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Summary of My Post-CPI Tweets

The following is a summary of my post-CPI tweets. You can follow me @inflation_guy.

  • Core CPI +0.12%, a bit lower than expected.
  • Core 1.56% y/y
  • Both core services and core goods decelerated, to 2.2% y/y and -0.4% y/y. This is highly surprising and at odds with leading indicators.
  • Accelerating groups: Food/Bev, Housing, Med Care (63.9%). Decel: Apparel, Transp,Recreation, Educ/Comm (32.7%). “Other” unch
  • Primary rents fell to 2.82% y/y from 2.88%, OER 2.51% from 2.52%.
  • Primary rents probably fell mainly because of the rise in gas prices, which implies the non-energy rent portion is lower.
  • …but that obviously won’t persist. It’s significantly a function of the cold winter. Primary rents will be well into the 3s soon.
  • Household energy was 0.7% y/y at this time last year; now it’s 5.5%. Again, that slows the increase in primary rents
  • Medical Care moved higher again, slowly reversing the sequester-induced decline from last yr. Drugs +1.86% y/y from 0.91% last month.
  • Core ex-housing leaked lower again, to only 0.84% y/y. Lowest since 2004. If you want to worry about deflation, go ahead. I don’t.
  • The Enduring Inflation Angst Index rose to -0.51%, highest since Nov 2011 (but still really low).

I must admit to some mild frustration. Our call for higher primary rents and owners’ equivalent rents has finally been shown to be correct, as these two large components of consumption have been heading higher over the last few months (the lag was 3-4 months longer than is typical). But core inflation, despite this, has stubbornly refused to rise, as a smattering of small-but-important categories – largely in the core goods part of CPI – are weighing on the overall number.

It is also almost comically frustrating that some of the drag on core CPI is happening because of the recent rise in Natural Gas prices, which has increased the imputed energy component of primary rents. As a reminder, the BLS takes a survey of actual rents, but since utilities are often included in rental agreements the BLS subtracts out the changing value of that benefit that the renter gets. So, if your rent last December was $1,000, and your utilities were $100, and your rent this month is still $1,000 but utilities are $125, then the BLS recognizes that you are really paying $25 less for rent. Obviously, this only changes where price increases show up – in this example, overall housing inflation would be zero, but the BLS would show an increase in “Household Energy” of 25% and a decline in “Rent of Primary Residence” of 2.78% (which is -$25/$900). But “Household Energy” is a non-core component, while “Rent of Primary Residence” is a core component…suggesting that core inflation declined.

There isn’t much we can do about this. It’s clearly the right way to do the accounting, but because utility costs vary much more than rental costs it induces extra volatility into the rental series. However, eventually what will happen is either (a) household energy prices will decline again, causing primary rents to recover the drag, or (b) landlords will increase rents to capture what they see as a permanent increase in utilities prices. So, in the long run, this doesn’t impact the case for higher rents and OER – but in the short run, it’s frustrating because it’s hard to explain!

Now, core inflation outside of housing is also stagnant, and that’s surprising to me. Apparel prices have flatlined after increasing robustly in 2011 and 2012 and maintaining some momentum into mid-2013. Ditto for new cars. Both of those series I have expected to re-accelerate, and they have not. They, along with medical care commodities, are the biggest chunks of core goods in the CPI, which is why that series continues to droop. However, medical care commodities – which was driven lower in 2013 due to the effect of the sequester on Medicare payments – is starting to return to its prior level as that effect drops out (see chart, source BLS).

medcarecomm

We will see in a few hours what happens to median inflation. My back of the envelope calculation on the median suggests median CPI might actually rise this month in reverse of last month.

Summary of My Post-CPI Tweets

September 17, 2013 10 comments

Here is a summary of my tweets after the CPI release this morning. You can follow me @inflation_guy.

