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Summary of My Post-CPI Tweets (August 2022)

September 13, 2022 6 comments

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

The tweets below may have some deletions and redactions from what actually appeared on the private feed. Also, I’ve rearranged the comments on the charts to be right below the charts themselves, for readability without repeating charts, although in real time they appeared in comments associated with a retweeted chart.

  • Back to CPI Day – my favorite day of the month. Yours too? I’m glad.
  • A reminder to subscribers of the path we take today: First the walkup; then at 8:30ET, when the data drops, I’ll be pulling that in and will post a number of charts and numbers, in fairly rapid-fire succession.
  • I will put replies to those charts as necessary. Then I’ll run some other charts. What I will NOT be doing this month is the live commentary. Last month, that actually slowed everything down because of the multitasking.
  • So instead, afterwards (hopefully 9 or 9:10ish) I will have a private conference call for subscribers where I’ll quickly summarize the numbers. Not sure if that’s valuable, but we’ll try it.
  • After my comments on the number, I will post a partial summary at https://inflationguy.blog and later will podcast a summary at http://inflationguy.podbean.com . And all of that also will be linked on the Inflation Guy mobile app.
  • Thanks again for subscribing! And now for the walkup.
  • There was a talking head this morning saying “we should only care about the sequential number, not the y/y number. Those usually say the same things but not recently. And the sequential number is fresher” (I’m paraphrasing).
  • Couple of things wrong with this statement but I will focus on the main one: there is no planet on which one economic data point should matter overmuch to your view.
  • Can one number refute your null hypothesis? These are experiment results, samples from a distribution we can’t know. One data point would have to be wildly different than your null, and if it was then you’d suspect there is some quirk in the data.
  • For example, that’s what happened last month: median CPI printed again a little above 0.5%, but there was a very low headline number (because of gasoline) and a very low core because of large movements in small categories.
  • Large moves in small categories aren’t likely to be repeated, and they don’t tell you a lot about the overall distribution. They are more likely to be mean-reverting than trending. They shouldn’t change your view much, especially since Median is still rising at >6% pace.
  • The other issue with what he said is: the real question isn’t whether inflation is accelerating or decelerating. It is decelerating, and so the y/y number will decline. Most of the deceleration is in core goods. That has been expected for some time. Partly ports, partly dollar.
  • The real question is: will we recede on core/median to 2.5%, or 5%? I think it’s closer to the latter than the former, and not until next year, but there is no way that ONE NUMBER could really answer that.
  • So I care about sticky, I care about whether we are seeing a new uptrend in core services, I care about rents. I don’t care so much about lodging away from home.
  • Now, that doesn’t mean we should ignore this number. Indeed, to me it seems that expectations for this number have swung really to the low side. Both in economist land and in trading land.
  • Here is a chart of changes over the last month. Large declines in breaks at the short end – although to be fair a decent part of that is carry. But the optics influence the forecasts of those who don’t really dig into the guts, and that might be an opportunity.
  • Forecasts to me look low. Consensus is -0.1% on headline, +0.3% on core. The y/y forecast for core is 6.1% (which tells us that the real forecast is 0.32%-0.34%. Any higher and m/m rounds to 0.4%. Any lower and the y/y rounds down to 6.0%.)
  • That seems low. Last month’s 0.31% on core was infected by a lot of one-offs. Airfares -7.8%, Lodging away from home -2.7%, car/truck rental, etc. But primary rents were 0.7% m/m, and OER 0.63% m/m. So how do we get another 0.32% on core?
  • Well, you COULD get a retracement of some of the rents rise last month. That’s really the only thing I’d worry about. Some of the drops from last month may retrace (although core goods deceleration is real). But 0.3% seems sporty, especially with median still where it is.
  • The core/headline spread looks to me like it should be about -0.36%, so if we get 0.4% on core then we could print a small positive on headline. I think that’s where the risk is, unless rents are way off.
  • Used cars will drag a bit again this month, but it won’t be large.
  • I should say the interbank market is more in line with me than with economists. 295.71 NSA traded yesterday. That would be an NSA m/m decline, and a small positive SA.
  • The real question is the Fed’s reaction function. And I think their reaction to THIS number is basically nil. They’re going to go 75bps at the next meeting because the market has validated that level. The question is NEXT meeting; that will depend on how markets are behaving.
  • The Fed BELIEVES they are close to done, which is why Powell can make a vacuous “until the job is done” statement. The job (shrinking the balance sheet) has barely started, but they may be close to done on short rates.
  • Because if they’re ahead (and they think they are), at some point they need to pause to see the effect of their actions to date.
  • For today, there may be downside equity risk if the number is a little higher as I expect. But if it’s as-expected, there may be UPSIDE risk…probably fadeable, but I think the market reaction function and the Fed reaction function may be diverging.
  • So I know what I’m going to do when the number prints what the number prints, but I am less sure of what the market is going to do. Kinda feels there is still downside to equities. With real rates where they are, equities still look expensive (chart uses our equity return model).
  • OK, that’s all for the walkup. Number in 10 minutes. Good luck!

  • oooops
  • M/M, Y/Y, and prior Y/Y for 8 major subgroups
  • Food and beverages still rising. 0.77% m/m and 10.9% y/y! All other subindices contributed. “Other” was +0.73% m/m so that will be interesting. Medical Care +0.68% and that is also going to be interesting/disturbing.

  • Here is my early and automated guess at Median CPI for this month: 0.738%
  • Look at the median chart. This is just an estimate, and depending what the median category is it might not be precisely right…but if it is, then the 0.738% m/m is a new high for the m/m. OUCH.
  • Core Goods: 7.06% y/y Core Services: 6.07% y/y
  • Core goods actually went UP y/y, just a tiny bit, 7.06%. And core services continuing to rise, 6.07%. Convergence at 6.5% is not what people were hoping for.
  • Primary Rents: 6.74% y/y OER: 6.29% y/y
  • Further: Primary Rents 0.74% M/M, 6.74% Y/Y (6.31% last) OER 0.71% M/M, 6.29% Y/Y (5.83% last) Lodging Away From Home 0.1% M/M, 4% Y/Y (1% last)
  • Primary rents 0.74% m/m. OER 0.71% m/m. That’s the big ouch. I read this morning on Bloomberg I think that ‘rents are near a peak.’ Uh, sure. Lodging Away from Home was positive…didn’t retrace last month’s drop, but didn’t repeat it either.
  • I mean, this is a little scary, right? No sign of a peak yet.
  • Some ‘COVID’ Categories: Airfares -4.62% M/M (-7.83% Last) Lodging Away from Home 0.08% M/M (-2.74% Last) Used Cars/Trucks -0.1% M/M (-0.41% Last) New Cars/Trucks 0.84% M/M (0.62% Last)
  • Airfares keep sliding, but again a lot of this is jet fuel. As has been pointed out elsewhere, if you quality-adjust airfares then inflation is still soaring. Used cars was a small drag, as expected. But look at new cars!
  • The rise in new cars is probably the reason that core goods advanced. 0.8% m/m in new cars is impressive.
  • Piece 1: Food & Energy: 15.7% y/y
  • Only surprise here is that it isn’t retracing nearly as much as people expected. You know why? FOOD. When was the last time we really worried about food prices driving the CPI?
  • Piece 2: Core Commodities: 7.06% y/y
  • Piece 3: Core Services less Rent of Shelter: 5.75% y/y
  • This is even more concerning than the shelter numbers, in my mind. I’ll dig deeper into medical care, but this has been a well-behaved part of CPI for a long time. BUT IT’S WAGES. That’s what matters in this group. This is where your wage/price spiral would show up.
  • Piece 4: Rent of Shelter: 6.31% y/y
  • So 0.12% on headline (SA), 0.57% on core. Not exactly what the market was expecting.
  • Yeah, so I guess last month were one-offs. But those of us “in the know” knew that, right?
  • Last 12 core CPI figures
  • Stocks are NOT happy with this. And that’s no surprise! But it’s not because the Fed is going to go 100bps this month. They won’t. It’s because suddenly “maybe they’re not as close to done as we thought.” More on my thoughts about the Fed later.
  • I need to run some of my slower charts now but looking at markets the only quirky thing – I understand the market but it’s weird – is that energy prices are down. The theory is that more Fed hikes slow the economy more, but if you’re connecting growth and inflation then>>
  • …you’d have to also say that growth must be stronger than we think. Energy is confusing nominal and real prices again, too. Maybe it’s a dollar thing. Dollar is definitely stronger as Fed arc is perceived higher now.
  • …but it’s a weird idea that the more inflation you get, the more you want to sell commodities, isn’t it?
  • Core ex-shelter rose to 6.36% from 6.04%. Back to the level of May. Hard to tell on this chart. This will probably continue to decline, but…this is the really surprising part of the report. Going to get to the smaller stuff in a bit and see what’s up.
  • Car and Truck rental was -0.5% m/m (NSA)…it was a big drop last month as well. Interesting and not sure what that means.
  • No other interesting declines. On the upside was New cars…at 4% of the basket, that was 3-4bps of the surprise roughly. Not enough to explain it all!
  • Lots of other motor vehicle stuff. Maintenance and repair, insurance, parts and equipment…all rose at greater than a 10% annualized pace.
  • Also…south urban OER rose 0.9% m/m or so. So rents and prices are rising in the south, but not falling in the north. Some of that is migration. The median category was Rent of Primary Residence, which as noted was large.
  • With the median as Primary Rents, my 0.74% m/m median guess is probably pretty solid. That takes y/y median to 6.7% I believe. yowza.
  • Medical Care…Prescription Drugs +0.36% m/m (NSA). Dental Services +1.31%. Hospital Services +0.78%. YES. I’ve been wondering where this was for a long time. Still only up to 4% y/y, but it’s way overdue.
  • Similarly, prescription drugs…3.2% y/y, highest since 2018. I wonder if the determination that Medicare will ‘negotiate’ more drug prices is leading manufacturers to hike prices in advance?
  • OK…college tuition and fees, +1.3% m/m. That’s not unusual for the NSA to jump in this month; tuition jumps once a year basically. But that means the y/y change is going to move higher as the SA adjustment is smoothed in. Now it’s at 2.79% up from 2.35%.
  • Colleges have cost pressures too. And wage exposure. Over the last few years tuition inflation has been low because endowments and government support has been huge. This is all fading though, and costs are still climbing. Look out above.
  • Finally, in “Other”. We have cosmetics, perfume, bath, nail preparations (yes that’s a category) +2.3% m/m. Financial Services ex-Inflation Guy +0.87% m/m. Haircuts and other personal care services +0.66%. Notice something there? A lot of wages.
  • On the plus side, “Funeral expenses” was -0.5% m/m. So we got that going for us. Cigarettes +1.1% m/m.
  • While I wait for the diffusion stuff to calculate I’ll start the (brief) summary call. Dial the conference line at <<redacted>>. I’ll start in 3-4 minutes.
  • OK last chart. The red line here isn’t really going off the chart (yet) – it’s median at 6.99% (est). The EI Inflation Diffusion Index – no surprise – is not coming off the boil. Inflation remains high, but also broad. Some categories are slowing, but some are accelerating!

