Below is a summary (and extension) of my post-CPI tweets today. You can follow me @inflation_guy.
- CPI +0.3%/+0.1% with y/y core figure dropping to 1.9%. That will be only by a couple hundredths on rounding, but it’s still a decline.
- Looks like core was 0.129% rounded to 3 decimal places. y/y went from 1.956% to 1.933% so a marginal decline.
- RT of Bloomberg Markets @themoneygame: Consumer Price Changes By Item http://read.bi/1nx0sUf
- Core goods still -0.2%, core services still +2.7%, unchanged from last month. [ed note: I reversed these initially; corrected here]
- All of this a mild miss for the Street, which was looking for +0.19% or so, but I though the Street was more likely low.
- Major groups accel: Apparel, Recreation, Educ/Comm, Other (19.7%). Decel: Food/Bev, Transp, Med Care (38.9%), Housing flat.
- There’s your real story. Recent drivers: medical care, which is a base effect and oddly reversed. That’s temporary. Also>>
- >>big fall in non-rental/OER parts of housing: insurance, lodging away from home, appliances. Those are not as persistent as rents.
- Primary rents went to 3.153% from 3.058%; OER unch at 2.640% from 2.638%. The rest will mean-revert.
- College tuition and fes at 4.142% from 4.001%.
- 60.5% of all low-level categories accelerating (down from 70.5%). Still broad but not as broad.
- Actually looks like Median CPI could downtick today.
This is why I try very hard to resist the urge to forecast the monthly CPI, and admonish investors (and even traders) to resist trading on the data. Chairman Yellen is right about this: the data are noisy, so one month can be almost anywhere. This month, there was a reversal in the recent rise in y/y medical care inflation. But that rise was due to base effects, which aren’t going away, so forecasting medical care inflation to continue to accelerate is more a statement of mathematical likelihood than it is an economic forecast. And it’s all the more surprising then when it reverses.
This month’s figure makes it a fair bit harder for my forecast of near-3% for 2014 on core or median inflation to come to pass, although it bears noting that median inflation (even though it may downtick later today) is still within striking distance. Since median is currently the better measure, and will be for much of this year, I won’t back off my forecast yet. Another weak month, though, would cause me to ratchet down the target simply because it becomes harder to hit as time becomes shorter.
However, I expect several months this year will exceed +0.3% on core inflation. And it is worth remembering that core inflation faces easy year-ago comparisons for the rest of the year. In July of last year, the seasonally-adjusted m/m core inflation figure was +0.167%; in August it was +0.138%; in September it was 0.132%; in October +0.124%; in November +0.175%; and in December +0.101%. So, even if core inflation only averages +0.2% for the rest of the year, core will still be at 2.3% by year-end. If core inflation averages what it has been for the last four months, we’ll be at 2.4%. What that means is that (a) my forecast of something near 3% doesn’t represent a massive acceleration, although we only have half a year to get there, and (b) anyone forecasting less than 2.3% by year-end is actually forecasting a deceleration in inflation from recent trends.
The breadth indicators also took a mild breather this month, with the proportion of the CPI that is accelerating (looking at low-level categories) dropping to around 60% from around 70% in May. As with the other analysis, however, we should be careful not to read too much into one month since this figure also jumps around a lot. Interestingly, the proportion of categories where the year-on-year change is at least 2 standard deviations above zero – so that we can reject the ‘deflation’ meme for these categories – is basically unchanged from last month at 24%. As the chart below shows, we last saw a level this high in 2006, which is also the last time that core CPI ran at 3%.
Housing inflation is now back below my model’s projections, inflation breadth is still high, and the persistent parts of CPI are maintaining their levels or advancing while a few of the skittish parts are retreating (or at least not yet converging to the mean). There is nothing here to indicate that the three months of accelerating core CPI were the aberration; in fact to me it appears that the June figure was the aberration. That question will be answered over the balance of the year. In the meantime, inflation markets remain priced at levels so low that even if you’re wrong in betting on higher inflation, you don’t lose much but if you’re right, you do very well. In my view (although admittedly I may be biased), most investors remain significantly underweight protection against this particular risk.
Heading into the CPI print tomorrow, the market is firmly in “we don’t believe it” mode. Since the CPI report last month – which showed a third straight month of a surprising and surprisingly-broad uptick in prices – commodity prices are actually down 4% (basis the Bloomberg Commodity Index, formerly known as the DJ-UBS Commodity Index). Ten-year breakeven inflation is up 1-2bps since then, but there is still scant sign of alarm in global markets about the chances that the inflation upswing has arrived.
