, since this tends to be a good seasonal time for bonds, but a bad CPI could change that. And, naturally, with a recession coming (we think?) it’ll be harder to get higher rates immediately.
- However…the secular bull market in bonds is over so the real question is whether interest rates are aimless for a decade, or in a secular bear market. Too long a topic for a tweet storm!
- So that’s it for the walkup. Pretty simple task today: 1. check OER, 2. check core ex-housing, 3. check core services ex-housing (“supercore” for a finer read on the Fed (?))
- Keep checking the improving distribution of inflation – core below median means the tails are moving to the downside, in a disinflationary signature, but not sure that will outlast 2024.
- Good luck!
- Very soft number! Let’s see how much of this is ‘payback.’
- If it’s CPI day there must be I.T. issues. It’s a law. Headline was +0.045%, Core +0.227%. Used cars was a DRAG, which is completely at odds with surveys. OER dropped to 0.41% m/m, but that by itself wouldn’t be enough for the downside surprise.
- Airfares fell, Lodging away from home fell significantly, New Cars was a marginal decline…and health insurance didn’t add as much as it was supposed to (not sure why) although it was positive. Looks like a well-rounded soft number.
- Here is m/m OER. Back to prior level, but no payback.
- In the big picture, the 3-month average isn’t all that soothing, especially when we look at Used Cars and other quirks that will likely be repaid.
- So Black Book was -1.85% in September, NSA CPI Used Cars was -5.63%. BB was +1.07% in October, NSA CPI Used Cars was -1.40%. Private auctions were strong. This is confounding – might be a seasonal quirk that BLS reflects different seasonals, but the NSA pretty far off.
- m/m CPI: 0.0449% m/m Core CPI: 0.227%
- Last 12 core CPI figures
- M/M, Y/Y, and prior Y/Y for 8 major subgroups
- Primary Rents: 7.18% y/y OER: 6.85% y/y
- Further: Primary Rents 0.5% M/M, 7.18% Y/Y (7.41% last) OER 0.41% M/M, 6.85% Y/Y (7.08% last) Lodging Away From Home -2.5% M/M, 1.2% Y/Y (7.3% last)
- Some ‘COVID’ Categories: Airfares -0.91% M/M (0.28% Last) Lodging Away from Home -2.45% M/M (3.65% Last) Used Cars/Trucks -0.8% M/M (-2.53% Last) New Cars/Trucks -0.09% M/M (0.3% Last)
- Here is my early and automated guess at Median CPI for this month: 0.359%
- Now, this is really the important thing. Median is still 0.36%. That tells you this is left-tail stuff more than the rents stuff.
- Piece 1: Food & Energy: 0.17% y/y
- Food at Home was +0.26% SA; Food Away from Home +0.37%. Food added 0.04% to headline, which was right on my forecast. Look, talk to any restaurateur – wages are still a big problem. Food AFH isn’t going to deflate soon.
- Energy was -0.22% m/m NSA; I’d estimated -0.17% so it was very slightly more drag.
- Piece 2: Core Commodities: 0.0948% y/y
- Piece 3: Core Services less Rent of Shelter: 3.71% y/y
- Piece 4: Rent of Shelter: 6.76% y/y
- Core Goods: 0.0948% y/y Core Services: 5.5% y/y
- Core goods actually ticked up slightly. Despite the decline in Used and New cars.
- This is part of the core goods story – continued acceleration in Medicinal Drugs. Honestly this is something we’ve been expecting for a long time and just surprised how long it has taken. Many of the APIs for pharma come from China.
- Core ex-housing actually ticked up very slightly from 1.97% y/y to 2.05% y/y. That sounds great but prior to COVID it hadn’t been above 2% since 2012 so that’s still too high.
- Largest declines (annualized m/m) in core were Lodging Away From Home (which is quite surprising) at -26% and Car and Truck Rental (also surprising) at -17%. Both core services but only the latter is “supercore”.
- Largest advances Motor Vehicle Insurance +26%, Tobacco +25%, Jewelry and Watches +16%.
- I am probably not going to be exactly right on median because in my calculation the median category is Northeast Urban OER, which means we’re relying on my ad-hoc seasonal adjustment. Could be as low as 0.32% m/m, or a smidge higher. Either way, it’s not price stability.