  • CPI +0.1%/+0.1% core, y/y core to 1.8%. Core only slightly weaker than expected as it rounded down to 0.1% rather than up to 0.2%.
  • Housing CPI was weak, second month in a row. Rents will eventually catch up w/ housing prices…but not yet.
  • Apparel CPI was weak after a couple of strong up months. I’ll have the whole breakdown in a bit.
  • Core was actually only 0.13%, suggesting last August’s 0.06% and this August’s number might merely be bad seasonals.
  • Market was only looking for 0.17% or so, so it’s not a HUGE miss. Still disappointing to my forecasts as upturn in rents remains overdue.
  • Core CPI now 1.766% y/y. More difficult comparison next month although still <0.2%.
  • Accelerating major grps: Apparel, Medical Care, Educ/Comm, Other (20.9%); decel: Food/Bev, Housing(!), Transp (73.1%), unch: Recreation
  • Housing deceleration actually isn’t worrisome. Primary rents were 3.0% y/y vs 2.8% last. OER was 2.23% vs 2.19% last.
  • Housing subcomponent drag was from lodging away from home, household energy, other minor pieces. So housing inflation story still intact.
  • Core services inflation unch at 2.4% y/y; core goods inflation up to 0% from -0.2%. Source of uptick: mean reversion in core goods.
  • So OER still reaches a new cycle high at 2.23%…it’s just not accelerating yet as fast as I expect it to. Lags are hard!

The initial reading of this number, as the tweet timeline above shows, was negative. The figure was weaker-than-expected, and Housing CPI decelerated from 2.26% to 2.17%. This seemed to be a painful blow to my thesis, which is that rising home prices will pass through into housing inflation (expressed in rents) and push core inflation much higher than economists currently expect.

Housing CPI is one of eight major subgroups of CPI, the other seven being Food and Beverages, Medical Care, Transportation, Apparel, Recreation, Education and Communication, and Other. Housing receives the most weight, at 41% of the consumption basket and an even heavier weight in core inflation. So, a deceleration in Housing makes it very hard for core inflation to increase, and vice-versa. If you can get the direction of Housing CPI right, then you’ll have a leg up in your medium-term inflation forecast (although it isn’t very helpful in terms of projecting month-to-month numbers, which are mostly noise). Thus, the deceleration in Housing seemed discouraging.

But on closer inspection, the main portions of Housing CPI are doing about what I expected them to do. Primary Rents (aka “Rent of primary residence”) is now above 3%, in sharp contrast to the expectations of those economists and observers who thought that active investor interest in buying vacant homes would drive up the price of housing but drive down the price of rents. Though I never thought that was likely…the substitution effect is very strong…it was a plausible enough story that it was worth considering and watching out for. But in the event, primary rents are clearly rising, and accelerating, and Owners’ Equivalent Rent is also rising although less-obviously accelerating (see Chart, source BLS).

oerprimarySo, it is much less clear upon further review that this is a terribly encouraging CPI figure. It is running behind my expectations for the pace of the acceleration, but it is clearly meeting my expectations for what should be driving inflation higher. As I say above, econometric lags are hard – they are tendencies only, and in this case the lags have been slightly longer, or the acceleration somewhat muted, from what would typically have been expected from the behavior of home prices. Some of that may be from the “investors producing too many rental units” effect, or it might simply be chance. In any event, the ultimate picture hasn’t changed. Core inflation will continue to rise for some time, and will be well above 2% and probably 3% before the Fed’s actions have any meaningful effect on slowing the increase.

Don’t Look Now, But

July 16, 2013 2 comments

In our business, one must be very careful of confirmation bias of course (as well as all of the other assorted biases that can adversely affect one’s decision-making processes). And so I want to be very careful about reading too much into today’s CPI report. That being said, there were some hints and glimmers that the main components of inflation are starting to look more perky.

