interest rates | E-piphany

Summary of My Post-CPI Tweets (Oct 2023)

November 14, 2023 Michael Ashton 3 comments

Below is a summary of my post-CPI tweets. You can follow me on X at @inflation_guy. Sign up for email updates to my occasional articles here. Individual and institutional investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments! Check out the Inflation Guy podcast!

Welcome to the #CPI #inflation walkup for November (October’s figure). This is the next-to-last month I will be doing this!
If you miss the live tweets, you can find a summary later at https://inflationguy.blog and I will podcast a summary at inflationguy.podbean.com . Those will continue in 2024 after the live tweeting stops.
Well, this report ought to be interesting. My forecasts are very different from the other forecasts out there. The Bloomberg consensus has +0.09% on SA headline, and 0.30% on core. The swap market, Kalshi, and Cleveland Fed are all in the same ballpark.

I have 0.14% NSA, roughly 0.22% on headline, and 0.38% on core.
It is a little wild to me that everyone else is so low, and it makes me concerned that I’m missing something. But I think it comes down to the fact that everyone must be expecting a big give-back on OER this month.
Used car prices should add this month. Health care insurance pivots from an 0.04% drag to an 0.02% add. Even airfares could rise, despite sliding jet fuel, because fares are too low given the level of fuel.
All of those are in my forecast (well, I conceded flat on airfares but it could go either way). I assume they’re in everyone’s forecast. So that leads me to believe that the assumption is a correction in OER is in store.
OK, I see the chart too. It sure LOOKS like OER did something weird last month. If OER prints 0.45% m/m instead of 0.55%, then that takes 2.5bps off my forecast. That still doesn’t get there. You need an 0.35% or something.

And oh by the way, I’d argue that the jump might just be payback for a too-rapid fall that happened earlier this year. There was no reason to expect monthlies to drop from 0.7% m/m in Feb to 0.48% in March. Rents are not collapsing and home prices are now going back up.
I know that’s inconvenient to the deflation story but it’s right on par with where my model says it should be. (Our model is Primary Rents but OER is based on rents).

So okay, I’ll drop my forecast 2.5bps on the assumption we go back to 0.45% m/m for OER. Now ya happy?!? But I’m not assuming any ‘payback’.

Meanwhile, I haven’t even talked about the fact that I have +1% on Used Cars, but that might be too conservative given how strong auctions were in the latter part of September (not picked up in the last number).
And I don’t have anything for New Cars – but thanks to the new wage agreement, car prices both New and Used are going to go up again.
I’ve already spoken plenty about the reversal in Health Insurance; it shouldn’t take anyone by surprise this year.
The change in method means that the shift from -0.04% to +0.02% per month should only last six months – it shortens the lag but this transition period increases the effect to synchronize.
With all this, Core CPI should stay at 4.1% y/y, or rise (if my forecast is on point). As I said last month, getting it below 4% is going to be more of a challenge. And Median inflation will fall to probably around 5.25% this month, but again we’re in the hard part now.
Breakevens have net slumped a bit this month, but that hides the fact that after last month’s CPI they spiked for a week or so. 10y breaks got to 2.50% in the bond market selloff before settling back.

If the bond bear market continues (and the balance of large government budget deficits, smaller trade deficits, and a Fed in run-off means more pressure on rates to attract domestic savers), breakevens will go back up.
Not sure that’s a good play in Q4, since this tends to be a good seasonal time for bonds, but a bad CPI could change that. And, naturally, with a recession coming (we think?) it’ll be harder to get higher rates immediately.
However…the secular bull market in bonds is over so the real question is whether interest rates are aimless for a decade, or in a secular bear market. Too long a topic for a tweet storm!
So that’s it for the walkup. Pretty simple task today: 1. check OER, 2. check core ex-housing, 3. check core services ex-housing (“supercore” for a finer read on the Fed (?))
Keep checking the improving distribution of inflation – core below median means the tails are moving to the downside, in a disinflationary signature, but not sure that will outlast 2024.
Good luck!

Very soft number! Let’s see how much of this is ‘payback.’
If it’s CPI day there must be I.T. issues. It’s a law. Headline was +0.045%, Core +0.227%. Used cars was a DRAG, which is completely at odds with surveys. OER dropped to 0.41% m/m, but that by itself wouldn’t be enough for the downside surprise.
Airfares fell, Lodging away from home fell significantly, New Cars was a marginal decline…and health insurance didn’t add as much as it was supposed to (not sure why) although it was positive. Looks like a well-rounded soft number.
Here is m/m OER. Back to prior level, but no payback.

In the big picture, the 3-month average isn’t all that soothing, especially when we look at Used Cars and other quirks that will likely be repaid.

