The following is a summary of my post-CPI tweets. You can follow me @inflation_guy (or follow the tweets on the main page at http://mikeashton.wordpress.com)
- Core CPI +0.14%, close to rounding to +0.2%. An 0.2% would have caused a panic in TIPS, where there have been far more sellers recently.
- y/y core to 1.73%, again almost rounding to 1.8% versus 1.7% expected. This just barely qualifies as being “as expected”, in other words.
- Core services fell to 2.4%, but core goods rose to -0.3% y/y.
- OER re-accelerated to 2.71% from 2.68% y/y. It will go higher.
- really interesting that core goods did not weaken MORE given dollar strength. $ strength is overplayed by inflation bears.
- Apparel went to 0.5% y/y from 0.0%. That’s the category probably most sensitive directly to dollar movements b/c apparel is all overseas.
- Accel major groups: Food/Bev, Apparel, Recreation (24.1% of basket). Decel: Housing, Transp, Med Care, Educ/Comm (72.5%).
- Though note that in housing, Primary rents rose from 3.18% to 3.29%, and OER from 2.68% to 2.71%, so weakness is mostly household energy.
- That’s a new high for primary rental inflation. Lodging away from home also went to new high, 5.04% y/y. But it’s choppier.
- Airfares continued to decelerate, -3.01% from -2.71%. Ebola scares can’t have helped that category, which most expected to rebound.
- But these days, airfares are very highly correlated to fuel prices (wasn’t always the case). [ed note: see chart below]
- In Medical Care, pharmaceuticals rose to 3.08% from 2.72%. But the medical services pieces decelerated.
- Decel in med services is the surprise these days as the passage of the sequester cause positive base effects.
- The weakness in med services holds down core PCE, too. Median CPI continues to be a better measure as a result.
- College tuition and fees 3.36% from 3.32%. Still low compared to where it’s been. Strong markets help colleges hold down tuitions.
- Core CPI ex-housing partly as a result of continued medical care weakness is down to a new low 0.877% from 0.911%.
- That continues to be the horse race: housing versus a wide variety of other things not inflating. Yet.
We may hear about how this CPI report shows that there is “still no inflation,” but the simple fact is that the report was a little stronger-than-expected, that shelter inflation continues to accelerate with no end in sight, and that there was no large effect seen in core inflation from the strength of the dollar. The dollar has an evident effect on energy commodities, and a lesser effect on other commodities, but once you get to finished goods it takes a larger FX move or one longer in duration than the modest dollar rally we have had so far to cause meaningful movements in inflation.
The dollar’s strength, reflecting in energy weakness, also shows up in some categories where we don’t fully appreciate the link to energy. The airfares connection is always one of my favorites to show. Prior to 2004, there was basically no correlation between airfares and jet fuel prices (vertical part of the chart below). After 2004, the correlation went to basically 1.0 (see chart, source Enduring Investments).
The real conundrum in the CPI right now is the medical care piece. We always knew there would be difficulties in extracting what is really going on in medical care once Obamacare kicked in, because many of the costs of that program don’t show up immediately as consumer costs. But the main effect in the data all last year was the effect of the sequester on Medicare payments, which pushed down Medical Care inflation from over 4% in mid-2012 to 2% in 2013. But as the sequester passed out of the data, Medical Care CPI rose to nearly 3% earlier this year…and then slipped, abruptly, back to the lows (see chart, source Bloomberg).
Is it possible that Obamacare is really restraining consumer inflation for medical care? Sure, it is possible. But there is far too much noise at this point to know what is happening in that component. And it really matters, because the overweighting of medical care and underweighting of housing in core PCE is the main reason that the Fed-favored price index shows 1.5% while median CPI is at 2.2%, within a snick of the highs since the crisis (see chart, source Bloomberg – note median CPI isn’t out yet for September).