Headline (“all items”) inflation rose in June to 1.75% y/y, with core inflation 1.64%. About 20% of the weights in the major groups accelerated on a year-on-year basis; about 20% declined, and 60% were roughly flat. However, two thirds of the “unchanged” weight was in Housing, which moved from 2.219% to 2.249% y/y…but the devil is in the details. Owner’s Equivalent Rent, which is fully 24% of the overall CPI and about one-third of core CPI, rose from 2.13% to 2.21%, reaching its highest rate of change since November 2008. Primary Rents (that is, if you are a renter rather than a homeowner) rose from 2.83% to 2.89%, which is also a post-crisis high. Since much of my near-term expectations for an acceleration in inflation in the 2nd half of the year relies on the pass-through of home price dynamics into rentals, this is something I am paying attention to.

This is what I expected. But can I reject a null hypothesis that core inflation is, in fact, in an extended downtrend – that perhaps housing prices are artificially inflated by investor demand and will not pass through to rents, and the deflation in core goods (led by Medicare-induced declines in Medical Care) will continue? I cannot reject that null hypothesis, despite the fact that the NAHB index today surprised with a leap to 57, its highest since 2006 (see chart, source Bloomberg, below). It may be, although I don’t think it is, that the demand is for houses, rather than housing and thus the price spike might not pass into rents. So, while my thesis remains consistent with the data, the real test will be over the next several months. The disinflationists fear a further deceleration in year-on-year inflation, while I maintain that it will begin to rise from here. I still think core inflation will be 2.5%-2.8% by year-end 2013.nahbboom

In fact, I think there is roughly an even chance that core inflation will round to 1.8% next month (versus 1.6% this month), although the 0.2% jump will be more dramatic than the underlying unrounded figures. The following month, it will hit 1.9%. That is still not the “danger zone” for the Fed, but it will quiet the doves somewhat.

Meanwhile, the Cleveland Fed’s Median CPI remained at 2.1%, the lowest level since 2011. The Median CPI continues to raise its hand and say “hello? Don’t forget about me!” If anyone is terribly concerned about imminent deflation, they should reflect on the fact that the Median CPI is telling us the low core readings are happening because a few categories have been very weak, but that there is no general weakness in prices.

Although I maintain that the process of inflation will not be particular impacted by what the Fed does from here – and, if what they do causes interest rates to rise, then they could unintentionally accelerate the process – the direction of the markets will be. And not, I think, in a good way. We saw today what happens when an inflation number came in fairly close to expectations: stocks down, bonds flat, inflation-linked bonds up, and commodities up. Now, imagine that CPI surprises on the high side next month?

Speaking of the fact that commodities have had (so far at least) their best month in a while, there was a very interesting blog entry posted today at the “macroblog” of the Atlanta Fed. The authors of the post examined whether commodity price increases and decreases affect core inflation in a meaningful way. Of course, the simple answer is that it’s not supposed to, because after all that’s what the BLS is trying to do by extracting food and energy (and doing that across all categories where explicit or implicit food and energy costs are found, such as in things like primary rents). But, of course, it’s not that simple, and what these authors found is that when commodity prices are increasing, then businesses tend to try and pass on these cost increases – and they respond positively to a survey question asking them about that – and it tends to show up in core inflation. But, if commodity prices are decreasing, then businesses tend to try and hold the line on prices, and take bigger profit margins. And that, also, shows up in the data.

To the extent this is true, it means that commodity volatility itself has inflationary implications even if there is no net movement in commodity prices over some period. That is because it acts like a ratchet: when commodity prices go up, core inflation tends to edge up, but when commodity prices go down, core inflation tends not to edge down. Higher volatility, by itself, implies higher inflation (as well, as I have pointed out, as increasing the perception of higher volatility: see my article in Business Economics here and my quick explanation of the main points here). It’s a very interesting observation these authors make, and one I have not heard before.