Essentially, no one believes that inflation is about to take root. Few people believe that inflation can take root. Indeed, our measure of inflation angst is near all-time lows (see chart, source Enduring Investments).
…which, of course, is exactly the reason you ought to be worried: because no one else is, and that’s precisely the time that often offers the most risk to being with the crowd, and the most reward from bucking it. And, with 10-year breakevens around 2.22%, the cost of protecting against that risk is quite low.
I suspect that one reason some investors are less concerned about this month’s CPI is that some short-term indicators are indicating that a correction in prices may be due. For example, the Billion Prices Project (which is now Price Stats, but still makes a daily series available at http://bpp.mit.edu/usa/) monthly inflation chart (shown below) suggests that inflation should retreat this month.
However, hold your horses: the BPP is forecasting non-seasonally-adjusted headline CPI. The June seasonals do have the tendency to subtract a bit less than 0.1% from the seasonally-adjusted number, which means that it’s not a bad bet that the non-seasonally-adjusted figure will show a smaller rise from May to June than we saw April to May, or March to April. Moreover, the BPP and other short-term ‘nowcasts’ of headline inflation are partly ebbing due to the recent sogginess in gasoline prices, which are 10 cents lower (and unseasonally so) than they were a month ago.
But that does not inform on core inflation. The last three months’ prints of seasonally-adjusted core CPI have been 0.204%, 0.236%, and 0.258%, which is a 2.8% annualized pace for the last quarter…and accelerating. Moreover, as I have previously documented the breadth of the inflation uptick is something that is different from the last few times we have seen mild acceleration of inflation.
None of that means that monthly core CPI will continue to accelerate this month. The consensus forecast of 0.19% implies year/year core CPI will accelerate, but will still round to 2.0%. But remember that the Cleveland Fed’s Median CPI, to which core CPI should be converging as the sequester/Medical Care effect fades, is at 2.3% and rising. We should not be at all surprised with a second 0.3% increase tomorrow.
But, judging from markets, we would be.
This is not to say I am forecasting it, because forecasting one month’s CPI is like forecasting a random number generator, but I think the odds of 0.3% are considerably higher than 0.1%. I am on record as saying that core or median inflation will get to nearly 3% by year-end, and I remain in that camp.
The Employment number these days is sometimes less interesting than the response of the markets to the number over the ensuing few days. That may or may not be the case here. Thursday’s Employment report was stronger than expected, although right in line with the sorts of numbers we have had, and should expect to have, in the middle of an expansion.
As the chart illustrates, we have been running at about the rate of 200k per month for the last several years, averaged over a full year. I first pointed out last year that this is about the maximum pace our economy is likely to be able to sustain, although in the bubble-fueled expansion of the late 1990s the average got up to around 280k. So Thursday’s 288k is likely to be either revised lower, or followed by some weaker figures going forward, but is fairly unlikely to be followed by stronger numbers.
This is why the lament about the weak job growth is so interesting. It isn’t really very weak at all, historically. It’s merely that people (that is, economists and politicians) were anticipating that the horrible recession would be followed by an awe-inspiring expansion.
The fact that it has not been is itself informative, although you are unlikely to see economists drawing the interesting conclusion here. That’s because they don’t really understand the question, which is “is U.S. growth unit root?” To remember why this really matters, look back at my article from 2010: “The Root of the Problem.” Quoting from that article:
“what is important to understand is this: if economic output is not unit root but is rather trend-stationary, then over time the economy will tend to return to the trend level of output. If economic output is unit root, then a shock to the economy such as we have experienced will not naturally be followed by a return to the prior level of output.”
In other words, if growth is unit root, then we should expect that expansions should be roughly as robust when they follow economic collapses as when they follow mild downturns. And that is exactly what we are seeing in the steady but uninspiring job growth, and the steady if not-unusual return to normalcy in the Unemployment Rate (once we adjust for the participation rate). So, the data seem to suggest that growth is approximately unit root, which matters because among other things it makes any Keynesian prescriptions problematic – if there is no such thing as “trend growth” then the whole notion of an output gap gets weird. A gap? A gap to what?
Now, it is still interesting to look at how markets reacted. Bonds initially sold off, as would be expected if the Fed cared about the Unemployment Rate or the output gap being closed, but then rallied as (presumably) investors discounted the idea that the Federal Reserve is going to move pre-emptively to restrain inflation in this cycle. Equities, on the other hand, had a knee-jerk selloff on that idea (less Fed accommodation) but then rallied the rest of the day on Thursday before retracing a good part of that gain today. It is unclear to me just what news can actually be better than what is already impounded in stock prices. If the answer is “not very darn much,” then the natural reaction should be for the market to tend to react negatively to news even if it continues to drift higher in the absence of news. But that is counterfactual to what happened on Thursday/Monday. I don’t like to read too much into any day’s trading, but that is interesting.