Honestly, I came into today thinking that this was a less-important CPI report than we had seen in a while. As I said in the walk-up, I thought the real question is whether this changes the Fed’s decision at the next meeting, not this month’s meeting. As it turns out, the answer to that is probably yes (but we have another CPI before that meeting). But the more important question that has re-surfaced is, “have we really seen the highs in inflation yet?”

That seems crazy to ask, if you believed that this was all one-offs caused by clogged ports and “supply constraints.” It hasn’t been about that in a long time – and really, never was, since those clogged ports were caused by artificially-induced demand – but if you’re still in that camp you’re utterly shocked here. But it still seems wild to ask from my perspective. My view has been that if the money supply has risen 42% since the beginning of the COVID crisis, and prices are only up 15%, then prices have a lot more to do before they are in line with money growth. But I thought that would happen more gradually, with a 5%ish inflation that stuck around longer than people expected.

That’s less clear now. If core services ex-shelter is really taking the baton from core goods, that’s really bad news. Because core services ex-shelter is where wage pressure really lives. We don’t import services; we pay people to provide them. If you want a wage-price spiral, look in core services ex-shelter to see if it’s happening. Honestly? That part of CPI was already looking a little spritely in recent reports. But it looks to have really broken out now. That’s very disturbing. It adds momentum to the CPI.

Ultimately, it’s still all about whether there’s too much money chasing too few goods. But if a wage-price spiral gets started, then that will manifest in higher money velocity over time so that even slower money growth will be associated with rising prices. That’s a bad thing.

By the way, it isn’t anything the Fed can break with interest rates. Decreasing the money supply has never really been the Fed’s focus, but that’s the lever they needed to be moving. And now? Doing that now would have less of an effect, if we have momentum in pricing again.

It’s still the right move, but the FOMC has made a terrible mess of this and is going to wear it.

That being said, there is another CPI due before the next Fed meeting. My thinking had been that the Fed figured they were close to done (otherwise, Powell beating his chest with the manly-but-vacuous ‘until the job is done’ thing…which by the way is going to become a meme just like ‘transitory’…just didn’t make any sense), so that if this number was as-expected they would be considering just how soon to pause their hikes. Maybe as soon as November. Now, that’s sort of out the window.

The market reaction makes eminent sense given this backdrop. But you didn’t need me to tell you that. Before this even printed, the fact that expected real equity returns were basically below long-term TIPS returns meant that being in equities didn’t make a lot of sense. It makes less now…at least, at this level. We may be about to see a different level.

Summary of My Post-CPI Tweets (June 2022)

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

  • Here we go again. It’s #CPI Day. #inflation
  • Before I get started with the walkup: after my comments on the number, I will post a summary at https://mikeashton.wordpress.com and later it will be podcasted at https://inflationguy.podbean.com . And all of that also will be linked on the Inflation Guy mobile app.
  • What sets apart this month from many over the last couple of years are two things.
  • First, economists are now fully in the inflation-liftoff camp, with forecasts that are starting to look more like the actual data. The consensus for Core CPI is 0.54%. The average core CPI for the last 8 months is…0.54%! Who says that Econ PhD isn’t worth the money.
  • Second, and more significantly: the market has completely erased the possibility of sticky inflation and reflects 100% confidence that the Fed will be immediately and dramatically successful in restraining inflation.
  • The interbank market is pricing in 1.2% headline CPI for this month, but a SUM of 0.3% for the next 3 months. Even if gasoline, which has recently plunged from $5/gallon to $4.66/gallon, goes to $3.50 and stays there, this implies core CPI immediately decelerating.
  • The decline in the inflation markets has been unprecedented. 1y CPI swaps have fallen more than 200bps over the last month. The real yield on the July-2023 TIPS as risen 220bps during that time. 10y breakevens are narrower by 47bps.
  • The 1y inflation swap of 3.75%, considering that core and median inflation – which move slowly – are currently rising at a 6%-7% rate, implies a massive collapse in core prices and/or gasoline.
  • And this is important to note: there is as yet almost zero sign of that. Could it happen? Sure. But the Fed just made a massive 7% screw-up on inflation. My confidence that they know exactly how to get it back to 2% is…low. And to do so quickly? Very low.
  • I mentioned earlier the consensus for core CPI is +0.54%, which would put y/y at 5.7%. The consensus for headline is +1.1% (interbank market is at 1.2%), putting y/y headline at 8.8% or 8.9%.
  • I don’t do monthly forecasts because I want you to respect me in the morning. But I will say that the SPREAD between core and headline this month seems very wide to me. Typically core vs headline is a function of gasoline prices in a pretty simple way (see chart).
  • Given where the monthlies have been trending, I think core could be a little higher than consensus and headline a little lower. But if headline surprises to the upside, I suspect that will be because core did also.
  • Rents will continue to be strong. Last month, primary rents and OER rose at >7% annualized pace, and that didn’t seem too out-of-whack. Used Cars will likely be close to flat, and we could get a drag from airfares (?). So I would shade the core forecast on the high side.
  • But unless core is a lot higher than that, 1.1% or 1.2% m/m seems a stretch.
  • Used Cars will likely be close to flat, and we could get a drag from airfares (?). So I would shade the core forecast on the high side, but I’m not hugely confident in that.
  • Later you will see a lot of headlines about that new high in y/y CPI, but core CPI will continue to slide from its recent high at 6.47% in March. But after this month, Core CPI has easy comps for the next 3 months. If we keep printing 0.5%, we’ll get a new high in September.
  • Like I said, that’s contrary to the market’s pricing at the moment.
  • As a reminder, I tend to focus on Median CPI partly for this reason – outliers in core can pollute interpretation. And the Median CPI y/y chart is unambiguous at this point: still accelerating. In fact, the m/m Median CPI is looking even more disturbing than this y/y version.
  • Which brings me to an announcement of sorts. I do all of these charts more or less manually from big spreadsheets. But this month I am trying something new with my Median estimate (the Cleveland Fed reports Median CPI around lunchtime).
  • This month I’m trying an experiment with that figure. It’s going to be produced automatically when the CPI data drops, within about 1 minute (fingers crossed). And tweeted automatically. Does that make me a bot??! If it works, I may do others of my charts.
  • The actual core and headline m/m changes will also be bot-tweeted. I hope.
  • Anyway – market reaction to this number will be very interesting. If CPI is higher than expected, I would anticipate a very negative reaction to stocks and bonds, and v.v. People will start talking about 100bps of tightening this month (I doubt we will get that though).
  • And if CPI is soft, we should get a positive reaction from nominal stocks and bonds…naturally.
  • But what of inflation markets? Traditionally, an upside surprise would be met by a rally in breakevens. However, if investors really believe the Fed is going to respond aggressively and sucessfully, with a chance of overdoing it, then breakevens may FALL with a high surprise.
  • I don’t think that would make sense, but it also doesn’t make sense for 5y breakevens to be at 2.52% with median CPI at 5.5% and rising, wages at 6.1% and rising, and rents at 5.1% and rising.
  • However, markets clear risk; they don’t forecast. The inflation markets are telling us that people believe they have far more exposure to declining prices than to rising prices, and so need to sell it. That seems nonsensical to me, but ::shrug::.
  • So it will be interesting to look at the reaction in breakevens, especially if it seems nonobvious with the number.
  • That’s all for now. Number coming up. Good luck.

  • well…the consensus got the spread right, if not the level!
  • m/m CPI: 1.32% m/m Core CPI: 0.706%
  • Here is my early and automated guess at Median CPI for this month: 0.731%
  • Hey, that worked.
  • So, Owners’ Equivalent Rent was +0.7% m/m; Primary Rents +0.78% m/m. Rents will eventually decelerate, although not decline, but this will take a while.
  • Largely as a result of rents, core services rose to 5.5% y/y; core goods fell to 7.2% y/y. Not actually good news, since services are stickier.
  • So airfares fell, -1.82% m/m after a 12.5% surge last month. Lodging away from home -2.82% m/m. Car and truck rental -2.2% m/m. But Used Cars and Trucks +1.6%; New cars and trucks +0.7%.
  • Baby food +1.1% (NSA), and 12.6% y/y. But the main plant that had been shutdown is reopening. So, we got that going for us.
  • With y/y core falling to only 5.9%, it makes it even clearer that we will hit new highs in September if not before. Especially with core services continuing to rise, the m/m figures just aren’t going to drop that fast. And the comps for the next 3 months are +0.31, +0.18, +0.26.
  • I kinda buried the lede that headline CPI rose to 9.06% y/y. However, that is going to be the high for a little while unless energy sharply and quickly reverses.
  • Babysitting the bot got me off my game a little. Forgot to post this chart of the last 12 core CPIs.
  • So, this was not the highest core CPI we have seen. We had bigger ones back in 2021. But those were driven by outliers – you know that because median CPI did NOT have those spikes. This 0.7% is much worse…it’s not from outliers.
  • In the major groups, Apparel was +0.79% m/m. medical Care was +0.67% m/m. “Other” was +0.47%. The rise in medical was broad, with Pharma (+0.38% m/m), Doctors’ Services (+0.12%), and Hospital Services (+0.26%) all contributing. Still lower than core CPI, but trending higher.
  • Core CPI ex-shelter did decline, though, to 6.1% from 6.4%. That’s good I guess?
  • 10y BEI +7bps. So remember I was concerned that an upside surprise could be met with LOWER breaks if investors really believe the Fed is in charge and is gonna go large. Well, they may go large (stocks getting killed), but inflation folks less sure they are “in charge.”
  • The median category looks to be Medical Care Services. And that bot chart actually matches my spreadsheet. It was just truncated until I clicked on it. Man, this looks ugly.
  • That would put median CPI at 5.952%, rounding up to 6%, y/y. Another record high.
  • Biggest increases in core categories were Motor Vehicle Maintenance and Repair (+27% annualized) and Motor Vehicle Insurance (+26%), both a function of rising parts and replacement costs. Used Cars/Trucks +21%. Footwear +21%. Jewelry +19%. Infants’ apparel +16%.
  • In median, the Cleveland Fed splits OER into four geographic categories. This month, “South Urban” OER was up at roughly 12.5% annualized (roughly, because I seasonally adjusted it differently than the Cleveland Fed does).
  • Biggest monthly decliners were lodging away from home -29% annualized; -23% car and truck rental. Public Transp -5%, Misc Personal Goods -4%.
  • OER at 5.5% is well above my combo model. But it’s actually a little below one component of the model, which is based on incomes. 6.1% annualized income growth means the REAL rent growth isn’t as big as it looks.
  • This is a disturbing chart. It shows Atl Fed wages minus median CPI. I’ve estimated the last point (Wages could still accelerate this month, but won’t as much as Median). For a while, the median wage was steadily ahead of inflation. No longer. That’s why cons confidence is weak.
  • Let’s do four-pieces. Piece 1. Food & energy up more than 20% over the last year. That’s the highest in many, many years. And it’s why Powell is suddenly interested in headline.
  • Piece 2: Core goods. Yay! This is the story they were all sellin’ back when we first started spiking. “Once the ports clear, inflation will collapse back.” Actually, they told ya that PRICES would collapse. That is not ever going to happen. But inflation in core goods will slow.
  • Part of the reason core goods inflation will slow is because of the persistent strength in the dollar. I don’t know that will last forever, but while it happens it will tend to pressure core goods inflation lower.
  • Piece 3, core services less rent of shelter. This is the scariest one IMO, because it has been in secular disinflation for a long long time.
  • Piece 4, rent of shelter. This is also a candidate for scariest. People keep telling me home prices and rents will collapse but there’s a massive shortage of housing and building is difficult. Real prices could fall and nominal prices still rise, and that’s what I expect. Later.
  • So, this is fun. I have run this in the past but had to shift the whole thing because most of the distribution was off the right side. So the left bar shows the sum of categories inflating less than the Fed’s 2% target. The right bar is the weight of categories inflating >10%.
  • The sum of the weights of categories inflating faster than 5% is now over 70%. This was essentially zero pre-Covid.
  • Well, I guess we can wrap this up with a look at the markets. S&P futures -60 just before the open. 10y yields +5bps. 2y yields +12bps. 10y breakevens +5bps. Actually less-severe than I’d have expected. This is an ugly number.
  • So, we keep being told tales that inflation is peaking. And it will. Surely it will. It’s just that there are things that are still going up.
  • Our problem is that we have trained our perception on a low-inflation world. When prices go up 10%, we expect them to fall back. That isn’t automatic in an inflationary world. Prices going up too fast are followed by prices still going up, but a little slower.
  • There is most definitely a wage-price feedback loop going on. The black line below is going to get to about 6% today. The red line – which is a better measure than avg hourly earnings – is not likely to fall under that pressure.
  • We are still in an inflationary world. We are still in an accelerating-inflation world. It won’t last forever. But it isn’t over yet.
  • That’s all for now. Remember to visit https://mikeashton.wordpress.com to get the tweet summary later. Try the free Inflation Guy mobile app to get lots of inflation content. Check out the Inflation Guy podcast. https://inflationguy.podbean.com Like, click, retweet, etc. Thanks for tuning in!