So Black Book was -1.85% in September, NSA CPI Used Cars was -5.63%. BB was +1.07% in October, NSA CPI Used Cars was -1.40%. Private auctions were strong. This is confounding – might be a seasonal quirk that BLS reflects different seasonals, but the NSA pretty far off.
m/m CPI: 0.0449% m/m Core CPI: 0.227%
Last 12 core CPI figures

M/M, Y/Y, and prior Y/Y for 8 major subgroups

Primary Rents: 7.18% y/y OER: 6.85% y/y

Further: Primary Rents 0.5% M/M, 7.18% Y/Y (7.41% last) OER 0.41% M/M, 6.85% Y/Y (7.08% last) Lodging Away From Home -2.5% M/M, 1.2% Y/Y (7.3% last)
Some ‘COVID’ Categories: Airfares -0.91% M/M (0.28% Last) Lodging Away from Home -2.45% M/M (3.65% Last) Used Cars/Trucks -0.8% M/M (-2.53% Last) New Cars/Trucks -0.09% M/M (0.3% Last)
Here is my early and automated guess at Median CPI for this month: 0.359%

Now, this is really the important thing. Median is still 0.36%. That tells you this is left-tail stuff more than the rents stuff.
Piece 1: Food & Energy: 0.17% y/y

Food at Home was +0.26% SA; Food Away from Home +0.37%. Food added 0.04% to headline, which was right on my forecast. Look, talk to any restaurateur – wages are still a big problem. Food AFH isn’t going to deflate soon.
Energy was -0.22% m/m NSA; I’d estimated -0.17% so it was very slightly more drag.
Piece 2: Core Commodities: 0.0948% y/y

Piece 3: Core Services less Rent of Shelter: 3.71% y/y

Piece 4: Rent of Shelter: 6.76% y/y

Core Goods: 0.0948% y/y Core Services: 5.5% y/y

Core goods actually ticked up slightly. Despite the decline in Used and New cars.
This is part of the core goods story – continued acceleration in Medicinal Drugs. Honestly this is something we’ve been expecting for a long time and just surprised how long it has taken. Many of the APIs for pharma come from China.

Core ex-housing actually ticked up very slightly from 1.97% y/y to 2.05% y/y. That sounds great but prior to COVID it hadn’t been above 2% since 2012 so that’s still too high.
Largest declines (annualized m/m) in core were Lodging Away From Home (which is quite surprising) at -26% and Car and Truck Rental (also surprising) at -17%. Both core services but only the latter is “supercore”.
Largest advances Motor Vehicle Insurance +26%, Tobacco +25%, Jewelry and Watches +16%.
I am probably not going to be exactly right on median because in my calculation the median category is Northeast Urban OER, which means we’re relying on my ad-hoc seasonal adjustment. Could be as low as 0.32% m/m, or a smidge higher. Either way, it’s not price stability.
I guess on Health Insurance I’ll have to leave the explanation to someone with a pointier pencil. My calculations had the effect being about 2bps/month; this month is was about 0.8bps. I would call that negligible except that previously it had been a 4bps drag.
Our housing model, updated with the latest data. Kinda right on par. But notice our model never gets anywhere close to deflation in housing. Those calling for such are going to be disappointed.

This is a strange dichotomy and I wonder if some physician can explain it. Maybe doctors are making their money by channeling expensive services through hospitals. But it’s weird to see hospital inflation so buoyant while doctors’ services are deflating.

Education and Communication was a little soft. Some of that was a curious (to me) -0.24% NSA m/m decline in College tuition and fees. Probably a quirk. Also Telephone hardware was -1.9% m/m.
Apparel was soft – partly this is expected because of the lagged strength of the dollar on core goods, but the -5.1% decline in Women’s outerwear seems unusual.
The EI Inflation Diffusion Index is back almost to flat. Note that doesn’t mean 0 inflation. To get back to persistently having Median CPI around 2-3%, you’d want to see the diffusion index quite a bit negative. I think that’s going to be difficult.

Last chart, and it tells the story. Left tail is growing, but rest of the distribution is moving left only reluctantly. The big fingers on the right are housing. It’s encouraging that there is more diversity here – a sign that the money impulse that affects everything is waning.

Here is today’s summary. Core was surprisingly tame but it was largely from some quirky one-offs. Median didn’t improve very much. Neither Core nor Median over the last 3 months is where the Fed wants it. This doesn’t change, therefore, the higher-for-longer meme.
It also doesn’t demand further tightening, but that’s not news. We already knew the Fed was done.
Looking ahead, there will be further slow progress on housing, although as I keep saying – not as much as some forecasters think. The problem is that outside of housing, core inflation doesn’t look like it wants to fall much further.
Naturally all of this depends on what the Fed does going forward. If the money supply keeps bumping along around zero growth, then eventually the velocity rebound will run its course and inflation will go back to 2-3%.
But higher rates mean that velocity is probably going to do more than just rebound, so higher for longer will need to be longer than people expect – or, possibly, than the Fed can maintain in the face of recession.
That’s the hard part. This so far has been the easy part. If market rates rise again in sloppy fashion after the new year, despite recession signs…what does the Fed do? Inflation won’t be at target yet, or even close. Stay tuned!
…and thanks for staying tuned. Have a good day.

The CPI was a happy surprise today, but not so much that I would throw a party. The low miss was partly caused by inexplicable declines in autos and lodging away from home, while the correction in rents basically just went back to the prior level rather than stepping down to a slower pace. Rents are still going to come down, and in some places in the country they are falling – but in some places they are still rising briskly.

That dispersion in experienced rental inflation is actually part of the good news, and it’s good news that we see throughout the CPI over the last several months. It’s the good news that the Enduring Investments Inflation Diffusion Index is capturing: all prices are not moving as one, as they mostly did during the upswing in inflation. A high correlation between unrelated categories tends to suggest a common impulse is causing the movement – and is yet another reason that the notion that inflation was coming from various idiosyncratic supply chain issues should never have been entertained. There was clearly a large impulse acting on all prices: the 20%+ spike in money growth. Now that the money supply is flat, though velocity is rebounding, price dispersion is reasserting.