Commodities were roughly unchanged on Thursday, but fell back strongly today. Well, a 1.2% decline in the Bloomberg Commodity Index (formerly the DJ-UBS Commodity Index) isn’t exactly a rout, but since commodities have been slowly rallying for a while this represents the worst selloff since March. The 5-day selloff in commodities, a lusty 2.4%, is the worst since January. Yes, commodities have been rallying, and yet the year-to-date change in the Bloomberg Commodity Index is only 2% more than the rise in M2 over the same period (5.5% versus 3.5%), which means the terribly oversold condition of commodities – especially when compared to other real assets – has only barely begun to be corrected.
I do not really understand why the mild concern over inflation that developed recently after three alarming CPI reports in a row has vanished so suddenly. We can see it in the commodity decline, and the recent rise in implied core inflation that I have documented recently (see “Awareness of Inflation, But No Fear Yet”) has largely reversed: currently, implied 1 year core inflation is only 2.15%, which is lower than current median inflation – implying that the central tendency of inflation will actually decline from current levels.
I don’t see any reason for such sanguinity. Money supply growth remains around 7%, and y/y credit growth is back around 5%. I am not a Keynesian, and I believe that growth doesn’t matter (much) for inflation, but the recent tightening of labor markets should make a Keynesian believe that inflation is closer, not further away! If one is inclined to give credit in advance to the Federal Reserve, and assume that the Committee will move pre-emptively to restrain inflation – and if you are assuming that core inflation will be lower in a year from where it (or median inflation, which is currently a better measure of “core” inflation) is now, you must be assuming preemption – then I suppose you might think that 2.15% core is roughly the right level.
But even there, one would have to assume that policy could affect inflation instantly. Inflation has momentum, and it takes time for policy – even once implemented, of which there is no sign yet – to have an effect on the trajectory of inflation. Maybe there can be an argument that 2-year forward or 3-year forward core inflation might be restrained by a pre-emptive Fed. But I can’t see that argument for year-ahead inflation.
Of course, markets don’t always have to make sense. We have certainly learned this in spades over the last decade! I suppose that saying markets aren’t making a lot of sense right now is merely a headline of the “dog bites man” variety. The real shocker, the “man bites dog” headline, would be if they started making sense again.
As expected, and as I’ve been saying for a long time, (a) median inflation is rising and now is at 2.3% y/y, the highest level since 2009, and (b) core inflation is converging to median inflation as the one-off effects of the sequester on Medicare payments is removed from the data.
Following is a summary of my post-CPI tweets. You can follow me @inflation_guy!
- Well, I hate to say I told you so, but…increase in core CPI biggest since Aug 2011. +0.3%, y/y up to 2.0% from 1.8%.
- Let the economist ***-covering begin.
- Core services +2.7%, core goods still -0.2%. In other words, plenty of room for core to continue to rise as core goods mean-reverts.
- (RT from Bloomberg Markets): Consumer Price Inflation By Category http://read.bi/U60bLJ pic.twitter.com/R2ufMjVRRM
- Major groups accel: Food/Bev, Housing, Apparel, Transp, Med Care, Other (87.1%) Decel: Recreation (5.8%) Unch: Educ/Comm (7.1%)
- w/i housing, OER only ticked up slightly, same with primary rents. But lodging away from home soared.
- y/y core was 1.956% to 3 decimals, so it only just barely rounded higher. m/m was 0.258%, also just rounding up.
- OER at 2.64% y/y is lagging behind my model again. Should be at 3% by year-end.
- Fully 70% of lower-level categories in the CPI accelerated last month. That’s actually UP from April’s very broad acceleration.
- That acceleration breadth is one of the things that told you this month we wouldn’t retrace. This looks more like an inflation process.
- 63% of categories are seeing price increases more than 2%. Half are rising faster than 2.5%.
- Back of the envelope says Median CPI ought to accelerate again from 2.2%. But the Cleveland Fed doesn’t do it the same way I do.
- All 5 major subcomponents of Medical Care accelerated. Drugs 2.7% from 1.7%, equip -0.6% from -1.4%, prof svs 1.9% from 1.5%>>>
- >>>Hospital & related svcs 5.8% from 5.5%, and Health insurance to -0.1% from -0.2%. Of course this is expected base effects.
- Always funny that Educ & Communication are together as they have nothing in common. Educ 3.4% from 3.3%; Comm -0.24% from -0.18%.