Okay, to be sure I have long been in the camp that inflation would go higher, and remain stickier, than most people thought. The early spikes in inflation, due to used cars, were to me a harbinger and not a one-off. This is not, and never has been, primarily a supply-side problem. Today’s inflation did not start on the supply-side. The shortages were caused by a sudden resurgence in demand, and that demand was entirely artificial. It was that demand that created the shortages. To call this a ‘supply side problem’ is either ignorant or disingenuous. In some rare cases, supply was permanently impaired. Refinery capacity, for example. But in most cases, it wasn’t. Real GDP is back on trend.

So then surely we can get inflation back down by destroying demand? No – that’s not how it works. If you destroy demand you will also destroy supply…because that’s how you destroy demand, by getting people laid off. Hiking interest rates will eventually do that – hurt demand and production, but not necessarily do anything to inflation.

To get demand down without destroying supply, you need to run the movie in reverse. You’d need to suck away excess money from the system. That’s not going to happen, of course; it’s easier to do a helicopter-drop than a helicopter-suck. At best, we can hope that money supply flattens out, and recently it has started to look like that’s happening. That would mean that inflation would continue until a new price level consistent with the new quantity-of-money level had been achieved. This is what we can hope – that even though the Fed isn’t draining marginal reserves, somehow money growth slows because demand for loans evaporates even though banks remains eager to lend.  

It might happen, but since we’ve never tightened policy in this way – rates only, not reserve restraint – we don’t really know how, how much, or if it will work. In the meantime, inflation continues to surprise us in a bad way.

The topic for the next couple of weeks is going to be whether the Fed decides to hike 100bps, as the Bank of Canada just did in a surprise move. The market had priced in 75bps, and then a deceleration. I expect they will not, although we need to be defensive against the same leaks-to-the-big-guys that happened last meeting. While the inflation numbers continue to be ugly, and employment has not yet rolled over in a big way, inflation expectations have collapsed. To a Fed that depends very much on the idea of anchored inflation expectations, those markets are saying “okay Fed, you win. Inflation is dead. Your current plan is sufficient.”

That’s not my view, of course. In my view, if you keep using the paddles and the patient doesn’t respond you either need to code him, or you need to find a different treatment. I rather think, though, that the FOMC will say “inflation lags monetary policy by 12-18 months, so we just haven’t seen our effect yet.” Then again, so far I have been completely wrong about the Fed’s determination to hike rates (to be fair, they haven’t yet been tested by a sloppy market decline or a rise in unemployment, but I didn’t think they’d even do this much so I am willing to score that as -1 for the Inflation Guy.)

What to do? With inflation markets fully pricing a return to the old status quo, and that right quickly, it would seem to be fairly low-risk to be betting that we don’t get there so quickly. It would be hard to lose big by buying short breakevens in the 3s, when it’s currently printing in the 9s. Possible, but I like that bet especially since it carries well. And since real yields have risen so much, and the inflation-adjusted price of gold has fallen so much, I’m even starting to like gold for the first time in years. I’m not nutty about it, but it’s starting to look reasonable. It has been a rough couple of months for just about every investment out there (except real estate!), but opportunities are coming back.

Summary of My Post-CPI Tweets (April 2022)

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

  • It’s #CPI day and #inflation has peaked! Yay!
  • Well, in a few minutes it will be official: peak CPI has passed. Of course, that’s entirely a mechanical fact due to the fact that core CPI in April, May, and June last year was +0.85%, +0.75%, and +0.80%, and it (probably) won’t be that high this year.
  • It certainly doesn’t mean inflation pressures themselves have peaked. In fact Median CPI, which is a better measure of the central tendency of inflation pressures, is almost certain to rise to new y/y highs today. But don’t let the facts get in the way of a party.
  • The bigger issue I think is that people confuse peak INFLATION, which is a rate of change, with peak PRICES. Prices aren’t going to fall, even if the inflation rate falls. (Some prices will fall, of course, but not generally). Price level is here to stay.
  • Before I go on: after my comments on the number, I will post a summary at https://mikeashton.wordpress.com and later it will be podcasted at http://inflationguy.podbean.com . And all of that also will be linked on the Inflation Guy mobile app. AND….
  • What is more, at 1:00ET I will be live with @JackFarley96 on @Blockworks_ to talk (for a long time) about inflation. It’s on YouTube and free, so tune in! https://youtube.com/watch?v=mrG8IHXzlQU  And he had a nice placard made up.
  • Back to the report walk-up. The consensus for CPI is +0.2% m/m, dropping y/y to 8.1%. Gasoline should actually be a small drag this month, but contribute again next month. Consensus for core is +0.4%/6.0% after 6.5% y/y as of last month.
  • The interbank market isn’t so sanguine; it has been trading today’s headline print at a level suggesting 0.3%/8.2% for the headline number, so a snick higher than economists’ estimates.
  • That’s my feeling too. There’s more risk to the upside than the downside in this number today, I think.
  • The good news is that truckload rates are coming down, and this tends to precede ebbing in core. Not sure that effect is being felt yet; the typical lead is pretty long and manufacturers I speak to are still assuming high shipping in their pricing.
  • And the strong dollar will bring down core goods eventually too (it should decline today but is still double-digits). That is also a long lead. Used cars should drag slightly today. They were -3.8% m/m last month and private surveys have them a smidge lower this month.
  • But again, the rate of increase in used car prices is declining mostly because of base effects, not because prices themselves are going back to the old levels. And they won’t. We have 40% more money than we had 2y ago; that’s not consistent with prices where they were 2y ago.
  • On the other side of the coin, primary rents surprised on the low side last month. I expect a bit of a retracement higher this month, and I’m still not sure we’ve seen the peak m/m OER rate. Those are the 500-lb gorillas and until they ebb we won’t get 2% CPI.
  • As longtime followers know, I’ve also been watching Medical Care for a while. This month I actually saw stories about nurses’ salaries starting to pressure hospital prices higher. So still attentive to that. It’s one of the only sectors that hasn’t really participated.
  • We are also eventually going to get a bump higher in college tuition CPI – saw a story y’day about BU raising tuition ~5% (I put the story on the Inflation guy app). But the NSA series mostly puts those adjustments in the summer so we shouldn’t see an inflection yet.
  • In the markets, the past month has seen a massive shift in interest rates higher, and breakeven inflation rates lower (the breakeven reversal coming mostly over the last few days). 1y inflation swaps are -58bps on the month. Only some of that is carry.
  • Stocks have obviously been under pressure from rising inflation and real rates. Over the last couple of days, the stock market debacle has caused some unwinding of the rate selloff but breakevens are still on the back foot.
  • Stocks today seem chipper, but most of that is coming from signs of lower COVID transmission in Shanghai and a sense that lockdowns there may end soon. We will see if they’re still chipper after CPI.
  • I still don’t see the Fed as hawkish as what is priced in, mainly because I think they’ll lose their nerve as asset prices fall. I don’t really care about them changing the price of money. I’m watching for a change in quantity of money. So far, not impressed.
  • Just 4 minutes to the figure. Good luck!