(Spoiler alert: it isn’t yet happening on the inter-country experience – all countries saw their inflation move in synchrony when it went up, and all are seeing it move in synchrony coming down, so it’s early to say the battle is won.)

We’re still just starting the difficult part, from the standpoint of monetary policy but also from the standpoint of figuring out how quickly inflation can get tamped back down to target. And the dispersion makes that more difficult, because the signal gets lost in the noise – just as it used to, before the money gusher. Next month we’ll have to deal with likely rebounds in Lodging Away from Home as well as increases in autos, reversing this month’s surprises, but we’ll probably get slightly better rent numbers.

What I can say is that the market reaction to all of this is absurd. This just doesn’t move the needle on the Fed. There was no tightening and no easing in the pipeline before this number, and after this number that hasn’t changed an iota. But at this hour stocks are +2% and bonds are soaring. I know the conventional wisdom is that rates are going back to zero…it just seems kind of early to get on that train when median inflation is still 5.3%…

Categories: CPI, Tweet Summary Tags: core cpi, core inflation, CPI, Fed, inflation, interest rates

Summary of My Post-CPI Tweets (August 2023)

September 13, 2023 Michael Ashton 2 comments

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

Welcome to the #CPI #inflation walkup for September (August’s figure).
At 8:30ET, when the data drops, I will pull down the data and then run a bunch of charts. I think I’ve figured out how to autopost these again, fingers crossed. Then I’ll comment and post some more charts.
Later, I will post a summary of these tweets at https://inflationguy.blog and then podcast a summary at inflationguy.podbean.com . Thanks again for subscribing!
This month, after some low prints recently, we’re going to get some higher ones. Not terrible like last year, mind you, but higher. The economist consensus…which I’m again closer to than the swap market estimate…is for a high 0.2% on core and a low 0.6% on headline.

That will raise y/y headline and drop y/y core (all the way to 4.3%!). Core should also fall again next month due to a harsh comp from Sep 2022. After that, progress will be slower. If there’s progress.
The last couple of prints have been very low: core of +0.16% in both June and July. These were due to non-repeatable things, and I’ll talk about some of them in a bit.
But the point is that we’ve gotten most of the positive surprises for a while I think (although I guess that’s the nature of surprises!)
A positive (drag) today, and ongoing for a while, will be the deceleration in rents. Last month Primary Rents were +0.42% and OER was +0.49%. I am penciling the combined ‘rent of shelter’ in for +0.41% this month. That might be aggressive. But it will keep slowing for a while.
But there are a few things that are going to be reversing soon. One is health insurance. I wrote about this recently https://shorturl.at/agtCX . It will still drag today but that will reverse in October.
Used Cars is a little indeterminate. I would have thought it was overdone on the downside but am less sure of that now. Here’s why:
Black book implies continued downward pressure on used car prices. This is partly because auto finance companies have really jerked back on lending, sharply raising rates along with their cost of funding and actually checking credit occasionally.
The rates make sense but the rationing not so much – delinquency rates have risen from the 2021 covid-funding inspired lows but are still at normal rates. Anyway the result has been downard pressure on used car prices.

The rate effect is what people had been expecting from housing – the difference between a 5% car loan and a 0% car loan for 7 years is about 13% higher cost for the non-cash buyer so a budget-conscious buyer lowers his price somewhat as a result. Hasn’t happened in housing.
But in housing the seller also has a loan with value and so is reluctant to sell at a lower price AND lose the low rate. That symmetry doesn’t exist in autos. I suspect that’s why used car prices have fallen farther than I expected (and I should have seen that).
The Fed though is done (at worse, ALMOST done), and rates will level off for car loans. So this downward pressure will eventually ebb. And they should end up adjusting to a higher overall price level.
Used cars will still be a drag today (I have a -3.5% fall in used cars penciled in), but that too should ebb soon.
The real mystery from last month was airfares. That has been down >8% two months in a row, and the current level is about 15% too low for the level of jet fuel (which is rising).

Do airfares recover 3%? 8%? 15%? I’m wild-guessing 6% but every 1% is worth 3/4 of 1bp on the core m/m. So I’m projecting it to add 4bps, basically. This is a big source of uncertainty, but mostly on the upside, this month.
Now, we should also recognize that last month’s CPI was also pretty BROADLY low, which meant that median CPI also printed low.
That would be wonderful if it happened again (but it’s unlikely). Indeed, between higher headline, core, and median, it will be very easy for some people to get carried away with negativity.
But still, we’re talk ing about 0.23% on core, maybe rounding up to 0.3% if we get stuff a little high. That’s settling in towards the high-3s, low-4s, which is where I think we are going. But watch the breadth, and median.
The markets, on net, have done almost nothing this last month. Real yields and nominal yields went up a touch, but longer breakevens and swaps are almost exactly unchanged. Shorter breakevens are wider on the strength in gasoline.

I think markets recognize that the narrative is turning, from “we are in an inflationary spiral” to “inflation is coming down” to “okay now it gets harder.” And that leaves breakevens a bit aimless for now.
I do think breakevens are too low!
Energy is back rising, and this time there’s nothing left in the SPR to hold down gasoline prices. Government deficits are ballooning again, partly because interest costs are skyrocketing.
Navigation from here, both macroeconomically and in a trading sense, starts to get difficult again. Good luck out there today!