This was potentially a watershed CPI report. There are several things that will tend to reduce the sense of alarm in official (and unofficial) circles, however. The overall level of core CPI, only just reaching 2%, will mean that this report generates less alarm than if the same report had happened with core at 2.5% or 3%. But that’s a mistake, since core CPI is only as low as 2% because of one-off effects – the same one-off effects I have been talking about for a year, and which virtually guaranteed that core CPI would rise this year toward Median CPI. Median CPI is at 2.2% (for April; it will likely be at least 2.3% y/y from this month but the report isn’t out until mid-day-ish). I continue to think that core and median CPI are making a run at 3% this calendar year.
The fact that OER and Primary Rents didn’t accelerate, combined with the fact that the housing market appears to be softening, will also reduce policymaker palpitations. But this too is wrong – although housing activity is softening, housing prices are only softening at the margin so far. Central bankers will make the error, as they so often do, of thinking about the microeconomic fact that diminishing demand should lower market-clearing prices. That is only true, sadly, if the value of the pricing unit is not changing. Relative prices in housing can ebb, but as long as there is too much money, housing prices will continue to rise. Remember, the spike in housing prices began with a huge overhang of supply…something else that the simple microeconomic model says shouldn’t happen!
Policymakers will be pleased that inflation expectations remain “contained,” meaning that breakevens and inflation swaps are not rising rapidly (although they are up somewhat today, as one would expect). Even this, though, is somewhat of an illusion. Inflation swaps and breakevens measure headline inflation expectations, but under the surface expectations for core inflation are rising. The chart below shows a time-series of 1-year (black) and 5-year (green) expectations for core inflation, extracted from inflation markets. Year-ahead core CPI expectations have risen from 1.7% to 2.2% in just the last two and a half months, while 5-year core inflation expectations are back to 2.4% (and will be above it today). This is not panic territory, and in any event I don’t believe inflation expectations really anchor inflation, but it is moving in the “wrong” direction.
But the biggest red flag in all of this is not the size of the increase, and not even the fact that the monthly acceleration has increased for three months in a row while economists keep looking for mean-reversion (which we are getting, but they just have the wrong mean). The biggest red flag is the diffusion of inflation accelerations across big swaths of products and services. Always before there have been a few categories leading the way. When those categories were very large, like Housing, it helped to forecast inflation – well, it helped some of us – but it wasn’t as alarming. Inflation is a process by which the general price level increases, though, and that means that in an inflationary episode we should see most prices rising, and we should see those increases accelerating across many categories. That is exactly what we are seeing now.
In my mind, this is the worst inflation report in years, largely because there aren’t just one or two things to pin it on. Many prices are going up.
We all have our hot button issues. It will not surprise you, probably, to learn that mine involves inflation. For the rant which follows, I apologize.
Reasonable people, smart people, learned people, can disagree on how precisely the Consumer Price Index captures the inflation in consumer prices. And indeed, over the one hundred years that the CPI has been published such disagreements have been played out among academics, politicians, labor leaders, and others. The debates have raged and many changes – some large, some small; some politically-driven, most not – have occurred in how prices have been collected and the index calculated. If you are interested, really interested, in the century-long history of the CPI, you can read a couple of histories here and here.
If someone is not interested in how CPI is calculated, in how and why changes were made in the methodological approach to calculating price change, then that’s fine. But if a person can’t spend the time to learn the very basics of this hundred-year debate, during which changes were made in the CPI with much public input, not in a smoky back room somewhere, then I wonder why such a person would spend time spewing conspiracy theories on the internet about how the CPI doesn’t include food and energy (um…it does), about how the CPI underestimates prices because it doesn’t account for changes in quality and quantity (um…it does), or about how sneaky methodological changes have caused the CPI to be understated by 7% per year for thirty years.
Recently, the CFA Institute’s monthly magazine for CFA Charterholders was duped into accepting an article that brings together some of the dumbest theories into one place. At some level, the article asks the “interesting” question about whether a consumer price index should include asset prices. Interesting, perhaps, but asked-and-answered: assets are not consumer goods but stores of value. If you are not consuming something, then why would you ever expect it to be included in a consumer price index? You might argue that we should include asset prices into some other sort of index that measures price increases. But we already do. They are called asset price indices, and you know them by names like the S&P 500, the NCREIF, and so on.
Worse, the magazine gives a great big stage to the person who has singlehandedly done more to confuse and anger people, to poison the well of knowledge about inflation, and to stir up the conspiracy theorists about inflation, than anyone else in the world – and all because he is selling an ‘analysis’ product to those people. I won’t mention his name here because I don’t want to advertise his product, but he claims that the CPI is understated by “about 7 percentage points each year.”