From a markets perspective, the TIPS market (and the commodities market, for that matter) have been pricing in a pernicious disinflation and/or deflationary pressure. It is simply not there. And so, even with a print that couldn’t reach 0.2% on core, and even heading into a big auction tomorrow, inflation breakevens are rallying nicely, up 3.5-4.5bps across the board. Imagine what they would have done with a print that was a bona fide strong print!
Here is a summary of my post-CPI tweets. You can follow me @inflation_guy or (if you’re already following me on Twitter or seeing this elsewhere) subscribe to direct email of my free articles here.
- Complete shocker of a CPI figure. Core at +0.01%, barely needed any rounding to get to 0.0. Y/y falls to 1.73%. Awful.
- Zero chance the Fed does anything today, anyway. The doves just need to point to one number and they win.
- Stocks ought to LOVE this.
- Core services dropped to 2.5% y/y from 2.6% and core goods to -0.4% from -0.3%.
- Accelerating major groups: Food/bev. That’s all. 14.9% of basket. Everything else decelerating.
- I just don’t see, anecdotally, a sudden change in the pricing dynamics in the economy. That’s why this is shocking to me.
- Primary rents to 3.18% from 3.28%. Owners’ Equiv to 2.68% from 2.72%. Both in contravention of every indicator of market tightness.
- Apparel goes to 0.0% from +0.3% y/y. That’s where you can see a dollar effect, since apparel is mostly manufactured outside US.
- Airline fares -2.7% versus -0.2% y/y last month and +4.7% three months ago. It’s only 0.74% of the basket but big moves like that add up.
- Medical care: 2.09% versus 2.61% y/y. Now THAT is where the surprise comes in. Plunge in ‘hospital and related services.’ to 3.8% vs 5.5%.
- …we (and everyone else!) expect medical care to bounce back from the sequester-inspired break last year. I still think it will.
- core inflation ex-housing at 0.91% y/y, lowest since August 2004. Yes, one decade.
- core inflation ex-housing is now closer to deflation than during the deflation scare. In late 2010 it got to 1.08% y/y.
- Needless to say our inflation-angst indicator remains at really really low levels.
- Interestingly, the proportion of CPI subindices w y/y changes more than 2 std dev >0 (measuring broad deflation risk) still high at 38%.
- To sum up. Awful CPI nbr. Housing dip is temporary & will continue to keep core from declining much. Suspect a lot of this is one-off.
- …but I thought the same thing last month.
- Neil Diamond said some days are diamonds, some days are stones. If you run an inflation-focused investment mgr, this is a stone day.
- Interestingly, Median CPI was unchanged at 2.2% this month. I’d thought it fell too much last month so this makes sense.
I am still breathing heavily after this truly shocking number. This sort of inflation figure, outside of a crisis or post-crisis recovery, is essentially unprecedented. Lower prints happened once in 2010, once in 2008, three times in 2003, and once in 1999. But otherwise, basically not since the 1960s.
The really amazing figure is the core-ex-Housing number of 0.91% y/y. A chart of that (source: Enduring Investments) is below.
There are interesting similarities between the current situation and late 2003, which is the last time that ex-housing inflation flirted with deflation. Between late 2000 and June 2003, money velocity fell 11%, in concert with generally weakening money growth. Velocity fell primarily because of a sharp decline in interest rates from 6% on the 5y note to around 2.25%. The circumstances are similar now: 5y interest rates declined from around 5% to 0.5% from 2006 through mid-2013, accompanied by a 24% decline in money velocity. And voilá, we have weakness in core inflation ex-housing.