- I guess on Health Insurance I’ll have to leave the explanation to someone with a pointier pencil. My calculations had the effect being about 2bps/month; this month is was about 0.8bps. I would call that negligible except that previously it had been a 4bps drag.
- Our housing model, updated with the latest data. Kinda right on par. But notice our model never gets anywhere close to deflation in housing. Those calling for such are going to be disappointed.
- This is a strange dichotomy and I wonder if some physician can explain it. Maybe doctors are making their money by channeling expensive services through hospitals. But it’s weird to see hospital inflation so buoyant while doctors’ services are deflating.
- Education and Communication was a little soft. Some of that was a curious (to me) -0.24% NSA m/m decline in College tuition and fees. Probably a quirk. Also Telephone hardware was -1.9% m/m.
- Apparel was soft – partly this is expected because of the lagged strength of the dollar on core goods, but the -5.1% decline in Women’s outerwear seems unusual.
- The EI Inflation Diffusion Index is back almost to flat. Note that doesn’t mean 0 inflation. To get back to persistently having Median CPI around 2-3%, you’d want to see the diffusion index quite a bit negative. I think that’s going to be difficult.
- Last chart, and it tells the story. Left tail is growing, but rest of the distribution is moving left only reluctantly. The big fingers on the right are housing. It’s encouraging that there is more diversity here – a sign that the money impulse that affects everything is waning.
- Here is today’s summary. Core was surprisingly tame but it was largely from some quirky one-offs. Median didn’t improve very much. Neither Core nor Median over the last 3 months is where the Fed wants it. This doesn’t change, therefore, the higher-for-longer meme.
- It also doesn’t demand further tightening, but that’s not news. We already knew the Fed was done.
- Looking ahead, there will be further slow progress on housing, although as I keep saying – not as much as some forecasters think. The problem is that outside of housing, core inflation doesn’t look like it wants to fall much further.
- Naturally all of this depends on what the Fed does going forward. If the money supply keeps bumping along around zero growth, then eventually the velocity rebound will run its course and inflation will go back to 2-3%.
- But higher rates mean that velocity is probably going to do more than just rebound, so higher for longer will need to be longer than people expect – or, possibly, than the Fed can maintain in the face of recession.
- That’s the hard part. This so far has been the easy part. If market rates rise again in sloppy fashion after the new year, despite recession signs…what does the Fed do? Inflation won’t be at target yet, or even close. Stay tuned!
- …and thanks for staying tuned. Have a good day.
The CPI was a happy surprise today, but not so much that I would throw a party. The low miss was partly caused by inexplicable declines in autos and lodging away from home, while the correction in rents basically just went back to the prior level rather than stepping down to a slower pace. Rents are still going to come down, and in some places in the country they are falling – but in some places they are still rising briskly.
That dispersion in experienced rental inflation is actually part of the good news, and it’s good news that we see throughout the CPI over the last several months. It’s the good news that the Enduring Investments Inflation Diffusion Index is capturing: all prices are not moving as one, as they mostly did during the upswing in inflation. A high correlation between unrelated categories tends to suggest a common impulse is causing the movement – and is yet another reason that the notion that inflation was coming from various idiosyncratic supply chain issues should never have been entertained. There was clearly a large impulse acting on all prices: the 20%+ spike in money growth. Now that the money supply is flat, though velocity is rebounding, price dispersion is reasserting.
(Spoiler alert: it isn’t yet happening on the inter-country experience – all countries saw their inflation move in synchrony when it went up, and all are seeing it move in synchrony coming down, so it’s early to say the battle is won.)
We’re still just starting the difficult part, from the standpoint of monetary policy but also from the standpoint of figuring out how quickly inflation can get tamped back down to target. And the dispersion makes that more difficult, because the signal gets lost in the noise – just as it used to, before the money gusher. Next month we’ll have to deal with likely rebounds in Lodging Away from Home as well as increases in autos, reversing this month’s surprises, but we’ll probably get slightly better rent numbers.
What I can say is that the market reaction to all of this is absurd. This just doesn’t move the needle on the Fed. There was no tightening and no easing in the pipeline before this number, and after this number that hasn’t changed an iota. But at this hour stocks are +2% and bonds are soaring. I know the conventional wisdom is that rates are going back to zero…it just seems kind of early to get on that train when median inflation is still 5.3%…
Money Velocity Update!