That this is being published in a magazine of the CFA Institute is almost enough for me to renounce my membership. It is offensively idiotic to claim that the CPI may be understated by 7% per year, and simple math (which CFA Charterholders were once required to be able to perform) can prove that. If inflation has risen at a pace of around 2.5% per year over the last 30 years, it implies the price level has risen about 110% (1.025^30-1). This seems more or less right. But if inflation had really been 9.5% per year, as claimed, then the cost of the average consumption basket would have risen about 1422% (1.095^30-1).
Can that be right? Well, Real Median Household Income, using the CPI to deflate nominal household income, has risen about 13% over the last 30 years. http://en.wikipedia.org/wiki/File:Median_US_household_income.png But if we use the 9.5%-per-year CPI number, then real median household income has actually fallen 84%. If this was true, we would be living in absolute Third-World squalor compared to how things were in the salad days of 1984. You don’t have to be an economist to know the difference between a slightly-better standard of living and one in which you can afford 1/6th of what you could previously afford. You just need a brain.
Any person who does even rudimentary research on the CPI – say, visiting http://www.inflationinfo.com and reading some of the hundreds of papers gathered there, or perusing the BLS website, or speaking with an actual inflation expert – cannot possibly think that this guy is anything other than a nut or a shill. It is a tragedy that the CFA Institute would publish such trash, and it tarnishes the CFA Institute brand. Let’s hope they publish an apologetic retraction in the next issue.
I also like to point out, when I am in rant mode over this (and, as an aside, let me thank the tolerant reader for allowing me to rant – this allows me to forever point people to this link when they bring up this guy), that if the CPI=9.5% number is right then you must also believe a bunch of other ridiculous things:
First: MIT is in on the conspiracy. The Billion Prices Project, which uses very different methodology from the BLS, figures inflation to be about the same as the BLS does. (Digressing for a bit, I think it’s also interesting that the BPP index has tracked Median CPI much better than headline CPI over the last year, when headline CPI has been dragged lower by one-off changes in medical care prices).
Second: Consumers consistently underestimate inflation, or else are serially optimistic about how it is likely to decline from 9.5% to something much lower. The University of Michigan survey of year-ahead inflation expectations – and every other consumer survey of inflation expectations – is much closer to reported inflation than to the shill’s numbers (see chart below, source Bloomberg). I’ve written elsewhere about why consumers might perceive slightly higher inflation than really occurs, but I cannot come up with a theory that explains why consumers would always say it’s much lower than what they are in fact seeing. Maybe we’re all stupid except for this guy with the website.
Third, and related to the prior point: Investors who pour money into inflation-indexed bonds must be complete morons, because they are locking up money for ten years at what is “really” -9% real yields (meaning that they are surrendering 62% of the real purchasing power of their wealth, rather than spending it immediately). We don’t see this behavior in countries where it is known that the official index is manipulated. For example, we know that in Argentina the inflation data really is rigged, and in September of last year long-dated inflation-linked bonds in Argentina were showing real yields of more than 20%. In recent months, the government of Argentina has begun to release figures that are much more realistic and real yields have plunged to around 10% as investors are giving the data more credibility. The upshot is that we have bona fide evidence that investors will base their demanded real yields on the difference between the inflation index they are being paid on and the inflation they think they are actually seeing. The fact that we don’t see TIPS real yields around 6% or 7% is evidence that investors are either really stupid, or they believe the CPI is at least approximately right.
Fourth, and related to that point: if inflation has really being running at 9.5%, then every asset is a losing proposition. There is no way to protect yourself against inflation. You’re not really getting wealthy as you ride stocks higher; you’re only losing more slowly. Since there is no asset class that has returned 10% over a long period of time, we are all doomed. The money is all going away. Especially housing, and real goods like hard commodities – there is nothing you can do that is much worse than holding real stuff, which is only going up in price a couple of percent per year over time while inflation is (apparently) ravaging everything we know and love. There is no winning strategy. Of course, the good news is that it turns out that the U.S. government is being extremely fiscally responsible, with the real deficit falling by 5% or more every year. Right.
I really should not let this bother me. It is good for me, as an investor with a brain, when mindless zombie minions follow this guy and do dumb things in the market. But I can’t help it. The Internet could be a tool for great good, allowing people access to accurate, timely information and the opportunity to learn things that they couldn’t otherwise. It allows this author to come into your mailbox, or onto your screen, to try to educate or illuminate or amuse you. But there is also so much detritus, so much rubbish, so much terribly erroneous information out there that does real harm to those who consume it. And perhaps this is why I get so exercised about this issue: I absolutely believe that people have a right to say and to believe whatever they want, no matter how stupid or dangerous. I am simply aghast, and deeply saddened, that so many people are so credulous that they believe what they read, without critical thought of their own. Everyone has a right to his/her opinion, but they are not all equally valid. There is no FDA for the Internet, so snake-oil salesmen run rampant among their eager marks.