A bit on the high side. Core 0.278 to three decimals. Working on downloading data now.
As I said, core was a little higher than expected, but still at the low end of what we’d seen for the prior year.

CPI for Used Cars and Trucks was -1.23%, less than I expected. Airfares were +4.89% (I had +6%), so in the ballpark.
M/M, Y/Y, and prior Y/Y for 8 major subgroups

Core Goods: 0.234% y/y Core Services: 5.9% y/y

Primary Rents: 7.76% y/y OER: 7.32% y/y

Further: Primary Rents 0.48% M/M, 7.76% Y/Y (8.03% last) OER 0.38% M/M, 7.32% Y/Y (7.66% last) Lodging Away From Home -3% M/M, 3% Y/Y (6% last)
Some ‘COVID’ Categories: Airfares 4.89% M/M (-8.09% Last) Lodging Away from Home -2.97% M/M (-0.34% Last) Used Cars/Trucks -1.23% M/M (-1.34% Last) New Cars/Trucks 0.27% M/M (-0.08% Last)
A little surprising that we aren’t seeing the same effect on New Cars (loan interest rate effect) that we are on used cars.
Here is my early and automated guess at Median CPI for this month: 0.328%

OK, this is what I expected. The broad everything-was-soft month was a one-off. Median is still slowwwwwly decelerating, but not collapsing like it appeared.
Piece 1: Food & Energy: 1% y/y

The energy story is known – OPEC is cutting supplies in anticipation of weak growth, but so far the main economic driver globally (the US) isn’t having the weak growth. And supplies are low. So headline was bubbly and will probably get more of that next month.
Piece 2: Core Commodities: 0.234% y/y

Core Commodities driven lower this month partly by Used Cars of course. But it’s going to be challenging to push it a lot lower. That said, the strength of the USD is putting constant pressure in the traditional way here – but nearshoring is still going to make this sticky.
Piece 3: Core Services less Rent of Shelter: 3.88% y/y

This is a little interesting…it’s just a little hook to the upside, but remember one of the big downward pressures here is Health Insurance and that’s due to reverse soon.
But the other big input is wages, and labor’s recent muscularity along with increases in minimum wage in California is going to keep this from decelerating as much as it ‘needs’ to.
Piece 4: Rent of Shelter: 7.33% y/y

This is going to keep decelerating. But not back to zero!
I had penciled in Rent of Shelter as +0.41%. OER slowed to +0.38% m/m, while Primary Rents (about 1/3 of the impact) was faster this month at +0.49%. But ‘Lodging Away from Home’ dropped about 3%, and that’s why Rent of Shelter was so soft. This should rebound next month.

Interesting and important dichotomy continues: Food at Home was +0.09% (NSA); Food Away from Home was +0.34% (NSA). The latter is wages. Keep an eye on that.
Medicinal Drugs was +0.61%m/m. Series obviously bounces around a lot but to my eye it’s creeping higher. I remember in 2020 and 2021 it was confounding that with COVID, there was downward pressure here. Looks like that’s ebbed.

Doctors’ Services was +0.11% m/m, and remains sort of soft. But Hospital Services (2.3% of CPI) was +0.67% m/m. It had been one of the soft categories last month at -0.44%.
Lodging Away from Home, as I’d mentioned, dragged down the overall Rent of Shelter. But it’s at the low end of its monthly range of wiggles and will probably add next month rather than subtract.

Worth pointing out because it’s been in the news. Motor Vehicle Insurance, which is 1.7% of CPI – has been steadily increasing. Causes are higher car prices, and big increases in carjackings as well as some natural disaster losses. This doesn’t look like it’s going away. (charts show m/m and y/y)

Core ex-housing is down to 2.36% y/y. This sounds low, but prior to COVID it hadn’t been over 2% since 2012. As noted earlier, core goods has squeezed out most good news already and core services – outside of housing – still faces wages growing faster than 5%.
The biggest-losers list (annualized monthly figures) among core categories is led by Lodging Away from Home (-30%), Misc Personal Goods (-25%), Infants/Toddlers’ Apparel (-20%), and Used Cars/Trucks (-14%).
Biggest gainers are Public Transportation (+58%), Motor Vehicle Insurance (+33%), Car/Truck Rental (+17%), Footwear (+15%), Car Maintenance/Repair (+14%), Misc Personal Services (+12%).
The dispersion stuff is actually decent news. Broadly, things are slowing down. That doesn’t mean we are going back to 2% inflation; in fact there are very few signs of that yet. But it does mean that the broad upthrust in the price level is ebbing.

It would be nice to go back to worrying mainly about relative price changes instead of absolute price-level changes. We aren’t there yet. The volatility of prices, and some of the broad pressures like trade and wages, remind us that we are still in the inflation episode.
This only FEELS like inflation is low, because we saw what high feels like. But 4% core/median inflation is no picnic. And it will keep correlations elevated.
Last chart. Here is the weight of categories inflating faster than 4%. Obviously we are getting close to 4% being the median. Now, about a third of the basket is housing so that third is in the >4% category. But if we flip and look at <2%, it’s still not back to the old normal.