  • Oh, snap.
  • Headline CPI fell to 8.3% y/y, not as far as expectations. Bigger deal is that core CPI was several ticks higher than expected. 0.57% m/m
  • I am scrunching up my eyes but I can’t see a decline in inflation pressures here.
  • Well, let’s see. Used Cars -0.38% m/m, small drag. New cars +1.14%, though. The spread Used:New needs to close but most of that spread probably will be new car prices coming up. After all, new price level as I said.
  • Owners’ Equivalent Rent 0.46% to 4.78% y/y from 4.54%. That’s in line with where it has been. But Primary Rents jumped back up after the surprise last month: 0.56% m/m to 4.82% y/y from 4.45% y/y.
  • COVID recovery continues: Lodging Away from Home +1.7% m/m; airfares +18.6%!
  • Now, I have been seeing a lot of stories about this one. It’s only 0.04% of the consumption basket but it really hits viscerally. Baby Food, +3.05% m/m, +12,9% y/y.
  • Food and Beverages as a whole, +0.84% m/m, +9.00% y/y. Ow!
  • Now, I don’t know if this is good news or not but core inflation EX HOUSING declined to 6.8% y/y from 7.5%. Good news is that means some of the outliers are coming back. Bad news is that means the big slow categories are carrying most of the upward momentum.
  • I guess looking at the chart, I probably shouldn’t get very excited about that last point.
  • Of note is that Apparel was -0.75% m/m. Apparel is only 2.5% of the basket these days (yet still a major subgroup), but it is Core Goods and one of the categories that you’d expect to see a dollar effect in. Core goods y/y dropped under 10%. But still a long ways to go.
  • …in that chart you can also see core services up to 4.9% y/y, which is the highest since 1991. So there’s part of the economy that’s not inflating at 40-year highs. And it’s not a small part of the economy. But, 5% isn’t exactly great news.
  • Turning to Medical Care – it was +0.44% m/m, up to 3.23% y/y. Led by Hospital Services, +0.48% m/m. Still not alarming and below the price pressures we’re seeing everywhere else. Weird.
  • Within food, here are some of the m/m NSA changes that people are seeing. This is why they’re yelling, Joe. Putin’s arm is long: Dairy +2.4% m/m. Meats poultry fish and eggs +1.7%. Cereals/bakery products +1%. Nonalcoholic beverages +1.4%.
  • Biggest losers in core (annualized monthly rate): Jewelry/Watches -19%, Footwear -15%, Women’s/Girls’ Apparel -10%.
  • Biggest winners in core (annualized monthly rate): Lodging away from home +23%, Motor Vehicle Parts and Equipment +15%, New Vehicles +15%, Car/Truck Rental +10%. Shorter list than we’ve seen in a while, anyway.
  • My guess at Median CPI is not good news: 0.53% m/m is my estimate, 5.23% y/y. That’s a better sense of where the inflation pressures are. We’ll revert to something like 4.5%-5% just on y/y effects, but until the monthly Median CPI is not hitting 0.5%, we’re not out of the woods.
  • There’s also this. I’d want to see core below median as a sign inflationary pressures are ebbing. In disinflationary environments tails are to the low side (so avg<median). In inflationary environment, tails to the upside (median<avg). We are still in inflationary world.
  • Quick check of them there markets…whoops, it appears equity investors don’t like this number.
  • By the way, for everyone thinking that rents have to stop going up because people can’t afford these levels. Again, the price level has changed. And wages are keeping up with rent increases, on average. There is no obvious sign to me that rents are overextended at all.
  • Here are the four-pieces charts, and I think we’re going to see the same story in the diffusion calculations. The stickier stuff is coming along for the ride. Here is piece 1, food and energy. No surprise here. And gasoline will be back as an addition next month.
  • Core goods. This is where the dollar effect, and the decline in the cost of shipping, will eventually be felt. And at some level actually is (see Apparel).
  • But now we get to core services less rent of shelter. This has been inert for years until just recently. This is the second-stickiest of the four pieces.
  • And rent of shelter. The stickiest. Rising, and not yet showing signs of slowing (although I think 5-6% is where it flattens out for a while). There’s just not a lot of great news here.
  • Tying up one loose end here – used cars was a small drag. But look at how the y/y plunged. Again, this is because even with little change in the PRICE LEVEL of used cars the rate of change will decline.
  • Couple of quick diffusion charts and then I’ll wrap up. Here is the proportion of the consumption basket that is inflating faster than 4%. It’s at 76% and actually just reached a new high. No sign of peak inflation here.
  • And finally, the Enduring Investments Inflation Diffusion Index…actually declined slightly. Last few months it has rocked back and forth a little bit at a very high level. No real sign of peak inflation here either.
  • Summing up. The peak y/y CPI print is now behind us, at least for now. Expect a victory lap from policymakers talking about how their policies are winning. But there’s no sign of peak inflation pressure yet.
  • The core and headline numbers actually fell less than expected. And let’s face it, this month’s Core CPI figure annualizes to almost 7%.
  • In fact, 6 of the last 7 core CPI numbers have been between 0.5% and 0.6%, which would annualize of course to 6%-7.2%. If that’s what we’re celebrating with “peak CPI” behind us, I guess I’ll bring the whiskey but I’m not sure I’m celebrating.
  • And FWIW, the “peak” is because we dropped off 0.86% (core m/m) from April 2021. We have 0.75% to drop next month, then 0.80%. But then we see 0.31%, 0.18%, and 0.25%. In other words, apres le deluge, more deluge.
  • Core CPI is likely to still be 5%-6% at year-end! The sticky categories are still accelerating, and there will be other long tails to the upside. That’s just what an inflationary environment looks like. Watch Median CPI, which will be lower but no less concerning.
  • Will the Fed keep hiking raising the price of money? Probably, although I think the swagger might leave them when stocks are another 20% lower.
  • Will the Fed actually decrease the QUANTITY of money, which is what matters? They can’t, because banks are not reserve-constrained any more. So it’s up to loan demand and supply, and recently loan demand has been increasing, not decreasing. Chart is source Fed, h/t DailyShot
  • Bottom line, folks, is that this might be a clearing in the woods but there’s a lot of woods ahead. Eventually inflation will ebb to 4%ish, but it will take time. I don’t see 2% for quite a long time, and not until interest rates are quite a bit higher.
  • Thanks for tuning in. Don’t forget to check the summary later on the blog https://mikeashton.wordpress.com , and http://inflationguy.podbean.com  where I’ll have a podcast on this later. AND tune in at 1:00ET for Inflation Guy live with@JackFarley96 on @Blockworks_

The theme of the day is that “peak inflation” means different things to different people. To economists, and policymakers, and Wall Street brokers trying to get you back into the meme stocks, “peak inflation” means “the year/year rate of inflation will decline from here.” We already knew that was happening, before this number ever showed up on screen. Yes, the drop was less than expected, but the peak is still there in March 2022!

“Peak inflation” means something different to the average consumer, who isn’t a trained economist. Consumers tend to conflate “inflation” with “high prices”, rather than rising prices. That is, they tend to confuse the level of prices with the rate of change. So the consumer hears “peak inflation is here!” and expects that prices themselves should go back to the old levels. To some extent, this version is reinforced by the price they see most often: gasoline, which goes up and down. But most prices do not go up and down. They go up more quickly, and they go up more slowly, and sometimes they stay the same. Most prices don’t go down. The average consumer, thinking he has just been promised that used car prices, meat prices, gasoline prices, and rents are going to go back down is going to be even more upset when that doesn’t happen. (This is why politicians ought to be very careful about talking about “peak inflation” as a good thing. To the average consumer, prices that go up more slowly is just less-bad than prices that go up quickly…and they think you’ve promised them something good.)

And the inflation specialist doesn’t mean either of these things when he/she says “peak inflation.” The inflation specialist is looking at pressures, and whether those pressures are increasing, abating, or staying the same. For now, those pressures are staying about the same, with m/m core and median CPI in basically the same range they have been in for 6 months. There is not yet any sign that those pressures are ebbing. Yes, they are ebbing in some items, such as in Used Cars, and in some goods where supply chains are clearing (at higher prices). In general, we would expect goods and services which have reached a new equilibrium price level to stop going up so fast. But those are just the goods and services that moved first. With 40% more money and an economy that’s only 5% or 10% bigger, we should expect prices to eventually rise about 30%. Some more, some less, of course, and if money velocity stays down forever then it will be 20% and not 30%. But this is the point. Peak inflation does not mean peak prices. Prices continue to rise at a rapid rate, and there is as yet no sign that the pressure to do so is ebbing.

Inflation is a Tax

We all have heard it said before: “inflation is a tax.” It seems that when most people say it, they seem to mean that it’s painful, like a tax is. That both inflation and taxes hurt the little guy, more than the big guy. That the other political party is responsible for bad things, and these are both bad things, so they imply the same thing: vote for me!

When Milton Friedman said it, he meant inflation is a tax.

We recently have seen in an uncommonly explicit way just what this means. It isn’t something vague but an actual tax. It takes money from you, but it doesn’t stop there – it transfers that money to government coffers. I thought of this recently when I saw a headline about how government receipts were breaking records. The headline seemed to think this was great news, but I am a taxpayer so my natural reaction was: dang it. Indeed, receipts at all levels of government are way up for a bunch of reasons. Incomes are higher, so income taxes are higher. Corporate earnings are higher, so corporate taxes are higher. Retail prices are higher, so sales tax collections are higher. And real estate prices are higher, so real estate taxes are higher. To the extent that these things are higher because of higher real activity, it isn’t a bad thing – but at least part of the increase in receipts is due to inflation. Buy the same item today as you did last year and the price is going to be roughly 8-9% higher on average, which means that your sales tax will also be 8-9% higher. If your restaurant bill is 10% higher this year; so is the tax…and the tip, which is income. So it shouldn’t be a terrible surprise that overall federal receipts over the last twelve months are up. By about 27%, actually, compared to the twelve months ended in March 2021.

To be sure, the 12 months ended in March 2021 included a lot of the shutdown, although you can see in the chart that the shutdown didn’t really hurt receipts that much. But to make a better comparison: the first three months of 2022, compared to the first three months of 2021, federal receipts were +18.8%. It’s good to be the king, in inflationary times. At least until the rabble figures out where their money is going.

How much of the overall increase in tax collections is inflation? Over a long period of time, most of it although you are correct in your visceral sense that the pound of flesh has become more like 2.5 pounds of flesh over time.

The chart above shows rolling 12-month tax receipts, indexed to 12/31/1980. The red line is nominal receipts; the blue line is taxes adjusted for inflation. Since 1980, taxes have still gone up about 150% in real terms, about 2.25% per year. That’s not far from what the real growth rate of the economy has been, although to be fair about 22% of that is since the beginning of 2021.

[As an aside: if the “inflation truthers” are right about inflation really being about 5-6% higher per year than the government admits to, since the early 1980s, then either tax burdens have been going dramatically lower in real terms or the government is also lying about government receipts which must actually be orders of magnitude higher. You see how absurd this argument gets?]

So the government gets more revenue when you produce more, but it also gets more just because prices go up. Inflation is a tax.

While it isn’t directly illustrated in the charts above, this is one way that inflation contributes to inequality. It takes more from the less-well-off than it does from the well-heeled. Inflation is not only a tax – it is also a very regressive tax.

Categories: Government, Politics Tags: ,

High Prices Don’t Cure High Prices

April 23, 2022 10 comments

This was an interesting week, in which it seemed that equity investors finally and abruptly got the message that high inflation is bad for the market; increasing interest rates are bad for the market; declining bid/offer liquidity is bad for the market; high energy prices are bad for the market; global geopolitical unrest is bad for the market; and a strong dollar is (eventually) bad for the market. The last two days in the stock market was a remarkably steady and orderly melting. Will it continue? Well, none of those trends I just mentioned look as if they are about to change significantly, so the only question is whether the extraordinary popular delusion returns.

The proximate cause for the selloff seems to have been the hawkish talk from Fed speakers, including the floating of the trial balloon early in the week about the possibility of a 75bp tightening. By the end of Friday, Cleveland Fed President Mester was actively pouring cold water on the notion that anything so aggressive was out of the question, while still talking in terms of 50bps increments.

I admit that as of only a few months ago, I didn’t think the Fed would hike rates more than about 75bps in total before they lost their nerve. On the other hand, they’re about 500bps behind the curve, so color me surprised…but not impressed.

To be sure, I also thought the stock market would have reacted before this point. And I do think that it is easier to talk about how much you’re going to work out this summer until it gets hot. So we will see.