I want my readers to think. If you all agree with me, then I know you’re not all thinking! Look, it is perfectly reasonable to suggest that some minor improvements can be made to CPI. The number has been tweaked and improved for a hundred years, and it will be tweaked and improved some more in the future. It is in my opinion not reasonable to suppose that the number is completely made up and/or drastically incorrect. And that’s my opinion.
Today’s post-CPI update is later than usual (normally, on CPI day I ‘tweet’ my impressions as I have them). A prospect meeting got in the way – yes, isn’t it interesting that there is demand for creative inflation-linked solutions?
Probably, after today, this will be a trifle less surprising. Core inflation surprised on the high side. Consensus had been for the month-over-month figure to be +0.1%; instead it printed +0.236%. This pushed the year-on-year core inflation rate to 1.826%, the highest it has been in a year…and yet still the lowest it is likely to be for a very long time.
So, with the wonderful perfection of timing that is only possible from elite policymakers, the Fed has begun to chirp about deflation fears at just exactly the time that core inflation is turning higher. Do recall that core inflation never got below 1.6% – very far from “deflation” – and was only that low because of well-known effects stemming from the impact of the sequester last year on Medicare payments. Median inflation, which eliminates the influence of small outlier decreases (and increases) on the number, scraped as low as 2.0%, and now sits at 2.2%. It has not been higher than that since mid-2012. Median inflation hasn’t been higher than 2.3% since 2009, so it is fair to say that inflation is much closer to the highs of the last five years than to the lows. Deflation, indeed.
A closer view of the subcomponents do not give any less cause for concern. Of the eight major subcomponents, six (Food & Beverages, Apparel, Transportation, Medical Care, Recreation, and Education & Communication) accelerated on a year-over-year basis while only two (Housing and “Other”) decelerated.
At first glance, that sounds promising. Housing inflation dropped to 2.5% from 2.8%, and those people who are worried about another housing bust right now will be quick to seize on that deceleration. Housing inflation, which is 41% of the total consumption basket, has been a primary driver of core inflation’s recovery in recent months so a deceleration would be welcome. But a closer look suggests that the number for Housing overstates the ‘deceleration’ case considerably. “Fuels and utilities,” which is 5.2% of the entire consumption basket and about 1/8th of Housing, dropped from 6.8% y/y to 4.2%. That was the entire source of the deceleration in housing. The larger pieces, which are also much more persistent, were higher: Primary rents rose from 2.88% y/y to 3.05% y/y, while Owners’ Equivalent Rent was roughly flat at 2.62% compared to 2.61%. So it is perhaps too early to panic about deflation, since the rise in OER and Primary rents is right on schedule as we have been marking it for some time (see chart below, source Enduring Investments).
Outside of housing, core inflation accelerated as well. Core ex-Shelter rose to 1.16% from 0.90%. The inflation is still significantly in services, as core commodities are still only -0.3% year/year. But that will rise soon, probably starting as soon as next month, based on our proxy measure.
As has been well advertised, the temporary depression in Medical Care inflation growth has officially ended. Now that April 2013 is out of the year/year data, the Medical Care major group saw prices rise 2.42% over the last year compared with 2.17% y/y a month ago. Medicinal drugs are at +1.70% compared with +1.44%. Medical equipment and supplies -1.39% vs -1.53%. Hospital and related services +5.55% vs 4.69%. I don’t see the deflation, do you?
This rise in CPI was broad and deep, with nearly 80% of the lower-level indices seeing increases in the y/y rate. It is hard to find any major component about which I would have to express concern, if I was a Federal Reserve official worried about deflation. The breadth of increase is itself a signal. When some prices go up, it is a change in relative prices and will be considered inflation by some people (those who are sensitive to those prices) and not so much by others. But “inflation” is really about a general rise in prices, in which most goods and services participate. As I mentioned above, not all goods prices are participating but in general most prices are rising and, if this month is any gauge, accelerating.
We should hesitate to read too much into any one month’s inflation number. There is a lot of noise in any economic data, so that it can be hard to discern the signal. I believe that there is enough underlying strength here that this is in fact more signal than noise, though, and so I continue to expect core inflation to accelerate for the balance of the year.