…implication being the same as with the diffusion index, volatility, and correlations – we are on the right path, but not there yet.
NOW – that does NOT mean that the Fed needs to keep raising rates. That’s fairly ineffective anyway although it looks meaningful in used cars. That’s not the issue though. What the Fed should, and probably will do, is just keep rates steady here. And I think they will.
The real problem comes later: with burgeoning deficits and upward pressure on long rates (I worried about this here: https://inflationguy.blog/2023/08/02/three-colliding-macro-trends/ ), at some point the Fed is going to be under pressure to start buying Treasuries again.
That’s a bad path, but it’s going to be hard to resist.
That’s all for today. Thanks for tuning in! I’ll have the summary posted to the blog in an hour or two, and then the podcast later today. Have a good day.

The CPI number this month delivered broadly as expected (and, as expected, broadly). Used Cars continued to slide, and airfares did not repeat the -8% again. The surprise drop in Lodging Away from Home will likely reverse next month, and airfares will be another add. While Used Cars will remain soggy, we only have one more month of Health Insurance drag of 4bps/month before that reverses.

The upshot is that the balance of this year will likely see more 0.3s for the most part, with some high 0.2s (meaning that it rounds down). The easy lifting on core has been done. Due to base effects core will still drop next month, but after that…it is going to get difficult. Decelerating housing inflation will be a persistent following wind, but all of the other things that were rowing in one direction while housing was rising…are about to be rowing in the other direction. And housing’s drag is already reversing. (If you were looking 12 months ahead at the possible future declines in rents, to be fair you should be looking now at 12 months ahead when we’re going to start to see percolating through the re-acceleration that we’re seeing in spot rents and home prices.

There is no need for the Fed to tighten further. Rate hikes don’t really help very much (except in some categories like used cars!) to restrain inflation, and short rates are a bit above normal. But as noted in the tweet stream, we are converging on what will be a more difficult path to navigate. The Fed made a mistake and overdid the COVID response, and then held it too long. It deserves credit, on the other hand, for pivoting and throwing off the dovish history of the last two decades to begin shrinking the balance sheet and for being steady on that path even as the rate hikes cease. But those were, or should have been, easy decisions from the monetary policy standpoint as the central bank was leaning into the prevailing wind by pursuing restraint when the economy was robust.

Before too long, the Fed is going to face a circumstance where restraint remains necessary because inflation is sticky at too high a level, but longer-term interest rates begin to tick higher. This will put pressure on economic growth, and on the budget deficit, so that their restraint will be seen as wrong-headed. That’s the danger zone, and I think it probably is a 2024 problem. My fear is that it will be very difficult for the Fed to not give in, arguing to itself that “hey, slower growth means lower inflation” even though there’s no evidence for that, outside of energy, and start to temper its hawkish stance.

That would be a big mistake. But it’s probably next year’s mistake. For now, we can sit back and watch the core and median inflation numbers come down. Not as fast as people will be expecting, but the direction is right.

Categories: CPI, Tweet Summary Tags: core cpi, core inflation, CPI, inflation, interest rates

Enough with Interest Rates Already

June 21, 2023 Michael Ashton 17 comments

One of the things which alternately frustrates me and fascinates me is the mythology surrounding the idea that the central bank can address inflation by manipulating the price of money, even if it ignores the quantity of money.

I say “mythology” because there is virtually no empirical support for this notion, and the theoretical support for it depends on a model of flows in the economy that seem contrary to how the economy actually works. The idea, coarsely, is that by making money more dear the central bank will make it harder for businesses to borrow and invest, and for consumers to borrow and spend; therefore growth will slow. This seems to be a reasonable description of how the world works. But this then gets tied into inflation by appealing to the idea that lower aggregate demand should lower price pressures, leading to lower inflation. The models are very clear on this point: lower growth causes less inflation and more growth causes more inflation. The fact that this doesn’t appear to be the case in practice seems not to have lessened the fervor of policymakers for this framework. This is the frustrating part – especially since there is a viable alternative framework which seems to actually describe how the world works in practice, and that is monetarism.

The fascinating part are the incredibly short memories that policymakers enjoy when it comes to pursuing new policy using their preferred framework. Here’s the simplest of examples: from December 2008 until December 2019, the Fed Funds target rate spent 65% of the time pinned at 0.25%. The average Fed funds rate over that period was 0.69%. During that period, core inflation ranged from a low of 0.6% in 2010 to a high of 2.4%, hitting either 2.3% or 2.4% in 2012, 2016, 2017, 2018, and 2019. That 0.6% was an aberration – fully 86% of the time over that 11 years, core inflation was between 1.5% and 2.4%. Ergo, it seems reasonable to point out that ultra–low interest rates did not seem to cause higher inflation. If that is our most-recent experience, then why would the Fed now be aggressively pursuing a theory that depends on the idea that high interest rates will cause lower inflation? The most-recent evidence we have is that interest rates do not seem to affect inflation.

This isn’t just a recent phenomenon. But the nice thing about the post-GFC period is that for a good part of it, the Fed was ignoring bank reserves and the money supply and effecting policy entirely through interest rates (well, occasionally squirting some QE around, but if anything that should have increased inflation – it certainly didn’t dampen the effect of low interest rates). This became explicit in 2014 when Joseph Gagnon and Brian Sack, shortly after leaving the Fed themselves, published “Monetary Policy with Abundant Liquidity: A New Operating Framework for the Federal Reserve.” In this piece, they argued that the Fed should ignore the quantity of reserves in the system, and simply change interest rates that it pays on reserves generated by its open market operations. The fundamental idea is that interest rates matter, and money does not, and the Fed dutifully has followed that framework ever since. As I just noted, though, the results of that experiment would seem to indicate that low interest rates, anyway, don’t seem to have the effect that would be predicted (and which effect is necessary if the policy is to be meaningful).