But, on to my real topic today: the annoying canard that “high prices are the cure for high prices,” which is a phrase so absurd on its face that the discussion really shouldn’t go much further than that. The phrase implies that we can’t have inflation because if we have inflation, then prices will come down. It’s one reason that people are expecting used car prices to drop by as much as they previously rose – because “no one can afford a car at those prices!”

The idea is that as prices rise, the amount of money in your pocket can’t buy as many things. Therefore, real demand must suffer because higher prices mean that people can buy less stuff. Ergo, inflation causes recessions (which is weird, because we are always told how expansions cause inflation – which means that expansions must cause recessions. Are you feeling a ‘down the rabbit hole’ sensation yet?).

This is another example of a stock-flow fallacy. Or maybe it’s a fallacy of composition. It’s a micro/macro mistake. The point is that it doesn’t work that way.

The system can’t run out of money. If prices go up 25%, it doesn’t mean that you can buy 20% less stuff. Well, perhaps you can buy 20% less stuff, today, until you run out of money. But the person who sold you the car now has 25% more money than he would have previously, had he sold the same car before. Maybe you are out of money, but he has 25% more money. The money doesn’t leave the system when you buy something. It only leaves your wallet. (The stock market works exactly the same way, and no one ever questions why stock prices can’t keep going up because investors are using up all of their money, right?).

Now, if the total amount of money in the system is the same today as it was before the 25% increase in prices, and the velocity of exchange doesn’t change, then yes – that 25% price increase won’t stick because in aggregate we will be spending the same amount of money at higher prices, which means we take home fewer goods and services. If on the other hand the amount of money in the system went up by 25%, then total expenditures (if velocity is roughly constant) will be the same in unit terms as before. The system doesn’t grind to a halt and force prices lower. The system reaches equilibrium at prices that are 25% higher. By the same token, if there is 40% more money in the system, then those 25% price increases won’t be enough, there will be shortages, and prices will keep rising.

This seems like a good point to recall that M2 money since the end of 2019 has risen 42%. Tell me again why Used Car prices need to retrace so much?

The real question, to me, is why more prices haven’t gone up 42%. My answer is that we are still in the adjustment period. It takes time for that money to wash around the system, and it’s still on the rinse cycle.

Summary of My Post-CPI Tweets (March 2022)

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

  • It’s #CPI #inflation day again, and a watershed one at that. If you had told me back at the beginning of my career in 1990 that we would see 8.5% inflation again, I would not have been surprised. If you had told me it would take 32 years, I would have been flabbergasted.
  • But, here we are. The consensus Bloomberg estimate is for 8.4% on headline inflation with 6.6% on core. That’s monthly of about 1.25% and 0.5% (!) But last month, the interbank market was looking at an 8.6% peak, so I guess that’s good. Energy has come off the boil some.
  • But this is the first number that is fully post-Ukraine-invasion so it will still get a big dollop of energy inflation.
  • Before I go on: after my comments on the number, I will post a summary at https://mikeashton.wordpress.com and later it will be podcasted at http://inflationguy.podbean.com . And all of that also will be linked on the Inflation Guy mobile app. Please stop by/tune in.
  • First, the good news. I expect today’s figures will mark the highs for the year. The comps get really hard hereafter: in April 2021, Core CPI rose 0.86% m/m, 0.75% in May, and 0.80% in June.
  • The bad news is that inflation might not ebb very far. The last 5 monthly core prints have been between 0.5% and 0.6%. The central tendency of the distribution appears to have moved up from 2-3% to maybe as high as 6%+.
  • That means that even when inflation is at an ebb, we’re looking at 3-4 ish, not 1ish. More good news though! The Fed in theory has total control of this. If it aggressively shrinks the balance sheet, then it can wring inflation out of the system.
  • I have no doubts that the Fed has the tools. There have been signs they aren’t focusing on the right ones. And there’s at least new vigor in the talk. But I am still skeptical that they are willing to break things.
  • By aggressively shrinking the balance sheet, I don’t mean $60bln a month; I mean taking the whole thing down to $2-4T in a reasonably short period of time.
  • But while it now looks like the FOMC will bull ahead with 50bps this month (surprising me), I just can’t bring myself to believe that it will crack the stock market and keep tightening through the recession we’ll get in late 2022/early 2023.
  • 275bps of rate hikes? Color me skeptical as soon as the growth data starts to flag a bit, or unemployment ticks up.
  • That’s really the longer-term question. Will the Fed do what it takes to break the cycle they put into motion, by reversing it? AND will they resist responding to the next recession with more of the same? I have my doubts. Would be happy to be wrong.
  • Wages, food, and rents have been booming. There is some feedback going on here. Of course, the main culprit continues to be the huge increase in the quantity of money over the last few years. The rest of it is micro.
  • But if you’re looking at supply chain issues – they haven’t gone away. In some cases they’re getting worse. As a reminder, though, that’s how inflation manifests, is in shortages of things that are over-demanded thanks to the money gusher. Prices adjust in response.
  • The bond market is starting to adjust to the realities of a hawkish Fed although not yet really putting rates at anything we would consider neutral (with a 10y rate around GDP+desired inflation, say 4-5% total).
  • Over the last month, inflation expectations have been broadly unchanged to slightly lower – although a lot of that is carry going away. Real rates are up 50-100bps, and nominal rates up 80-85bps. That’s big, but not nearly big enough to make a serious difference.
  • Why hasn’t the stock market begun to reflect the higher inflation? Partly because inflation expectations still haven’t firmly broken higher. And, after all, real rates are still slightly negative. But we’ll get there.
  • Now, in today’s number we will look aghast at the food category. High and persistent inflation in food and energy is not something policymakers can do a lot about, but it IS what leads to global political unrest…which leads to more supply chain problems and de-globalization.
  • Rents will remain high, currently trending towards 5-6% as Primary Rents continue to adjust post-eviction-moratorium.
  • And Owners’ Equivalent Rent remains high but steadier (at least recently). This is likely to remain so for the rest of 2022. Remember, the rent pieces are the big slow-moving pieces. Usually slow-moving, that is.
  • On the other side, I think there is a chance that Used Cars are a drag although prices themselves aren’t going to go back to the old levels. Might retrace a bit, but the new price level is higher – that’s what the money does. So rate of increase will decline. Level? Not so much.
  • But airfares and lodging away from home may be adds. Look as usual for the breadth; the odd stories will be the categories that did NOT rise.
  • I’m also still watching the Medical Care subgroup, as the inflation there has remained surprisingly tame through all of this. Only Medical Care and Education/Communication are below 2.5% y/y among the major categories! They’re due to participate eventually.
  • Here we go. Three minutes. Good luck. Take a picture to remember this by. At least until we get higher numbers in 3 years.

  • Pretty close. The headline number showed 8.5% y/y because the monthly number was just a little higher than expectations. But with all the volatility, that’s a great consensus estimate. Core was quite soft, at 0.32% m/m. Well, that’s soft these days.
  • Y/y core CPI therefore was only a snick or two higher, 6.44% y/y vs 6.42% y/y last month. As a reminder, hard comps are coming up so that probably marks the highs in both headline and core. Question is how far and how fast they drop.
  • That was the lowest core CPI figure since the three soft ones of July/Aug/Sep last year. We’ll look at the components.
  • A big culprit was, as I thought it might be, Used Cars. The private surveys had had a decent drop recently; in the CPI they were -3.8% m/m so that the y/y is “only” 35.3%.
  • Airfares, were +10.7% m/m. Lodging away from home +3.28%. But those are smaller weights. New Cars were only +0.18% m/m, so it does look like while New Car prices are going up, Used Car prices are also going down to re-establish a more normal relationship. This will take some time.
  • Car and truck rental was +11.7% m/m. That’s remarkable too. Rental car companies are having trouble getting enough new cars, and that’s one reason used car prices won’t plunge any time soon. But also, people are traveling again!
  • Food & Beverages: +0.96% m/m, +8.5% y/y. Food prices won’t recede soon. In addition to the loss of Russian and Ukraine supplies, there has been a recent culling of chickens due to bird flu. Like we needed that.
  • Core inflation ex-housing declined from 7.6% to 7.5%. Big whoop.
  • Core goods prices, thanks significantly to Used Cars, decelerated to 11.7% from 12.3%. But core good prices accelerated to 4.7% from 4.4%. Until the last 3 months core services hadn’t been at a new 30-year high, but they are now.
  • Remember, services prices are the slower-moving ones. BTW, this month Primary Rents were +0.43% (y/y up to 4.54% from 4.31%) and OER was also +0.43% (y/y 4.45% vs 4.17%). Both still headed higher but both slightly lower than last month.
  • In Medical Care: medicinal drugs was +0.23%; Doctor’s Services +0.49%; Hospital Services +0.40% for an overall increase in medical care of 0.55% m/m. Y/Y up to 2.86%.
  • Education/Communication was DOWN m/m, -0.17%. It’s really the only holdout category here. And if you want to find a place where there should be adjustments to LOWER quality post-COVID (implying more inflation), this is it!
  • Haven’t talked abt Apparel for a while. The y/y increase there is now ~6.8%. Apparel is a category that has been in deflation on net since the Berlin Wall fell. We import almost all of it. And prices have recovered the entire COVID discount and don’t look like they’re slowing.
  • Looking at housing, it is now running a bit hotter than my model; however, I think we could get an offsetting snap-back above the model reversing the underperformance during the eviction moratorium.
  • The main problem with housing inflation isn’t that it is going to 18%, but that it is slow-moving and it’s going to stay high for quite a while. High means 4.5%-5.5%, maybe a bit more even; given its weight in the CPI that means core CPI isn’t going back to 2% soon.
  • Market check, just for comic’s sake: Stocks absolutely love the decline in used cars which led to a softer core number. Breakevens are lower, but not so much.
  • While I wait for the spinning beach ball, this is a good time to remind you that a summary of all of these tweets will be on https://mikeashton.wordpress.com within an hour or so after I conclude. Then later today I will have a podcast version at https://inflationguy.podbean.com
  • The median CPI chart kinda tells the story. This was really never ‘transitory.’ The entire distribution has been steadily moving higher and breaking from the old range to a new range.
  • People ask me the best inflation hedge these days? For most normal people with normal amounts of money (annual purchases of these are limited), i-series savings bonds are the best deal the US Government offers. Maybe ever, at least when real rates everywhere else are negative. “The interest rate on inflation-adjusted U.S. savings bonds will soon approach 10%”  https://on.wsj.com/3rkEFVw
  • We put our database in the cloud so everything is super slow at the moment. I’m going to call a halt here. Some of my other regular charts will be in the post, at https://mikeashton.wordpress.com , so stop by later and check it out (or go there now and subscribe to the post).
  • Bottom line is that the basic story is the same. Broad and deep inflationary pressures. Don’t get distracted by the used cars thing; it didn’t create the inflation and it isn’t putting it out.
  • No sign yet that these pressures are ebbing. In fact, the acceleration in Medical Care bears watching. Also, the extended rise in food & energy is going to have other repercussions.
  • Is the Fed going to hike aggressively and (more importantly) squeeze down the balance sheet aggressively in this context? If stocks and bonds were going to be unchanged, sure. But they’re not going to be.
  • Treasury probably can’t sustainably manage the debt if long interest rates get to 5% (unless inflation stays at 8%). And stocks aren’t worth the same when discounted at 5% as when discounted at 1%. I am confident the Fed will blink. Maybe not as early as I originally thought.
  • One final word and chart. 75% of the weight in the CPI are now inflating faster than 4%. More than a third of the basket is inflating faster than 6%. This is an ugly chart.
  • Thanks for tuning in. Be sure to call click or visit! https://mikeashton.wordpress.com  or https://inflationguy.podbean.com  to get the podcasts. And download the Inflation Guy app!
  • Correction here…the y/y should move up to more like 4.9%, not 4.5%.
  • Highlighting that the number today was mostly dampened by used cars…looks like Median CPI will come in something around 0.5% again. Since September it has been 0.4-0.58% and the y/y will move up to around 4.5%. So don’t get too excited (equity dudes) about the softer core.