I have no idea how long Fed officials will continue to fret about deflation, nor how long it will take the concern to shift to inflation. I suspect it will take a long time, although the stock market today seems less certain on that point with the S&P at this writing down -1.3%. Curiously bonds, which are clearly overvalued if inflation is not contained, rallied today (although breakevens predictably widened). But I think all markets are safe for some time from the risk that central bankers will develop a concern about inflation that is acute enough to spur them to action. (Not to mention that it isn’t at all clear to me what action they could take that would have an effect on the inflation dynamic in any reasonable time frame given that excess reserves must be drained first before any tightening has teeth). This does not mean that I am sanguine about the prospects for nominal asset classes such as stocks and nominal bonds – but at some point, they won’t need the Fed’s cudgel to persuade them to re-price. When inflation is obvious enough to all, that will be sufficient.
If it seems that the frequency of my posts has diminished of late, it is no illusion. There are many reasons for that, many business-related, but there is at least one which is market-related: a three-month-long, 20bp range in real and nominal yields and a year-to-date S&P return that seems locked between +2% and -2% with the exception of the January dip offers precious little to remark upon. Along with those listless markets, we have had plenty of economic data that it was very evident the market preferred to ignore and blame on “severe weather.” And, to the Fed’s lasting credit (no pun intended), the decision to start the taper under Bernanke and thus give Yellen a few months of simply sitting in the captain’s chair with the plane on autopilot has short-circuited the usual rude welcome the markets offer to new Fed Chairmen.
These sedate markets irritate momentum traders (you can’t trade what doesn’t exist) and bore value traders – at least, when the markets are sedate at levels that offer no value. For individual investors, this is a boon if they are able to take advantage of the quiet to pull their attention away from CNBC and back to their real lives and jobs, but for professional investment managers it is frustrating since it is hard to add value when markets are becalmed. Yes, successful investing – which is presumably what successful investment managers should be practicing – is very much about patience, and this is doubly or trebly true for value managers who eschew investing heavily into overvalued markets. I am sympathetic with the frustrations of great investors like Jeremy Grantham at GMO, but I will point out that his frustrations are more acute among less-legendary managers. It is, after all, much easier to pursue the patient style of a Hussman or Grantham…if you are Hussman or Grantham.
Again, I’m not whining too much about our own difficulty in securing good performance, because we’ve done well to be overweight commodities and with some of our other position preferences. I’m more whining about the difficulty of writing about these markets!
But let’s reset the picture, now.
The very weak Q1 GDP figure from last Wednesday (a mere +0.1%, albeit with strong consumption) is old news, to be sure, and investors are right to underweight this information since we already knew Q1 growth was weak. But at the same time, I would admonish investors who wish to patiently take the long view not to get too ebullient about Friday’s jobs figure. Payrolls of +288k, with solid upward revisions, sounds great, but it only keeps us on the 200k/month growth path that we have had since the recovery reached full throttle back in late 2011 (see chart, source Bloomberg).
As I wrote back in August, 200k is what you can expect once the expansion is proceeding at a normal pace, and that’s exactly what you’ve gotten for a couple of years now. Similarly, if you project a simple trend on the Unemployment Rate from late 2011 (see chart, source Bloomberg) you can see that the remarkable plunge in the ‘Rate merely operated as a ‘catch-up’ from the winter bounce higher.
If you believe that inflation is caused when economies run out of slack (I don’t), then the low unemployment rate should concern you – not because it fell rapidly, because it is nearer to whatever threshold matters for inflation. If you rather think that inflation is caused by too much money chasing too few goods, then you’ve already been alarmed by the continued healthy rise in M2 and the fact that median inflation rose to 2.1% this month. So, either way, people (and policymakers) ought to be getting at least more concerned about inflation, no matter what their theoretical predilections. And, in fact, we see some evidence of that. Implied core inflation for the next 12 months (taking 1-year inflation swaps and hedging energy) has risen in the past month to about 2.25% from 1.75%. To some extent, this seems to be seasonal, as that measure has risen and peaked in the last three March/April periods. Investors tend to mistake the rise in gasoline prices that normally happens in the spring to be inflation, even though it ordinarily falls back later in the year. But right now, the implied acceleration in core inflation from the current level of 1.7% is the highest it’s been in three years (see chart, source Enduring Investments).
The bigger spike, on the left side of that chart, corresponds with the significant fears around the time of QE2. But what’s interesting now, of course, is that the Fed is actually tightening (providing less liquidity is the definition of tightening) rather than easing. Some of this is probably attributable to base effects, as last year’s one-off price decline in medical care services due to sequestration-induced Medicare spending cuts is about to begin passing out of the data. But some of it, I suspect, reflects a true … if modest … rising concern about the near-term inflation trajectory.
 Unless, that is, you are overweight commodities…which we are. The DJ-UBS is +8.9% year-to-date.