Summary of My Post-CPI Tweets

June 18, 2013 3 comments

The following is a summary and further explanation of my tweets following today’s CPI release:

  • core #inflation +0.167, a smidge higher than expected but basically in line. Dragged down by medical care (-0.13%).
  • Housing #inflation a solid 0.3%…this part is, as we expected, accelerating.
  • Core commodities still dragging down overall core, now -0.2% y/y while core services still 2.3%.
  • I still think Owners’ Equiv Rent will get to our year-end target but core goods not behaving. Have to lower our core CPI range to 2.5%-2.8%
  • That 2.5%-2.8% still much higher than Street. Still assumes OER continues to accelerate, and core goods drag fades. Fcast WAS 2.6-3.0.
  • Note that CPI-Housing rose at a 2.22% y/y rate, up from 1.94% last month. Highest since late ’08 early ’09. Acceleration there is happening.
  • Major #CPI groups accel: Housing, Trans, Recreation (63.9%), Decel: Food/Bev, Apparel, Med Care, Educ/Comm (32.7%)
  • Overall, IMO this CPI report is much more buoyant than expected. Core goods is flattering some ugly trends.

The important part of this CPI report is that CPI-Housing is finally turning up again, as I have been expecting it would “over the next 1-3 months.” Hands down, the rise in housing inflation (41% of overall consumption) is the greatest threat to effective price stability in the short run. Home prices are rising aggressively in many places around the country, and it is passing through to rents. Primary rents (where you rent an apartment or a home, rather than “imputed” rents) are up at 2.8% year/year, the highest level since early 2009, but not yet showing signs that it is about to go seriously vertical. Some economists are still around who will tell you that rapidly rising home prices are going to cause a decline in rents, as more rental supply comes on the market. That would be a very bizarre outcome, economically, but it is absolutely necessary that this happen if core inflation isn’t going to rise from here.

The last 7 months of this year see very easy comparisons versus last year, when CPI rose at only a 1.6% annualized pace for the May-December period. Only last June saw an increase of at least 0.20%. So, even with a fairly weak trend from here, core CPI will rise from 1.7% year/year. If each of the last 7 months of this year produces only 0.2% from core CPI, the figure will be at 2.2% by year-end. At 0.25% monthly, we’ll be over 2.5%; at 0.3% per month core CPI will be at 2.9% by year-end. So our core inflation forecast, at 2.5%-2.8%, is not terribly aggressive (and if we are right on housing inflation, it may be fairly conservative).

We have not changed our 2014 expectation that core CPI will be at least 3.0%.

Is This the “Real” Selloff?

June 5, 2013 3 comments

Let the wailing and gnashing of teeth begin: the stock market is down almost 5% from the highs!

It was once the case that investors viewed equity market volatility with aplomb. When you could only check your stock prices daily in the paper, and when people were cautious and unlevered because they recognized that crazy things sometimes happened and they couldn’t count on the central bank to bail them out, a 5% setback was just part of the normal zigs and zags. But now we see the VIX rising into the high teens, and a bid developing in Treasuries.

The bid, however, is not as apparent in TIPS. Investors irrationally consider TIPS a “risk-on” asset, even though they are safer than Treasuries since they pay in real dollars. It’s a wonderful thing, because every time there is a market upset “risk-off” trade, TIPS and/or breakevens start to offer terrific value and instead of losing when the panic passes, as with normal Treasuries that slide back down when the flight-to-quality passes, TIPS valuations will snap back. In the meantime, they offer hard-to-miss entry points. For example, right now the 10-year breakeven is at 2.19%, which means expectations are that the Fed will miss its 2% target on PCE on the low side over the next ten years (since PCE is regularly around 0.25%-0.5% below CPI).

Even if that happens, the Fed surely will not miss it by very much (in that direction) – in the worst recession of our lifetimes, core CPI printed 1.8% for 2009, 0.8% for 2010, 2.2% for 2011, and 1.9% for 2012. Headline CPI was 2.7%, 1.5%, 3.0%, and 1.7%, so the average for core over the last four years of epic financial disaster has been 1.7% and for headline, 2.2%. So why in the world would someone buy a 10-year Treasury note at 2.09% when they can own 10-year TIPS for -0.10% + inflation? There seems to me to be mostly downside to holding nominal bonds relative to TIPS…but investors will consistently make this error, and it may get worse, if stocks continue to correct.