The Federal Reserve didn’t get any favors from the Bureau of Labor Statistics today. While the core CPI number was a little below expectations, that miss was entirely due to Used Cars. But while that category was an early champion of the “transitory” crowd, the fact that used car prices are declining slightly after a massive run-up is not a sign that the broader economy is slipping into deflation! It is a sign that that particular market is getting into slightly better balance.

Don’t confuse the micro and the macro. We get wrapped up in the supply and demand thought process because that’s how it works at the micro level. When we look at a product market, we don’t see ‘money’ as being a driver. It is, because you can think about the inflation of any item as (general price inflation) plus (basis: difference in the item and overall), where that basis is driven by those microeconomic supply/demand effects. The former term drives the overall level of inflation; the micro concerns drive the relative price changes. The used car market is getting into (slightly) better balance, but other markets are getting worse. Until the overall level of money growth slows a lot, and the aggregate price changes catch up with the aggregate change in the money supply, inflation is not going to vanish no matter what happens to “aggregate demand.”

As a reminder, M2 has risen some 40% since early 2020. Subtract out net real growth, and you’d expect to see 25%-30% aggregate rise in the price level – if M2 growth went flat. That’s why I say that if the Fed wants to crush inflation, it actually needs to cause M2 to decline, not just level out at 6%. I don’t see any chance of that happening because to do it the Fed would need to remove basically all of the excess reserves and make banks reserve-constrained in lending markets so that lending declines. This seems very unlikely! So will the Fed tighten 275bps? Someday…maybe over a couple of cycles when the real damage from inflation finally wakes them up. Right now, this is a short-term problem to them. I don’t think they’re willing to take a massive market correction to solve what they believe is a short-term problem.

Anatomy of a Monetary Policy Error

Well, it isn’t as if no one warned that monetary policymakers were eventually going to get painted into a corner. Long before the Covid crisis, there were many voices warning that the Fed’s tendency to ease aggressively, but to find excuses to tighten slowly, would eventually get them into trouble. And here we are.

The Federal Reserve, prior to the Ukraine/Russia war, had started to talk hawkishly about raising interest rates; that talk, combined with 40-year highs in core inflation, persuaded Wall Street economists that the Fed would raise interest rates by more than 200bps this year.

That was never going to happen, even if Russia had not invaded Ukraine. Not since the early 1980s has there been a tightening cycle of at least 200bps over 10 months that also ended with the overnight rate above where the 10-year rate had been at the beginning of that period. So the calls for 200bps of tightening with the 10-year rate under 2% was always an incredibly aggressive call. Moreover, those cycles where it did happen occurred in an era when the Fed Chairman didn’t go in front of the cameras every meeting to explain why the Fed was ‘trying to increase unemployment’ – and, in fact, back in those days almost no one outside of the financial community paid much attention to the Fed at all. Plus financial leverage, ancient source of dramatic accidents, was much lower then. So my operating assumption has always been that the Fed would probably tighten about 3 times this year, pausing in between each hike…or maybe hiking 4 times and then easing once. Especially since the Fed no longer controls the marginal reserve dollar (there being copious excess reserves), the effect of monetary policy moves is less clear…and this also mitigates in favor of taking time to assess the effect of policy moves by watching the economy evolve. Ergo, this tightening cycle was always destined to be late and halting, and focused on interest rates rather than on money supply. Such a trajectory already qualifies as a ‘mistake’ when inflation is threatening 8%.

But now there’s even more room for error. Because the skyrocketing energy prices trigger another mistaken belief at the Fed, which enhances the desire to tighten even slower/later.

The Fed thinks that rapid energy price increases have this effect on the economy: rapid increases in energy prices tends to cause slow growth or recession as those increases consume discretionary income and leave less for non-energy purchases. And recession causes a decrease in pressure on other resources, such as labor. Which, in turn, leads to lower pressure on core inflation. Since energy prices are mean-reverting (at least, the rate of change is!), the central bank is “supposed” to ignore inflation that is caused by energy price increases, since if they tighten according to some Taylor-Rule-like dictum then they’ll tighten into a recession and increase the amplitude of the business cycle. Ergo, the Russian invasion of Ukraine means that the Fed should tighten less.

However, that’s not the way this works.

Rapid increases in energy prices do in fact tend to cause recession. But inflation is not caused by too little economic slack, and disinflation is not caused by too much slack. Inflation is caused by money growth, period, and M2 money growth is currently above 12%. It is true that an increase in energy prices would lead to a decline in non-energy discretionary spending, which would limit core inflation, if money growth was low. But if money growth is high, the increase in energy prices just rearranges the relative price changes because there is plenty of money to go around. It doesn’t change the overall impact of the rapid money growth. (Small caveat: a scary recession would increase the demand for precautionary cash balances, lowering money velocity…but people are already holding such precautionary balances so it’s hard to see how that could be a large effect from this level). Ergo, when the Fed slows down its tightening campaign because of the way they believe inflation works, and especially if they decide to not shrink the balance sheet – because “higher long-term rates would be bad in a recession” – they won’t have any real effect on growth but they’ll be accommodating a much higher level of inflation.

And just like that, you have it. The genesis of a really colossal monetary policy error. Get ready.

Summary of My Post-CPI Tweets (December 2021)

January 12, 2022 2 comments

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

  • Welcome to the first #CPI Day of 2022 (although technically it’s really the last of 2021 since we’re releasing December #inflation figures). Exciting times, as headline inflation might sport a 7% handle and core inflation definitely will be well above 5% y/y.
  • The last three numbers have been so broad, so worrisome OUTSIDE of the “Covid Categories”, that even the Federal Reserve is saying the right things. Will they really hike rates 4 times this year? I’m skeptical but we will see.
  • Core CPI for October and November were 0.599% and 0.535% m/m, respectively…but most importantly, there wasn’t a clear outlier causing these jumps. Median inflation, which is unaffected by those tails, has had three straight months above 0.45% (5.4% annualized).
  • Not only the Fed, but also the market, is finally starting to listen a little. This chart shows the changes from 1 month ago for real rates, inflation expectations, and nominal rates. All higher from mid-December.
  • But the theme from economists over the next few months – brace for it – will be “But economists expect inflation to moderate in the months ahead.” You’ll see this everywhere.
  • That’s because after easy year-ago comps for the next 3 months, they get difficult in April-June. So, while core inflation should get to 6% in early Q2, the y/y numbers PROBABLY won’t get worse than that (in 2022).
  • So, mix that story with “see, the Fed is serious and inflation is already coming down” and you’ll get the touts for stonks going in full force. Don’t worry, be happy. Buy the stuff that Wall Street needs to sell. Etc.
  • And there IS some good news. For example, the rate of increase in overland truckload rates is declining. Still high, but declining. Since trucking goes into all kinds of goods, it’s often a leader of the rate of change (not always).
  • Similarly, some modest good news from global shipping rates, which are down from their highs although edging back up a little (chart shows east-west container rates).
  • but … Other than those big base effects in April/May/June, there’s not a lot of reason to think the m/m #inflation figures will drop down to 0.15-0.2 again.
  • Going forward there will be a peak…but won’t be as serious as you think. We can all imagine used cars fading eventually. But no one bothers to imagine what will go up. So if you forecast a reversion to the mean for the first and ignore the second, of COURSE you forecast a peak.
  • Example: what about insurance? President Biden’s latest plan is to force insurance companies to provide 8 free COVID tests per person per month. Ignore whether the tests exist, but … Who do you think pays for that? Insurance company? Nope. More policy error.
  • What about China re-shutting some parts of its economy due to Omicron? Remember, (as I wrote in February 2020): “COVID-19 in China is a Supply Shock to the World” https://inflationguy.blog/2020/02/25/covid-19-in-china-is-a-supply-shock-to-the-world/ This is not policy error, just bad luck. But bad luck happens.
  • Last month I said “This is not about the pandemic any longer; it is about policy response to the pandemic. It is almost entirely policy error.” I feel strongly about this. While there is tough talk on this from the Fed, let’s see if it’s followed by tough action.
  • I’m concerned about that, since the Fed is still getting the story wrong. Powell says higher labor costs are not driving inflation. Well – that’s because labor costs generally FOLLOW inflation. Labor pushes when they see their own cost of living going up. Not before.
  • And thanks to workers’ pricing power, wage increases should rise around another 1% y/y by Q3, based on the current unemployment rate (green). This is good news for workers, bad news for consumers. Wages don’t cause inflation but they DO give it momentum.
  • So inflation will peak around April, but core will ebb to maybe 4%, not 2%.
  • Back to today’s number. Consensus is 0.4%/0.5% headline/core for the month and 7.0%/5.4% y/y. The ‘inside market’ is really 0.46-0.52 on core. The interbank market has the headline figure reaching 7.03%.
  • But remember this is December, and there are lots of weird seasonals, so anything can happen.
  • We are still watching rents, which should remain solid for a while here. Catching up from the end of the eviction moratorium, but there’s still plenty of heat in the housing market generally. And amazingly, we’re still watching used cars.
  • Here’s a chart of the level of used car prices. Not exactly collapsing! I mean, wow! I don’t know anyone who thought we’d get another leg higher.
  • And even the rate of change is reaching new highs. So we will likely get another push in the CPI from used autos, and new cars as well since they’re a substitute.
  • But most important in today’s #CPI remains the breadth. That’s the main focus today. If we get 0.7% but it’s all used cars, that’s not nearly as significant as if we get 0.4% and there are no outliers at all. That has been the recent story and I expect it to continue.
  • Good luck!  I will have a summary of all my tweets at https://mikeashton.wordpress.com  sometime mid-morning and then I plan to put out an Inflation Guy podcast  (https://inflationguy.podbean.com) sometime today. Like, click subscribe, all that.
  • Also look for the Inflation Guy app in your app store (once we get enough users we will probably do livestreams to those users, rather than on Twitter).
  • And finally, book your free place at the Institutional Fixed Income Virtual Summit on January 22nd. https://lnkd.in/dab2WfEP
  • Hey! I finished with the walk-up early. Still time to grab a coffee. Number in 7 minutes.