I haven’t written in a couple of weeks – a combination of quiet markets, and a lack of intersection between stuff that’s interesting to write about and my having time to write – but I thought I would “global cc” everyone on something I just wrote in a private email about some common misconceptions regarding the CPI:
A friend and longtime reader (name withheld) writes:
I thought you might find these interesting….
My response is below:
Thanks. Unfortunately Stockman doesn’t understand what he’s talking about. He understands better than most, but then he starts saying how the BLS asks homeowners what their homes would rent for…which they do, but only to determine weights, every couple of years, not to determine OER. It says this very clear in a paper on the BLS website called “Treatment of Owner-Occupied Housing in the CPI:“
“To obtain the expenditure weights for the market basket…Homeowners are asked the often-cited question:
If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?
This is the only place where the answers to this question is used; in determining the share of the market basket. We do not use this question in measuring the change in the price of shelter services.”
For that purpose – calculating inflation itself – a survey of actual rents is used. I can understand how the casual observer doesn’t ‘get’ this, but there’s no excuse for Stockman not to know, especially if he is railing about the CPI…he should take some time to understand its main piece.
In short, Stockman writes a good populist screed, but he avoids the main questions:
1. Is headline inflation a better predictor of future inflation than core inflation? Answer: No, even if we can now realize that the rise in energy prices was a permanent feature of the decade ended in 2010, it tells us exactly nothing about whether those are likely to persist. The Fed uses core CPI not because they don’t think people use cars (whenever a columnist uses that silly argument, I know they’re just writing to please a certain audience), but because core CPI is persistent statistically in a way that headline is not. In fact, some Fed statisticians prefer median, or trimmed-mean, neither of which proscribes any particular category. So whining about how the Fed doesn’t include the particular brand of inflation that concerns you misunderstands how and why policymakers actually use measures of inflation in policymaking.
2. Suppose the CPI represents a miserable mis-estimation of actual inflation. Then, pray tell, why does a trillion-dollar market based on that index get priced as if it is accurate? In Argentina, where the inflation numbers are made up, the inflation-linked bonds trade very cheap because they will pay off in a number that is assumed to be too low. And the bond yields are too high by roughly the amount that inflation is assumed to be understated in the future. Markets are efficient, especially big markets. How did the Fed manage to convince at least $1T in private money to misprice the bond market?
3. If the CPI is so wrong, so manipulated, then why to measures of inflation that the government has nothing to do with, like the Billion Prices Project, come up with the same number?
It’s nice that Stockman has a following. And he’s gotten the following partly by ranting about a number people love to hate. That gets him read, but it doesn’t make him right.
Below is a summary of my post-CPI tweets. You can follow me @inflation_guy, or see the twitter scroll on the right side of the page here :
- CPI +0.2%/+0.2%, above expectations.
- Core actually 0.204%, almost a full tenth above the implicit rounding in the forecasts. y/y at 1.66%, rounding up to 1.7%.
- Perfect, just after the Fed starts publicly fretting about deflation. Those guys are funny.
- Core services up to 2.3%; core goods still at -0.3% although that’s up from last month. If that number ever mean-reverts (and it will).
- Accel major groups: Food/Bev, Housing, Apparel, Transp (76%). Decel: Med Care (8%). Unch: Rec, Educ/Commun/Other
- Med Care inflation decelerated to 2.17% from 2.26%, so not a big drop. But Housing rose to 2.8% from 2.45%!
- In housing: OER 2.61% from 2.51%, Primary rents 2.88% from 2.82% (all what we have been saying). Lodging away from home 3.3% from 1.8%.
- Core ex-housing 0.9% from 0.8% – still very low. The rise in core will be driven by housing, but the rest will come along.
- Our OER model had 2.62% as the y/y forecast this month; actual was 2.61%. Model says we’ll be at 3.1% on OER at least by year-end.
- Median CPI won’t be out for a while but there’s a decent chance it ticks back up to 2.1%, based on my back-of-the-envelope.
It is worth pointing out that it was not particularly difficult to forecast that housing inflation would accelerate, and continue to accelerate, for a while. The chart below (source: Enduring Investments) is something I’ve been running for more than a year.
A simple blend of just these three components suggests a 3.3% rise in Owners’ Equivalent Rent by the end of the year (our more-detailed model has it at 3.1%, so consider that the forecast range), with primary rents a few tenths above that. If all of the other core components inflate at just 1.2%, overall core would be above 2%.
The other components of core include Medical Care, which has been held down by unusual factors for the last year but has recently been rising again. It includes Apparel, which is only rising at 0.5%. It includes airfares, which have been declining at a 4% rate over the last year, and automobiles, which are unchanged over the last year. In short, there is a lot of upside in the non-housing core elements.