Now that we have our first estimate of GDP for Q3, we also have our first estimate of M2 velocity for the third quarter. Because there is an amazing amount of uninformed hypothesis out there, I figured it was worth a quick review of where we are and where we’re going, and why it matters.
Why it matters: without the rebound in velocity, the slow-but-steady decline in M2 that we have experienced since mid-2022 would be outright deflationary. The money decline and the velocity re-acceleration are part and parcel of the same event, and that is the geyser of money that was squirted into the economy during COVID. Velocity collapsed for mostly mechanical reasons: it is a plug number in MVºPQ, and since prices do not instantly adjust to the new money supply float, velocity must decline to balance the equation. Another way of looking at it is that if you add money to people’s accounts faster than they can spend it then velocity will decline. I have previously presented an analogy that in this unique circumstance money velocity behaves as if it were a spring connecting a car, speeding away suddenly, with a trailer that has some inertia. Initially the spring absorbs the potential energy, and later provides it to the trailer as it catches up. Ultimately, the spring returns to its original length, when the car has stopped accelerating and the trailer is going at the same speed.
As M2 has declined in an unprecedented way, after surging in an unprecedented way, velocity has rebounded in an unprecedented way after plunging in an unprecedented way. All of these things are connected, episodically (but we will look at the underlying, lasting dynamics in a bit). With this latest GDP update, M2 velocity rose 1.9%, the 9th largest quarterly jump since 1970. Over the last four quarters, it has risen 10.4%, the largest on record, and 16% over eight quarters, also the largest on record.
https://fred.stlouisfed.org/series/M2V
To return to the level M2 Velocity was at, at the end of 2020Q1, it needs to rise another 4.8%. For M2 to return to the level it was at, at the end of 2020Q1, it needs to fall another 23%. One of these is likely to happen; the other one is not. The net difference, after subtracting cumulative growth (8.8% since then, so far), is a permanent increase in the price level. If M2 continues to come down, the net effect is a higher level of inflation over this period but not calamitous.
Note that there is no way we get the price level back to where it was, unless M2 declines considerably farther for considerably longer, or unless money velocity inexplicably turns around and dives again. I know that some well-known bond bull portfolio managers have been calling for that, but they were wrong the whole way along so why would you listen to them now?
I’ve been pretty clear that (a) I have been surprised that the Fed was successful in decreasing the money supply, since I thought the elasticity of loan supply would be more than the elasticity of loan demand (I was wrong), (b) I think the Fed deserves credit for shrinking the balance sheet, which they have long said doesn’t matter (it matters far more than interest rates, for inflation), (c) Powell deserves credit for turning into a hawk and pushing the institution of the Federal Reserve to become hawkish after decades under Greenspan, Bernanke, and Yellen where the only question being asked was ‘do we wait for the stock market to drop 10%, or only 5%, before we flood the system with money?’ Chairman Powell deservedly will go down in history as the guy who recognized the ‘spring effect’ that kept long-term upward pressure on inflation even as so many people were chirping about supply constraints and ‘transitory inflation’ (including, to be fair, Powell himself. But whatever he said, what he did was pretty reasonable).
However, the next bit is going to be challenging.
Velocity, being the inverse of the demand for real cash balances, is primarily affected by two main forces – one of them durable and one of them ephemeral. The ephemeral effect, which is rarely super-important, is that people tend to want to hold more cash when they are uncertain. Indeed, our model for velocity actually captured accidentally some of the ‘spring effect’ because for us it showed up as extreme uncertainty. Put another way, even if the Fed hadn’t flushed tons of money into the system, velocity would have had something of a sharp decline because of the high degree of economic uncertainty. Ergo, it was crucial that they flush in at least some money because otherwise we would have had outright deflation. They didn’t get the magnitude right, but they got the sign right. Anyway, the ‘uncertainty’ effect doesn’t last forever. The measure of uncertainty I use is a news-based index of economic policy uncertainty; it has retraced about 85% of its spike although it has been persistently high since political divisiveness became the main fact of US political life back in 2009 or so.
The more durable effect on the desire to hold cash is the presence of better-yielding alternatives to cash. When interest rates are uniformly zero and the stock market is on the moon, there’s very little reason to not hold cash. But when non-cash rates are high, and stocks and other investments more reasonably priced, cash is a wasting asset that people want to ‘put to work.’ The easiest way to see that is with interest rates, which for the last couple of decades have tracked the decline in money velocity closely as both declined.