The important differences now, though, are twofold. The first is that the absolute levels of money velocity, and of interest rates, are much lower and very unlikely to fall much further – indeed, money velocity is lower than it “should” be for this level of interest rates. And the second is that there is an enormous supply of inert reserves in the system which will be difficult to remove once inflation begins to rise again. The Fed began to increase interest rates in 2004, which helped increase money velocity (and hence, inflation) while it also caused M2 growth to decline to below 4% y/y. Core inflation rose to 3%, but the Fed was basically in control. Today, however, the Fed has no direct control over the money supply because any reserves they remove will be drawn from the “excess” reserves held by banks. This will make it difficult to increase overnight rates except by fiat (and increasing them by setting a floor rate will merely cause money velocity to rise while having no effect on the money supply). So the ‘potential inflation energy’ is much higher than it was in 2003. As an aside, in 2004 I was quite vocal in my opinions that inflation was not about to run away on the upside, which is another key difference!
If you are a tactical inflation trader, today’s CPI figure should make you despise inflation-linked bonds for a few weeks. But they have already taken quite a drubbing this month, with 10-year breakevens falling from 2.27% to 2.08% as I type. It’s okay to watch them fall, tactically, especially if nominal bonds generally rally. But strategically, not much has changed about the inflationary backdrop. I don’t expect airline fares to continue to drop. I don’t expect Medical Care inflation, which has a strong upward bias due to base effects, to plunge further but to return to the 3%-4% range over the next 6-12 months. And Housing inflation slowed slightly this month but remains on course to continue to rise. So, if you are considering your inflation allocations, this is a good time to increase them while markets are dismissive of any possibility of higher prices.
Without a doubt, today’s number – especially following another weak CPI print last month – is a head-scratcher. But there aren’t a lot of downside inflation risks at the moment. Our forecast had been for core (or median) inflation to reach 2.6%-3.0% in 2014. I would say that core CPI isn’t going to get to that level this year with 4 prints left, and even median CPI (which is a better measure right now of the central tendency of inflation, thanks to the aforementioned base effects in medical care, and remained at 2.2% this month) is going to have a harder time reaching that target. I’d lower and narrow the target range for 2014 median inflation to 2.5%-2.8% based on today’s data.
Below is a summary of my post-CPI tweets today. You can follow me @inflation_guy.
- Weak cpi: 0.1%, core +0.1%. Unrounded core was +0.096, so it rounded UP to 0.1%. Y/y core stayed at 1.9% but just barely: 1.85%.
- That’s a real surprise since virtually all signs had been for higher core going forward. Breakdown will be interesting.
- Core svcs y/y slipped to 2.6%; core goods fell further to -0.3%. Leading indicators on both still point higher though.
- Accel major groups: Food/Bev, Housing (56.3%). Decel: Apparel, Transp, Recreation, Other (29%). Unch: Med Care, Educ/Comm (14.7%)
- Primary Rents 3.28% from 3.15%. OER 2.72% from 2.64%. No danger of inflation declining while these are rising strongly.
- Dramatic fall in airline fares: from 5.34% y/y to -0.25%.
- Airline fares are only 0.74% of the basket but that took 0.04% from headline and 0.05% from core.
- Big move in one item suggests median CPI won’t fall, though I haven’t yet done the math. In any event, number not as weak as I thought.
- Medicinal drugs 3.12% from 3.00%. Med equip/supplies 0.2% from -1.08%. Much of this is unwind of sequester effect last yr.
- Easy comparison next month means core will be back to 1.9% in August, chance of 2.0%. It needs to converge with median!
- I think Median CPI might actually accelerate today from 2.3%, based on my rough calculations.
The initial headline was a bit of a shock, as it looked very weak. But as I looked deeper into the numbers, it didn’t seem nearly as weak as I had first thought. To be sure, this is not a strong report, but the seeming weakness came largely from one component. The most-important components (and the ones with the most inertia) are the housing pieces, and those are moving strongly ahead.
When I did my calculations of the median CPI (I don’t do it the same way as the Cleveland Fed does it), I came up with a decent rise over last month’s figure. That is to say that most categories continue to see accelerating inflation. We will see if the Cleveland Fed agrees, but an uptick in the median CPI (which was 2.3%, unchanged, last month) would go a long way towards removing any sense that this was actually a weak figure.
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.