And really, this shouldn’t be a surprise because for the prior three decades, the level of the real policy rate (adjusting the nominal rate here by core CPI, not headline) has been completely unrelated to the subsequent change in core inflation.

So, to sum up: for at least 40 years, the level of real policy rates has had no discernable effect on changes in the level of inflation. And yet, current central bank dogma is that rates are the only thing that matters.

I stopped the chart in 2014 because that’s when the Gagnon/Sack experiment began, but it doesn’t really change anything to extend it to the current day. Actually, all you get is a massive acceleration and deceleration in core inflation that all happened before any interest rate changes affected growth (seeing as how we have not yet had a recession). So it’s a result-within-a-result, in fact.

Any observation about how the Fed manages the price of money rather than its quantity would not be complete without pointing out that the St. Louis Federal Reserve’s economist emeritus Daniel L Thorton, one of the last known monetarists at the Fed until his retirement, wrote a paper in 2012 entitled “Monetary Policy: Why Money Matters and Interest Rates Don’t” [emphasis in the original title]. In this well-argued, landmark, iconic, and totally ignored paper Dr. Thornton argued that the central bank should focus almost entirely on the quantity of money, and not its price. Naturally, this is concordant with my own view, plus more than a century of evidence around the world that the price level is closely tied to the quantity of money.

To be fair, the connection of changes in M2 to changes in the price level has also been weak since the mid-1990s, for reasons I’ve discussed at length elsewhere. But at least money has a history of being related to inflation, whereas interest rates do not (except as a result of inflation, rather than as a cause of them); moreover, we can rehabilitate money by separately modeling money velocity.

There does not appear to be any way to rehabilitate interest rate policy as a tool for addressing inflation. It hasn’t worked, it isn’t working, and it won’t work.

Categories: Causes of Inflation, Economics, Federal Reserve, Monetarism, Other Research Posts Tags: core cpi, core inflation, Fed, interest rates

Summary of My Post-CPI Tweets (February 2023)

March 14, 2023 Michael Ashton 1 comment

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Just sayin’.

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

Summary of My Post-CPI Tweets (August 2022)

September 13, 2022 Michael Ashton 7 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.

Categories: Tweet Summary Tags: core cpi, core inflation, CPI, Fed, inflation, interest rates

Summary of My Post-CPI Tweets (June 2022)

July 13, 2022 Michael Ashton Leave a comment

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.

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

Why Roughly 2.25% is an Equilibrium Real Rate

June 6, 2022 Michael Ashton 1 comment

Recently, Fed officials have taken to discussing “long-term equilibrium” interest rates as a way of indicating to the market where interest rates might ultimately be heading. It is not exactly a terrifying prospect. The Fed seems to collectively believe that the “neutral” short-term nominal interest rate is in the 2.50%-2.75% range; some fear that the Fed funds target right may have to be lifted “modestly” above this level for a time. This seems hard to believe, with inflation running with an 8% handle – such an overnight rate would equate to an annual 5-6% incineration of purchasing power. The only way this could be considered “neutral” is if one begs the question by asserting contrary to evidence that the long-run equilibrium inflation rate is around 2%-2.25%.

I have noted repeatedly over the last year or so why it is unlikely in my opinion that the current equilibrium for inflation is in the 2% range; I feel it is closer to 4%-5% in the medium-term. But if an observer has a model which has been ‘trained’ on data from the last thirty years, the model will assuredly tell you that any time inflation deviates from 2%, it comes back to 2%. In fact, any model which did not produce that prediction would not have been considered a good model: it would have made predictions which, for 30 years, would have been noticeably incorrect from time to time. Ergo, all surviving models will view something like 2% as an attracting level for inflation, and we know the Fed continues to believe this. So, evidently, do many other economists. I keep showing this following chart because I think it’s delicious. Take today’s level; take the level your model says is a self-enforcing equilibrium, and draw a straight line. That’s your forecast. You too can be a million-dollar Wall Street economist.

Faced with awful predictions from this cadre of models, one solution is to consider why they had bad predictions, and attempt to develop models that would perform on data from the 1970s and 1980s as well. A more attractive solution, from an institutional perspective, is to blame model-exogenous events. That is, “the model is fine; who could have foreseen that supply chain issues would have triggered such a large inflation?” And so, we preserve the FOMCs ability to continue making terrible forecasts.

Similarly, Minneapolis Fed President Neel Kashkari stated not too long ago that the Fed may have to “push long-term real rates into restrictive territory.”[1] This continues the Fed’s error of obsessing on the price of liquidity rather than its quantity, but that isn’t the point I am making here. Kashkari made a different error, in an essay posted on the Minneapolis Fed website on May 6^th.[2] He claimed that the neutral long-term real interest rate is around 0.25%, which conveniently is where long-term real rates are now.

However, we can demonstrate that logic, reinforced by history, indicates that long-term real rates ought to be in the neighborhood of the economy’s long-term real growth rate potential.