And here is the problem. If interest rates are back at 2007 levels, then naïvely we would expect velocity to be back in the vicinity of 2007 levels also. But that is massively higher than the current level. In 2007, money velocity was around 1.98 or so: about 49% higher than the current level!
Needless to say, there’s no way the money supply is contracting that much. If velocity rose even, say, 30% then we would have a serious and long-lasting inflation problem. Fortunately, because of the economic policy uncertainty and other non-interest rate effects (I did say that “naïvely” we would be looking for 1.98, right?), the eventual rise in velocity beyond the snap-back level is much less than that. It actually only adds about 6% to the snap-back level. That still means 2% more inflation than would otherwise be expected, for three years, or 3% more for two years.
Of course, interest rates could fall again and ‘fix’ that problem. But it’s hard to see that happening while the money supply continues to contract, isn’t it? And that’s where it gets difficult. If you continue to decrease the balance sheet – which you need to do – and money continues to contract, then you probably get more velocity and inflation stays higher than you expect. Or, if you drop interest rates then you don’t get velocity much over the pre-COVID level, but you also get more money growth and inflation stays higher than you expect.
All of which adds up to one reason why I continue to think that inflation will stay sticky and higher than we want it, for a while. Powell has surprised me before, though, and this would be a good time to do it again.
Summary of My Post-CPI Tweets (September 2023)
Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy. 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 for October (September’s figure).
- At 8:30ET, when the data drops, I will pull down the data and then run a bunch of charts. Then I’ll comment and post some more charts. As usual. But nearing the end of this string. December is the last month I’ll do this live.
- Later, I will post a summary of these tweets at https://inflationguy.blog and then podcast a summary at inflationguy.podbean.com . Those will continue after the live tweeting stops in 2024!
- The estimates for this month’s CPI data are fairly uniform across sources in expecting 0.26% m/m core, and 0.31% or so on seasonally-adjusted headline. My forecasts are a bit higher on Core, but in-line on headline. Here’s why.
- First of all, while used car prices declined this month they fell by less than the seasonal adjustment factor would suggest. Instead of -1.9%, which is the non-seasonally-adjusted pace that Kalshi shows for its used car CPI market, I see +1.3% for the SA pace.
- However, there’s a huge amount of variance there so I am actually penciling in flat. Partly, that’s also because used car prices haven’t yet fallen as much in the CPI as the Black Book survey would project, so maybe I’m too high.
- Used car auctions in the latter half of this month were very strong, though, thanks to the strike against US auto makers. That hasn’t yet affected sales, but the auctions show it SHOULD affect prices since there is less reason to clear the lot if there are no more cars coming.
- But although used car auctions have been strong, I don’t expect CPI to LEAD the Black Book survey. CPI almost never leads.
- So if new car CPI isn’t strong this month, I expect it to be strong next month. Ditto with used cars. In fact, “if not this month, next month” will be a constant theme here.
- Same is true of airfares, which last month rose about 5% but still lag far behind jet fuel – which has continued to rise. I expect another add there. And Lodging Away from Home was a surprise decline last month, which I am expecting to reverse this month.
- Now, this month we do still have the 4bps drag from health insurance…but that reverses next month. Enjoy it while you can.
- We are coming to the end of several of these trends that have flattered the CPI (or flattened it) recently: health insurance & the drag from used cars being the big ones. Used cars still has downward pressure from rates, but the strike is more important.
- Thus, while y/y core CPI should get down to 4.1% or 4.2% this month (due also to easy comps vs 2022), getting it BELOW 4% is going to be tougher.
- One trend that will be continuing for a while is the slow (accent on slow) deceleration in shelter inflation. Last month, OER was +0.38% and Primary Rents +0.48% m/m. That was right on my model. This month I have Primary Rents at +0.40% m/m, and the combination at +0.38% m/m.
- Obviously the rent thing will continue for a while, but it won’t slow down as fast as people expect. I think that must be the reason that the consensus forecasts are soft given the obvious adds this month. So we will see.
- Interestingly, the consensus on headline is roughly where MY headline estimate is despite my higher core. That means economists see food and energy adding more than I do. I don’t see that. Gasoline was basically flat Sept/Aug. I have 1bp from energy and 1bp from food.