  • A bit higher than expected 0.5%/0.6% on core. Headline did get to 7%, core hit 5.5%. Bloomberg kinda slow-rolling the seasonally-adjusted core number so  don’t know the 2nd digit yet.
  • OK, here we go. The seasonally-adjusted core number, m/m, was 0.5501. So it just BARELY squeaked out the 0.6%. Still, higher than expected but not drastically.
  • Jumping out at me is the 1.72% rise in Apparel prices m/m. Apparel is only 2.7% of the basket but has been in deflation for years, punctuated by occasional attempts at price increases. Right now Apparel is +5.8% y/y. Some of that is likely shipping b/c apparel isn’t made here.
  • Used Cars, true to form, +3.5% m/m after +2.5% last month. Y/Y up to 37.3%. New cars +1% m/m.
  • Overall, core goods and services continue to look…um…disturbing?
  • Here is core services by itself. 4% looks like the big level. However, it’s no longer the case that this inflation is all about goods. Ergo, it isn’t all about supply chain.
  • OK in the COVID categories, 1.18% m/m from lodging away from home; +2.72% m/m from airfares. Car and truck RENTAL though was -5.3% m/m. That’s only 0.13% of CPI though!
  • Rents: Primary rents +0.39%, 3.33% y/y. That’s slightly lower than the last couple of months but still pretty hot. Owners’ Equivalent Rent +0.40%, 3.79% y/y. Ditto – lower but still hot. 4.8% annualized from a third of core would make it hard to get core back to 2%!
  • Medical Care was +0.28% m/m. But Pharma (+0.01%), Doctors’ Services (-0.05%), and Hospital Services (+0.16%) were all lower. Which means it came from insurance.
  • Here is medical insurance, y/y. Up 1.6% m/m. Medical insurance is a residual in the CPI (not directly calculated), but this is where added costs to insurance companies is showing up.
  • So core inflation at 5.5% is still “the highest since 1991”, but starting next month it will probably be “the highest since 1982” since the 1991 high was 5.6%.
  • Vehicle insurance (-16.8% one-month change, annualized) and Car and Truck Rental (-48%) were the only core categories that fell more than 10% annualized.
  • Categories that ROSE >10% annualized: Jewelry/Watches (+59%),Used Cars/Trucks(+51%),Womens/Girls Apparel(+30%),Public Transport(+26%),Motor Vehicle Parts/Equip (+21%),Footwear(+20%),Lodging Away from Home(+15%),Household Furnishings(+14%),Mens/Boys Apparel(+14%),New Cars(12%)
  • I am afraid this also looks like we are going to have another 0.45% or so on Median inflation. Hard to tell b/c regional OERs are the median categories it looks like, so it might be as low as 0.38% but unlikely I think.
  • Core ex-housing is +6.4% y/y. It’s worth remembering that core is currently being pulled DOWN by rents.
  • Folks, grab the reins on the change in the CPI weightings. They are a totally normal biannual thing. The changes will be larger this time than normal because consumption patterns changed – but there’s no conspiracy. Consumption patterns DID change. That’s all that’s happening.
  • Stories remain approximately the same for the four-pieces charts. The first is Food & Energy – most volatile, and the best chance for dropping the y/y headline number. But still, pretty ugly and this likely affects wage negotiations as people pay more for food and gas!
  • Core goods – a chunk is new and used autos. And there is upward pressure from shipping and trucking rates. But those are ebbing a little. This will eventually come back to earth, on a rate of change basis, but that doesn’t mean the price LEVELS will decline.
  • Core services ex-rents. This is still looking a little perky although not breaking to new highs like a lot of the rest of the index. Medical Care is actually holding down inflation. But uptick in health insurance is concerning.
  • Rent of Shelter – totally expected if you’ve been watching housing. Still has more to go! Again, it’s going to be hard to get core CPI back to 2% while rents are running 4-5% or more.
  • Slight good news on distribution. The weight of the consumption basket that’s inflating more-slowly than 3% is back above 25%!
  • OK, one more chart and then a quick wrap-up. Remember later to check out the summary at https://mikeashton.wordpress.com  and look for the podcast version of it at https://inflationguy.podbean.com
  • I said the most important part of this report was the breadth. And it was again a very broad report; Median CPI will again be around 0.4%-0.5%. The Enduring Investments Inflation Diffusion Index reached a modest new high.
  • There is nothing in today’s number that suggests the underlying inflation pressures are ebbing. The y/y change will eventually come down because the comps will get more difficult, but there is NO SIGN that core will be dropping back to 2%.
  • My base case is that we end 2022 with something like a 4% core inflation rate. Could be as low as 3.5%, but the potential miss on the upside is larger than that.
  • The Fed is talking tough, but talk is cheap. They’re still easing at this hour! Eventually they’ll stop digging the hole. When will they start filling it in – not by raising rates which has small effect if any on inflation, but by selling bonds? Don’t hold your breath.
  • I think they’ll raise rates once or twice, maybe even thrice if bond and stock markets don’t seem to mind. But eventually, they’ll mind because discount rates matter. When that happens, I can’t imagine the Fed keeps sticking the knife in.
  • We have Volcker-like inflation, but we have no Volcker.
  • And that’s the problem. Thanks for tuning in! If you’re curious about what we do at Enduring Investments, come by http://enduringinvestments.com and say hi. I do these tweet storms for many reasons – but some of those reasons are commercial! See you soon.

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

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

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

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

Summary of My Post-CPI Tweets (November 2021)

December 10, 2021 2 comments

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

  • It’s #CPI Day again. And it’s official, this is now the MOST WATCHED economic number of the month. It’s crazy to think that if you had told me two years ago that we would be pushing 40-year highs on #inflation in 2021, I’d have thought you were mad.
  • Amazingly, economists’ predictions for today’s figure would take headline inflation to 6.8% and core to 4.9%. The month/month forecast for CORE is actually 0.5% – an amazing testimony in itself.
  • Some economists are ‘getting religion.’ The last couple of numbers have been shocking (especially last month’s). The September CPI released in Oct was only 0.24% core, but it was broad.
  • The October CPI released last month was 0.599%, AND it was incredibly broad. Median CPI rose 0.57% m/m – by far the largest increase since 1982. Not even close.
  • So this month, people aren’t looking for retracements in an outlier. There’s nothing much to retrace. Indeed, it looks like we might get another push from autos.
  • Used car prices in the CPI rose 2.5% m/m last month; it could be 4% this month. It COULD even be more than that.
  • New car prices have also risen 1.3% in each of the last two months. With used car prices skyrocketing, it’s hard to imagine new car prices flattening out. So from autos, you could contribute 0.2% to core, if they play to chalk.
  • Rents have also been jumping. Unlike Used Cars, only the timing was surprising. I thought it would take longer after the end of the eviction moratorium to see 5% rates of increase and more, but here we are. Both OER and Primary rents were +0.42%-0.45% each of last two months.
  • If that repeats, it adds another 0.16% or so to core. So then you just need to find price increases of 0.14% from everything else in the core categories, to get to your 0.5% forecast. So it’s not a big reach.
  • Lots can go wrong in any month, of course, which is why I try not to overanalyze the number pre-snap. But 0.5% doesn’t seem wildly off as a baseline guess, to me. (The inflation swaps market sees more like 6.9% on headline, so upside risk.)
  • The bottom line is this: although next month we may get some drag from gasoline thanks to the sharp fall in wholesale prices at the end of November, we’re still very likely to hit 7% on headline and will certainly exceed 5% on core over the next few months. That’s amazing.
  • It gets more amazing: Because of easy comps from last year, averaging 0.06% on core for Dec, Jan, Feb, it doesn’t take a lot of imagination to get y/y core to 6% by the end of Q1. Then it should recede…but it’s not going back to 2%.
  • So to put it bluntly, inflation right now is not aiming for the 5 o’clock news. It’s aiming for the history books.
  • Why is this happening? Simple: too much spending, too fast, financed with newly created reserves. Period. The shortages result from getting incomes back above pre-covid levels before we were ready to provide the goods and services to the people waving dollars.
  • Going forward it is hard to see how this resolves easily. There are still many more people not in the workforce than there were pre-pandemic…but more income, by a lot. Demand>supply, and financed by 12% money growth.
  • Moreover, one final thought and a h/t to Barclays for their chart of the HH index. The Herfindahl–Hirschman Index is a very widely-used (especially in antitrust) measure of market concentration. Over the last few decades, it has risen precipitously, meaning more concentration.
  • When market power is concentrated, so is pricing power. And those mega-firms that now dominate just about every niche in American life have re-learned that price increases can stick in this kind of environment. Who can blame them? You build market power for exactly this moment.
  • It’s hard to unscramble this egg. So hang on to your juevos, number in a few.
  • Cents and Sensibility: the Inflation Guy Podcast
  • inflationguy.podbean.com
  • As a reminder, I will have a summary of all my tweets at https://mikeashton.wordpress.com  sometime mid-morning and then I plan to put out an Inflation Guy podcast (https://inflationguy.podbean.com) sometime today.