I will use the classic economist’s expedient of a desert-island economy. Consider such an island, which has two coconut-milk producers and for mathematical convenience no inflation, so that real and nominal quantities are the same. These producers are able to expand production and profits by about 2% per year by deploying new machinery to extract the milk from the coconuts. Now, let’s suppose that one of the producers offers to sell his company to the other, and to finance the purchase by lending money at 5%. The proposal will fall on deaf ears, since paying 5% to expand production and profits by 2% makes no sense. At that interest rate, either producer would rather be a banker. Conversely, suppose one producer offers to sell his company to the other and to finance the purchase at a 0% rate of interest – the buyer can pay off the loan over time with no interest charged. Now the buyer will jump at the chance, because he can pay off the loan with the increased production and keep more money in the bargain. The leverage granted him by this loan is very attractive. In this circumstance, the only way the deal is struck is if the lender is not good at math. Clearly, the lender could increase his wealth by 2% per year by producing coconut milk, but is choosing instead to maintain his current level of wealth. Perhaps he likes playing golf more than cracking coconuts.

In this economy, a lender cannot charge more than the natural growth in production since a borrower will not intentionally reduce his real wealth by borrowing to buy an asset that returns less than the loan costs. And a lender will not intentionally reduce his real wealth by lending at a rate lower than he could expand his wealth by producing. Thus, the natural real rate of interest will tend to be in equilibrium at the natural real rate of economic growth. Lower real interest rates will induce leveraging of productive activities; higher real interest rates will result in deleveraging.

This isn’t only true of the coconut economy, although I would strongly caution that this isn’t exactly a trading model and only a natural tendency with a long history. The chart below shows (1) a naïve real 10-year yield created by taking the 10-year nominal Treasury yield and subtracting trailing 1-year inflation, in purple; (2) a real yield series derived from a research paper by Shanken & Kothari, in red; (3) the Enduring Investments real yield series, in green, and (4) 10y TIPS, in black.

The long-term averages for these four series are as follows:

Naïve real: 2.34%
Shanken/Kothari: 3.13%
Enduring Investments: 2.34%
10y TIPS: 1.39%
Shanken/Kothari thru 2007; 10y TIPS from 2007-present: 2.50%

It isn’t just a coincidence that calculating a long-term average of long-term real interest rates, no matter how you do it, ends up being about 2.3%-2.5%. That is also close to the long-term real growth rate of the economy. Using Commerce Department data, the compounded annual US growth rate from 1954-2021 was 2.95%.

It is generally conceded that the economy’s sustainable growth rate has fallen over the last 50 years, although some people place great stock (no pun intended) on the productivity enhancements which power the fantasies of tech sector investors. I believe that something like 2.25%-2.50% is the long-term growth rate that the US economy can sustain, although global demographic trends may be dampening that further. Which in turn implies that something like 2.00%-2.25% is where long-term real interest rates should be, in equilibrium.[3] Kashkari says “We do know that neutral rates have been falling in advanced economies around the world due to factors outside the influence of monetary policy, such as demographics, technology developments and trade.” Except that we don’t know anything of the sort, since there is a strong argument against each of these totems. Abbreviating, those counterarguments are (a) aging demographics is a supply shock which should decrease output and raise prices with the singular counterargument of Japan also happening to be the country with the lowest growth rate in money in the last three decades; (b) productivity has been improving since the Middle Ages, and there is no evidence that it is improving noticeably faster today – and if it did, that would raise the expected real growth rate and the demand for money; and (c) while trade certainly was a following wind for the last quarter century, every indication is that it is going to be the opposite sign for the next decade. It is time to retire these shibboleths. Real interest rates have been kept artificially too low for far too long, inducing excessive financial leverage. They will eventually return to equilibrium…but it will be a long and painful process.

[1] https://www.reuters.com/business/finance/feds-kashkari-we-may-have-push-long-term-real-rates-into-restrictive-territory-2022-05-06/

[2] https://www.minneapolisfed.org/article/2022/policy-has-tightened-a-lot-is-it-enough

[3] The reason that real interest rates will be slightly lower than real growth rates is that real interest rates are typically computed using the Consumer Price Index, which is generally slightly higher than the GDP Deflator.

Categories: Economics, Economy, Theory Tags: interest rates

Summary of My Post-CPI Tweets (March 2022)

April 12, 2022 Michael Ashton Leave a comment

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.

Categories: Causes of Inflation, CPI, Federal Reserve Tags: core cpi, CPI, cpi report, Fed, inflation, interest rates

What Happens Next?

March 29, 2022 Michael Ashton 3 comments

As far back as I can remember, I’ve been fascinated with the fetish that investors have about forecasts and predictions. When I was a strategist, clients wrangled me for a simple statement of where the market was going to go. I had my opinions, to be sure, but by the time I was a senior strategist I also knew that even good forecasters are wrong a lot. Forecasting, ironically, is not a job for people who care very much about being right. Because if they do care about being right, even good forecasters are depressed a lot.

So in my mind, a useful strategist was not one who gave all the right answers. Those don’t exist. A useful strategist was one who asked the right questions. Investing isn’t about being right; if it was, there would be no need to diversify. Just put everything in the one right investment. No, investing is about probabilities, and about maximizing the expected outcome even though that is almost never the best outcome given the particular path of events that actually transpires. Knowing the future is still the best way to make a million dollars.