- Of course, with war in the Middle East – though weirdly, energy markets have been incredibly insouciant here – there is much more upside potential to energy prices going forward. And not much downside, unless growth collapses.
- And while there are plenty of people looking for a growth collapse…I don’t see that. A recession, definitely, but a deep one? One that damages the financial infrastructure? Not really. Might be long, but not deep. And with inflation as well.
- From a markets perspective, it has been a weird month in inflation. Real rates have shot up MORE than nominals, which is something you’d expect at the start of an expansion, not with recession coming on.
- Breakevens are DOWN even though overall rates are UP, in other words. It’s bizarre;as I said in my podcast last week TIPS are finally an absolute buy, not just a relative buy compared to very-expensive nominals. https://inflationguy.podbean.com/e/ep-84-is-it-time-to-buy-tips/
- Incidentally, also take a look at the nice Q&A that Praxis did with me this week. https://lnkd.in/emCrcnHs
- And while I’m thinking about it, take a look at the new Enduring website: https://www.enduringinvestments.com
- I said last month: “I think markets recognize that the narrative is turning, from “we are in an inflationary spiral” to “inflation is coming down” to “okay now it gets harder.” And that leaves breakevens a bit aimless for now.”
- Still true…but we are further into that turning. It gets more difficult now. The Fed’s job is also getting more difficult, but we’ll wait to see what this number is before talking too much about that.
- That’s all for the (short) walkup. Good luck today!
- We are at 0.323% on Core, and 0.396% headline, so higher than expectations. BLS made some more changes in the way they roll out the release, so I’m about 1 minute behind schedule.
- I can already see Used cars was a drag but rents a big gain as OER rebounded from last month and Lodging Away from Home bounced (as expected).
- m/m CPI: 0.396% m/m Core CPI: 0.323%
- Last 12 core CPI figures
- OK, so looking at this…it’s a bad number but a lot of this is probably going to trade to OER. Still, June and July start to look like the aberrations they were.
- M/M, Y/Y, and prior Y/Y for 8 major subgroups
- Nothing really stands out here…Housing obviously strong.
- Core Goods: 0.0221% y/y Core Services: 5.69% y/y
- The overall trends in core goods and services are positive. Core goods going negative y/y is lower than I think is sustainable, and it should start to turn. Although with the dollar as strong as it is, it’ll take longer than I had been expecting.
- Primary Rents: 7.41% y/y OER: 7.08% y/y
- So you can see no big change on the y/y trends. They’re slowing, but (as I’ve said) they’re not slowing as fast as everyone seems to think they will. OER’s jump this month will get the press, but overall the trend is in line.
- Further: Primary Rents 0.49% M/M, 7.41% Y/Y (7.76% last) OER 0.56% M/M, 7.08% Y/Y (7.32% last) Lodging Away From Home 3.7% M/M, 7.3% Y/Y (3% last)
- However, the m/m on primary rents also are higher than my model. Remember, costs for landlords are continuing to rise – it’s hard to imagine that rents will actually decline and landlords will just accept losses. There’s new supply, but way more new demand from immigration.
- Some ‘COVID’ Categories: Airfares 0.28% M/M (4.89% Last) Lodging Away from Home 3.65% M/M (-2.97% Last) Used Cars/Trucks -2.53% M/M (-1.23% Last) New Cars/Trucks 0.3% M/M (0.27% Last)
- The rise in airfares is still lower than it should be and I will expect a further increase next month. Lodging Away from Home was an expected bounce, and on par. The decline in Used cars is probably at least temporarily over thanks to the strikes – we will see it next month.
- Here is my early and automated guess at Median CPI for this month: 0.439%
- The caveat to my median estimate is that the median category is a regional OER, which I have to guess at seasonal adjustment for. But this is the highest median since February. Again, July was an obvious outlier and now it’s more obvious.
- Piece 1: Food & Energy: 1.96% y/y
- No surprise there’s a bounce in food and energy y/y this month.
- Piece 2: Core Commodities: 0.0221% y/y
- Piece 3: Core Services less Rent of Shelter: 3.56% y/y
- This includes Health Insurance…and that will reverse next month. Instead of dragging 4bps/month on core, and 10-12 on this subgroup, it’ll be adding back 2bps/month on core.