  • Yawn. CPI as-expected. Just a soothing 6.4% annualized pace of core. 0.53% m/m,
  • Core was actually VERY close to printing 5.0%. Using the seasonally-adjusted numbers you’d get 4.96%, which would round up. NSA numbers give you 4.93%. Doesn’t matter; will be over 5% next month.
  • So, highest headline inflation since 1982, highest core since 1991, with more to come on both.
  • Running through the usual suspects: Used cars were 2.50%. That’s less than I expected. There’s still make-up there next month, believe it or not.
  • Owner’s Equivalent Rent +0.44% again this month. Primary Rents +0.42% again this month. Eerily steady at a high level. This month, Lodging Away from Home was +2.98% m/m. Consequently, the Housing subgroup was +0.52% m/m, 4.8% y/y.
  • I mentioned Used Cars; New Cars was 1.13% (seasonally adjusted) m/m. Car and Truck Rental +1.1% m/m. Airfares this month (a “Covid category”) +4.75%
  • So with airfares, lodging away from home, used and new cars, motor vehicle insurance (+0.66% m/m)…doesn’t look like this wave of COVID is doing much to hold down prices.
  • An eye on Medicinal Drugs is warranted. y/y it’s back to flat. Doctors’ Services also up smartly this month, 4.26% y/y. Hospital Services down m/m but still 3.5% y/y.
  • Overall, Core Goods rose to 9.4% y/y, with Core Services up to 3.4% y/y.
  • Interestingly, two of the eight major subgroups declined m/m: Recreation, and Education/Communication. And we still got 0.5% on core!
  • Here are core goods and core services. Supply chain still an issue for goods. Core services the highest since 2008, and will go higher still thanks to rents.
  • Core inflation ex-housing back up to 5.72% y/y. It was higher in June at 5.81%. But otherwise…back to early 1980s.
  • So let’s see. Only category that declined at a faster than 10% annualized rate was Jewelry and Watches (-20.5% annualized m/m).
  • The list of categories >10% annualized growth. Excluding the 6 food/energy line items there: Mens/Boys apparel, public transport, lodging AFH, Used cars, Women’s/Girls apparel, New cars, Motor vehicle parts/equip, misc personal goods, car/truck rental, tobacco,househld frnishings
  • Looks like the median CPI category will be an OER subindex, which gets separate seasonals, so hard to forecast exactly but another 0.44% m/m or so from Median pushing it up to 3.5% (just my early guess).
  • Median m/m. One exhibit in the ‘broadening’ argument.
  • Once again, not a lot of huge outliers here. Although November and December numbers get harder to tell because the seasonal adjustments are more important (e.g. lodging away from home, negative before SA but strong after SA).
  • Why did Recreation decline? Well, thinks like “admissions”, photographic equipment, cable/satellite television service all declined. So the cake we are supposed to eat is at least getting cheaper.
  • Fascinatingly, 10-year breakevens are down HARD, -4bps on the day to 2.45%. With core pushing 5% and rising. Wonder what kind of number folks needed to stay long??
  • Here are the Four Pieces. Food & Energy. Near multi-decade highs as well. And it’s not just energy – there are ripple effects in fertilizer and therefore food. The Food subindex itself was +5.82% y/y.
  • Core Goods – here is where the supply chain argument is most-salient. Obviously cars are in here and a big part of it. But not all of it! it will come down, but all the way to zero? I have my doubts. And…not soon.
  • Core services ex-shelter. Still the best news out there. Medical care not unreasonable. Mind you, this would have scared me two years ago, but right now it looks soothing compared to the other charts.
  • And the part that was the most-predictable (but took an amazingly long time for people to catch on to): rent of shelter. This has another 1% or more to go, at least. And it’s a big chunk of CPI.
  • The distribution of price changes by CPI component weights. Less of a distribution than a splatter, at the moment. Not much going up less than 3%!
  • And let’s put numbers on that. Only 20% of the consumption basket has risen LESS than 3% over the last year.
  • Almost double the weight of the categories slower than 3%? The categories faster than 4%.
  • Lastly, the Enduring Investments Inflation Diffusion Index reached a new record high. The inflation pressures now are broader than the deflation pressures in the Global Financial Crisis.
  • So wrapping this up…what does this mean for the Fed? In the Old Days, the Fed by now would have already tightened a bunch. Currently, we’re talking about reducing the amount they add in liquidity, maybe a little faster. And possibly raising rates in 2022. That is, UNLESS…
  • …unless stocks drop like a stone. And honestly, it’s not really clear to me that the government would care to see much higher interest costs on the debt. Only way Japan has survived its mountain of debt is that is it almost interest-free, after all.
  • But maybe the hawks will storm the Eccles Building and the Fed will not only raise rates, but also slow money growth (these were once tightly connected; now not so much, and it’s the money growth part that matters not the interest rate part). We can hope.
  • In a recent podcast, “How Many Swallows Make a Spring”, https://inflationguy.podbean.com/e/ep-12-how-many-swallows-make-a-spring/ I expressed my opinion that once the peak is in, the valley for inflation won’t be as low – because we have semi-permanently moved the distribution.
  • So we’re not looking, in late 2022, or in 2023, to get core inflation back to 2%. It’s just not going to happen unless housing collapses (which could happen – lots of weird things could happen – but we don’t base outlooks on what weird things COULD happen).
  • IMO, we’re now in a land of 3%-4% core, maybe if we’re lucky it’s 2.5%-3.5%. Getting it back to 1.5%-2.5% will take strong leadership (HA!) and a long time.
  • Recently, 10-year inflation breakevens reached 2.78% – matching the all-time highs (since TIPS were issued in 1997) from 2005. If you think about breakevens in the same way you think about TS…
  • So, as I wrote last month, you haven’t missed this trade yet. https://inflationguy.blog/2021/11/18/you-have-not-missed-it/
  • Thanks for tuning in. I’ll have the collated summary of these tweets up on my blog within a half hour or so, and will drop a podcast summary of it later. Retweet, call, click, visit, like, upvote, forward, or whatever the kids say these days.

The wonderful thing about December trading is that none of the market moves need to make sense. As I write this, stocks are up and inflation breakevens are down. It’s almost as if high inflation that didn’t actually surprise is somehow helping the ‘transitory’ story. Breakevens act as if the Fed is about to be aggressive and suck liquidity out of the system. But if that’s true, then it’s weird that stocks are higher because an elevated discount rate, with the stock market at record multiples, cannot be a good thing.

There is one way that those moves could be consistent, and that’s as if investors now believe that the inflation spike will indeed be transitory, and that the Fed won’t need to do anything after all. If it was all about some supply bottlenecks that will shortly resolve themselves, and the party can continue, then it would make sense to push inflation expectations lower and also not deflate stocks.

But to be clear, there is absolutely nothing in today’s number that would give any shape to that fantasy. For the third month in a row, the inflation figures were high and the price increases were spread across a very wide variety of categories. There is no one-off to point to. Used Cars adds something – but we haven’t yet seen the peak in that – and that rate of change will eventually ebb. At the same time, other categories are showing new life. This is a much more dangerous look than it was in the first half of 2021, when we expected broadening but it was still believable that “COVID categories” could be the main story. That story is dead and buried. This is not about the pandemic any longer; it is about policy response to the pandemic. It is almost entirely policy error. I will show again the picture from last month, which sums it up. Supply has done what supply usually does following a recession – if anything, it has recovered faster than usual and is back to trend. It’s demand that is far above normal, and that’s not an accident and it isn’t due to COVID. It is a policy error, and it will take many tears (and maybe many years) to reverse.

You Have Not Missed It

November 18, 2021 8 comments

Recently, 10-year inflation breakevens reached 2.78% – matching the all-time highs (since TIPS were issued in 1997) from 2005. If you think about breakevens in the same way you think about TSLA, then it may seem to you that this is a very bad time to buy inflation. No one who bought 10-year inflation at 2.78% or in that neighborhood has ever had a mark-to-market gain.[1] Heck, for a couple of decades it has been a fairly automatic trade to dump 10-year breakevens once they got a bit over 2.50%. Moreover, with y/y inflation at 6.2% – even if it goes a little higher still before it ebbs – it certainly seems like the worst is behind us, right?

I hear from a lot of investors who are afraid that they “missed the trade.” The first spike happened so quickly that not many people outside of the inflation geeks had time to get on board. And we’re only just now figuring out (well, it’s only just now becoming common knowledge) that the “transitory” effects have lasted and are lasting a lot longer than we were told to expect. These tactical traders feel like they missed a once-in-a-generation, if not a once-in-a-lifetime, trade in inflation, which is now over.

Relax. You have not missed it.

Okay, perhaps you should have bought inflation when 10-year breakevens were at 0.94%. At that level, the market was making a huge bet that inflation was forever dead. There was almost no risk in buying inflation at that level, as I pointed out at the time. That was the right trade, and the easy trade, and I know you’re committed to buying those levels the next time you see them. Unfortunately, you won’t. Those levels won’t be seen again for decades, if ever. The only way they could happen is because there was no natural bid for inflation risk, no one who was worried about it. No matter what happens to inflation from here, lots of people have learned that it’s something you ought to be worried about, especially if you can hedge it essentially for free as you could 19 months ago.

But that doesn’t mean you oughtn’t buy longer-term inflation even though the current levels are high. The chart below shows 10-year inflation breakevens, in white, versus contemporaneous core CPI in blue.

Obviously, I’m comparing a 10-year forward-looking rate to a 1-year backward-looking rate, but my point isn’t that there are good times and bad times to buy breakevens based on what has recently happened. In fact, my point is almost the opposite. My point is that historically, it has paid to ignore what has recently happened, and focus on whether or not breakevens are a bargain relative to the equilibrium level. Over the period since TIPS were first issued, core CPI has ranged from 1% to 3%, and averaged almost exactly 2%. That’s the blue line. The question then, is not whether breakevens are a good deal here if inflation is going to go back to a sedate 1%-3% range for the next decade; in that circumstance they certainly aren’t. On the other hand, they aren’t a disastrous trade in that case, but certainly not a very good one. The real question, though, is whether the equilibrium range going forward really is going to be centered around 2%. Because if instead it is going to be centered around 3%, then you’re buying breakevens below the midpoint of that future range (and you get great near-term carry in the bargain).

There are a number of reasons that I think we have moved into a new post-2% regime. A lot of those reasons were already hinted at prior to the current crisis and the ensuing irresponsible policy response. For example, one following wind that the global economy enjoyed from 1993 or so until the mid-2010s was a gradual increase in globalization. The movement of production to lower-production-cost countries, especially in an era of cheap transportation and low tariffs, was a net gain to society in the classic Ricardian sense, and allowed all economies to have a better growth/inflation mix. However, that impulse was already starting to wane prior to Trump, and in the last 5 years the globalization arrow has clearly reversed in no small part because of intentional policy decisions to do so. That’s just one example of how the cycle, in my view, was already reversing.

Since the policy response to COVID, however, the inflation idyll has been decisively shattered. Manufacturers in many industries have been forced to shift strategies about passing through costs – strategies that are very hard to restore to the old way. The high inflation prints, especially in the context of product shortages, have emboldened labor in ways we haven’t seen for some time. Increased unionization is likely to follow an increase in the level and volatility of inflation, which naturally will help institutionalize levels of inflation that are not outrageous in the grand scheme of things but which are still damaging compared to the Way Things Were.

Thus, I think we are out of the 2-percent-as-the-center-of-the-distribution era, and into an era where the middle is more like 3%. The bad part is that inflation regimes don’t usually stay stable except at low levels, so that we are going to have higher inflation volatility, and there’s a decent chance that equilibrium level bleeds higher over time.

That’s the bet with 10-year breakevens. In the short-term, some of the “transitory” factors are going to ebb (prices won’t fall, but their rates of change will), although other factors will emerge too. The inflation derivatives market is pricing in headline inflation over 7% in the next few months, but that will likely be the peak. But rents are going to be pushing up, and core and median inflation are not going to go back to 2% very soon. I’ve seen some forecasts that by late 2022, core will be around 1.5%. I think that’s wrong by 200bps.

There is one final point that I will explain in more detail in another post. Breakevens also should embed some premium because the tails to inflation are to the upside. When you estimate the value of that tail, it’s actually fairly large. But for now, let me just assure you: the train has left the station, but it is still making stops. There’s time to get on board.


[1] Sticklers will note that this isn’t quite true. In 2005, headline inflation reached 4.7%, so an owner of breakevens might actually have had a net profit on income and inflation accretion, at least for a while, even though breakevens retreated from there. But it still wouldn’t have been a great trade and you would have had to be nimble to make any money at all.

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