A valuable strategist/forecaster, then, is not the one who can tell you what they think the actual future will be. The most valuable strategists have two strong skills. First, they excel at if-then statements. “If there is conflict in the Ukraine, then grain prices will soar.” Second, they are very good at estimating reasonable probabilities of different possibilities, so you can figure out the best average outcome of the probability-weighted if-then statements.

However, there aren’t a lot of great strategists, because those same characteristics are exactly what you need to be a good trader. I can’t remember if it was Richard Dennis or Paul Tudor Jones or some other legend who said it, but a good trader says “I don’t know what the market is going to do, but I know what I am going to do when the market does what it is going to do.”

As an investment manager/trader, that’s the way I approach investing. I don’t often engage in a post-mortem analysis about why I was wrong about how a particular chain of events played out, but I often post-mortem about whether the chain of events caused the market outcomes I expected, or not, and why.

All that being said, people keep asking me what I think happens next, so here is my guess at how the year will unfold. Feel free to disagree. I don’t really care if this is what happens, since my job is really to be prepared no matter what happens. But, you asked.

I suspect the conflict in Ukraine will continue for quite a while. I also think there’s a reasonable chance that other countries will take advantage of our distraction to be adventurous on other fronts. April is a key month, and I think Russia might be waiting for this other front to open up before pushing harder in Ukraine.
However, except inasmuch as the geopolitical uncertainty plays into the general deglobalization of trade, I don’t think about particular outcomes of Russian or Chinese adventurism. I don’t think the long-term inflation trajectory has a lot to do with who is invading who. In the short term it matters, but in the long run it means certain goods will have different relative prices compared to the market basket compared to what they have now – not that incremental inflation of those items, the rate of change of those relative prices, will continue. For example, cutting off the supply of Russian natural gas to Europe would permanently raise the relative price of nat gas in Europe, but after prices adjusted it wouldn’t permanently cause a higher level of inflation of natural gas.
March’s CPI print, released on April 12^th, will probably be the high print for the cycle for headline inflation, at around 8.5%. Core inflation will also peak at the same time, around 6.50%. This is mainly due to tough comps, though. Monthly prints will still be running at a 4-5% rate, or higher, for at least the balance of the year, and we will end the year with core around 4.5%-5%.
The Fed is going to tighten again. I doubt they go 50bps at this next meeting unless the market is expressing desire for that outcome. The market sometimes fights the Fed, but the Fed these days doesn’t fight the market. The FOMC might even start reducing the mammoth balance sheet through partial runoff, but I suspect they will pocket-veto that and not do anything for a couple more months.
Interest rates are going to go up, further. Real interest rates are going to rise – actually, our model says that more of the rise in nominal interest rates so far should have been real rates, so TIPS are actually marginally expensive (which is very rare). Long-term inflation expectations are also going to continue to rise, until at least 3.5%…something in line with the reality of where equilibrium inflation really is now, with an option premium built in to boot.
Although the near-term inflation prints will come down, the increase in longer-term breakevens means that expectations of the forward price level will continue to rise. The chart below shows the level at which December 2027 CPI futures would be trading, based on the inflation curve, if some exchange actually had the courage to launch CPI futures. One year ago, the implied forward level of 310, compared to the November 2020 level of 266.229, implied that the market expected inflation from 2021-2027 to average 2.2%. That was in the thick of the “it’s transitory” baloney. Today, the theoretical futures suggest that inflation from 2021-2027 will average 3.6%, and that even ignoring the inflation we have seen so far, the price level will rise 3.25% per year above the current level over the next 5.75 years.

Stocks are going to decline. It is a myth, unsupported by data, that stocks do well in inflationary periods. At best, earnings of stocks may increase with inflation (and even exceed inflation in many cases since earnings are levered). But multiples always decline when real interest rates and inflation rise. Modigliani said it shouldn’t happen. But it does. And the Shiller P/E right now is around 40.
Then, the Fed is going to get nervous. Rising long-term inflation expectations will make the FOMC think that they should keep hiking rates, but the declining equity market will make them think that financial conditions must actually be tighter than they seem. And they’ll be afraid of causing real estate prices, which have risen spectacularly in the last couple of years, to decline as well. They will, moreover, be cognizant of the drag on growth caused by high food and energy prices, and in fact they will forecast slower growth (although it is unlikely that they will forecast the recession until it is over). And, since the Fed believes that inflation is caused by too much growth, rather than by too much money, the Committee will slow the rate hikes, pause, and possibly stop altogether. This is, of course, wrong but being wrong hasn’t stopped them so far.
Long rates will initially benefit from the notion that the Fed is abandoning its hawkish stance and because of ebbing growth, but then will continue higher as inflation expectations continue to rise. On the plus side, this will keep the yield curve from inverting for very long, ‘signaling a recession’, but a recession will come anyway.
Inflation by that point will only be down to 4-5%, but the Fed will regard what remains as ‘residual bottlenecks,’ since in their models a lack of growth puts downward pressure on inflation. They’ll stop shrinking the balance sheet, and may well start QE again if the decline in asset prices is steep enough or lasts long enough, or if real estate prices threaten to drop.

There you go – that’s my road map. I am not married to this view in any way, and am happy to discard it at any time. But I know what I am going to do when the market does what it is going to do. You should too!

Categories: Uncategorized Tags: economy, Fed, interest rates

Summary of My Post-CPI Tweets (November 2021)

December 10, 2021 Michael Ashton 2 comments

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.

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

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