- Piece 4: Rent of Shelter: 7.2% y/y
- In the good-news category, Core ex-housing is down to 1.97% y/y. So, if you ignore housing, the Fed is at target. Except that’s largely thanks to Used Cars and Health Insurance decelerations, both of which are tapped out. As I said, it gets harder from here.
- Core Categories with the largest m/m declines (annualized): Jewelry/Watches (-27%), Used cars & Trucks (-26%), Women’s/Girls Apparel (-20%), Infants’ Toddlers’ Apparel (-18%), Motor Vehicle Parts & Equipment (-16%). This last one also is probably going to reverse due to strikes.
- Biggest annualized monthly gainers: Lodging AFH (+54%), Misc Personal Goods (+22%), Motor Vehicle Insurance (+17%), Misc Personal Services (+14%), Tenants/Household Insurance (+11%), Alcoholic Beverages (+10%).
- Further to that, Misc Personal Services was +1.1% m/m and Misc Personal Goods was +1.7%. Those only sum to one percent of the whole CPI so not a big deal. A big reason that the “Other” subindex was +0.57% m/m though.
- I have to confess a little surprise that yields and BEI aren’t up more on this. Yes, some will say it’s “just OER” and that looks like something of a makeup number…but at the VERY LEAST it should make the disinflationists question that KEY PART of their theory.
- Maybe…just maybe…rents aren’t going to collapse into deflation? I dunno, just spitballing here, but since there’s no sign of it, and home prices are rising again…a number like this ought to at least make you think about the possibility.
- OK, the response after the initial drop-and-bounce looks like people are having a think. I should say that I don’t think this changes the Fed’s trajectory – they’re done, although this brings in the chance for one more 0.25% to appease the hawks.
- But clearly, 500bps of rate hikes hasn’t done the trick so what will 25 or 50 more do? Or 200? All that will do is slow the economy, without hurting inflation. There is little to no evidence that rate hikes push inflation lower, and at this point even the hawks must be noticing.
- Running some diffusion stuff now. The story there continues to be positive. But we always knew the spike wouldn’t last forever – the question now is, where does inflation fall to? And so far, there’s no sign we’re going to plunge back to 2%. The hard part has started.
- Another diffusion chart. Slightly worse this month (this is based on y/y), but overall improving. However, again…if 55% of the CPI, or 30% + OER, are still inflating faster than 4%…you’re not back to target yet. Far from it.
- That’s enough for today. The summary is that the big surprise was rents, but outside of rents the news wasn’t so wonderful that we can ignore the fact that rents are not decelerating as fast as people expected. I continue to expect core of high 3s, low 4s for 2023. On track.
- Thanks for tuning in. Be safe out there!
I started out with the theme “if not this month, then next month,” but we can dispense with that theme. Although that can be said of Used Cars, and Airfares – both which were lower than I expected – the more accurate theme is the one I started teasing last month: “now it gets harder.”
The lion’s share of the deceleration in core goods is over with. While the dollar’s continued strength will remain a pressure on goods prices, we’re down to zero in a category that even before COVID was only deflating 1-2% per year. And in the post-COVID, de-globalizing world, we are unlikely to see core goods prices sustainably deflating.
The decline in health insurance CPI is over with. Over the last year, that declined almost 4% per month and dragged 4bps per month on core CPI. In the coming 6 months, that is going to be an add of something like 2bps per month. You were sailing with that wind but now the wind is in your face.
Energy prices, a continued drag since the Biden Administration started flushing the SPR, are no longer going to drag. Whether or not gasoline prices rise back to the level they were prior to the SPR releases, they’re not going to be headed much lower especially with war in the Middle East. While the market seems amazingly insouciant about the widening of that war – “hey, neither Israel nor Gaza produce much oil so we good” – this does not feel like prior Israeli-Palestinian conflicts to me. Recent oil inventory numbers have been volatile and confusing, but unless the US recession is sharper or deeper than I (or OPEC) expect the cartel is likely to be able to keep prices high especially in an era when the US is not producing with heartfelt enthusiasm.
Further decelerations in rent are still ahead. But none of my models have primary rents slowing to below 3%, and that’s in contrast to what seems to be a general consensus that rents will outright decline nationally. I don’t see it.
The decline in rents is a big part of why core is down to the low 4%s, and will drop further over the next year even with other things no longer dragging. But again, this is no longer about when the peak in inflation will get here – it’s about where inflation is going to decline to. From 6.6% to 4.1% was the easy part. From 4.1% to 3% is going to be difficult. From 3% to 2%? So far, I don’t see anything that gets us there.
What Happens if CPI Isn’t Released?
One thing I’ve stopped worrying very much about is a government shutdown. It could even be a good thing, given the bloated deficit, except for the fact that the government basically keeps spending anyway. The federal government employs about 4.5mm workers, and no more than 800k have every been furloughed – moreover, many of those furloughed workers often receive back pay. Social Security gets paid, Treasuries get paid, and the wheel keeps turning. That’s not a guarantee, of course – it’s possible that an extended shutdown could cause Treasuries interest to not be paid, but we all know that before that happens, the Fed would just print the money and make sure the checks go out. At worst, there could be a one-day technical default, if important people had given the heads-up to insiders to get really long CDS.
But my cynicism is getting the better of me so let’s turn to what could happen in a shutdown that impacts the inflation markets: in the past, some data releases of federal agencies have been delayed (or their quality impacted), and if the delay was long enough then it could affect TIPS. Lots of people are asking about this, so I thought I’d lay out what would happen and how.
First of all, the quality of the CPI data could potentially be impacted. That has happened in the past, because data collection agents are not ‘essential workers’ so if the government shuts down, a lot of the data collection stops. This is less of a problem than it has been in the past, though, because a lot more of the data is collected electronically than in the past. For example, the new cars sample is no longer collected by hand but is sourced from J.D. Power. Prescription drugs data is partly supplied by one large firm that didn’t want to allow data collectors to collect data in store. A similar story applies to apparel. Many of these ‘big data’ changes are discussed in this BLS white paper, but the point is that these changes also mean that the quality of the data won’t be impacted as much as would be the case if data collection was entirely done by hand as it once was.
The bigger potential problem is that the CPI report could be delayed.[1] The NSA CPI is used almost exclusively as the index in inflation swaps, and is the index that determines escalation of TIPS principals. Other subindices are used in contract arrangements (for example, in long-term airplane purchase contracts), but those applications are generally less urgent.
If the BLS is unable to release the CPI on October 12th, what happens? The first thing to know is that the September CPI (which is what is released in October) is only relevant to swap payments and TIPS accruals in November and December. For each day in November, the inflation index is interpolated between the August and September prints; for each day in December, the inflation index is interpolated between the September and October prints. Ergo, missing the September print would make it impossible to settle inflation swaps payments – but more importantly, every TIPS trade that settles in November or December would be impossible to settle because the invoice price couldn’t be calculated.
Fortunately, the Treasury thought about that a very long time ago. Title 31 of the Code of Federal Regulations (CFR) spells out what would happen if the BLS didn’t report a CPI by the end of October (it also spells out what happens if the BLS makes a large change to the CPI, or stops calculating it). In a nutshell, the Treasury would use the August CPI index, inflated by the decompounded year-over-year inflation rate from August 2022-August 2023:
I’ll do the math for you. If the CPI isn’t released, the figure for September will be 307.94834, which is +0.3004% on the month. While that sounds very convenient, since economists are forecasting a +0.3% m/m change for this data point, remember that the economists’ +0.3% is seasonally adjusted while the +0.3004% change is NSA. The difference is that 0.3004% NSA is about 0.50% SA this month.
Naturally, this wouldn’t matter very much in the long run; once the October CPI was released at the proper level the artificial change from Sep-Oct would wash out the artificial change for Aug-Sep.
Except, that is, for one pain-in-the-ass way, and that is the second part of the code snippet shown above: the Treasury would never adjust the official number back to match the BLS back-dated release of September CPI. Forever after, if you ran the sequence of monthly Treasury CPI Index numbers and the BLS CPI numbers, they would be exactly the same except for the one data point. The economic significance of that approaches zero, but the Inflation-Guy-Irritation figure on that approaches infinity.
So let’s hope cooler heads prevail.
[1] How likely is this? Kalshi has a market for this as well as markets on the probability of a government shutdown and the length of a government shutdown. As of this writing, Kalshi traders are saying there is an 18% chance that the CPI data will not be released in October.