However, that error will not last for long, I suspect. CPI will be released on June 18th, and I expect everyone will expect a very soft core inflation number. I believe the housing part of inflation will start to heat up as soon as this month, and I would be very surprised to see inflation print below what will surely be very soft expectations. If core inflation prints 0.3%, rather than last month’s 0.1%, the market will be completely the other way.

That’s not the near-term concern, though. Near-term, investors are concerned that the weak economic growth we have seen for the last several years rolls over rather than continuing to accelerate. The weak ISM print on Monday (the first below 50 since 2009) and today’s modest downward surprise in the ADP employment number (135k new jobs, the weakest since September) has increased nervousness that a stock market which is currently trading at nearly 23 times 10-year earnings, in an environment of record gross margins, might not be able to handle an environment that is less than perfect. I don’t blame investors for that concern.

Another concern, which oddly seems to be vying for equal time, is that the Fed “sounds serious” about ceasing its program of securities purchases. I am highly doubtful that both the weak growth and the end-of-QE concerns can both come to fruition, but even if growth continued to bump along at soft, but not recession levels I doubt the Fed would be cutting QE very soon. The Fed speakers who “sound serious” about reining in QE are mostly established hawks like Dallas Fed President Fisher, who said on Tuesday that “we cannot live in fear that gee whiz, the market is going to be unhappy that we are not giving them more monetary cocaine.” Against that, set the people whose votes actually matter: Bernanke, who evinces few concerns that there’s anything negative about QE and so isn’t in any particular hurry to stop it, and Dudley, who said recently that it will be a few months before the Fed can even decide on a tapering strategy (which would presumably have to precede an actual taper). I side with Fisher on this one, but my vote counts just about as much as Mr. Fisher’s.

(However, I can’t wait to see what my friend Andy at fxpoetry.com does with the cocaine comment tomorrow).

My view has not changed much: I think growth is going to be slow, but we’re probably not going to slip back into recession although we are technically due for one by the calendar. I think inflation is going to rise, and keep rising, and I think the Fed will be very slow to stop QE. Even once it stops QE, it will be slow to remove the accommodation, and inflation will continue to accelerate while it does so. I think stocks are overvalued and offer very poor real returns going forward. I do think that TIPS are now a much better deal than Treasuries, and not a bad deal on an outright basis relative to equities – the first time in a while I could have said that. In fact, the expected 10-year real return on equities is less than 2% more than the expected 10-year real return on TIPS (the latter of which has no risk), which is the worst valuation for stocks relative to TIPS since August of 2011.

In fact, here’s a fact which is worth dwelling on for any investor who says that stocks are a good deal because nominal interest rates are low. Stocks, of course, are real assets (although they tend to do poorly in inflationary periods, as I have said), and if you want to compare them to an interest rate you ought to be comparing them to a real interest rate rather than a nominal interest rate. So, let’s do that. The chart below (Source: Bloomberg) shows the 10-year TIPS yield (in yellow, inverted) plotted against the S&P 500 for the period I just mentioned.

tipsandstocksI think the conclusions are likely obvious. The last time real yields were at these levels, the S&P was between 1200 and 1400 (if you want to be generous about the early-2012 example). It’s over 1600 now.

The Economy in the Plastic Bubble

March 21, 2013 9 comments

We’re going to leave behind the topic of Cyprus for a day. It does seem as if events are coming to a head, but with banks there closed until Tuesday (and the ECB lifeline in place until Monday), there will be lots of news over the next few days but most of it will be heat without light.

So, speaking of heat and light, let’s look at today’s data. Specifically, let’s look at Existing Home Sales.

While the total sales number fell just shy of the 5mm-unit level, the 4.98mm print still represented the highest number (aside from the home-buyer-tax-credit induced surge in 2009) since 2007 (see chart, source Bloomberg).

etsl

The inventory of homes available for sale bounced off of 14-year lows, but remains at levels lower than any we’ve seen in over a decade.

And, near and dear to my heart, the median price of existing homes accelerated from last month (although, due to historical revisions, last month’s y/y was revised down to 10.67%) and stands at 11.34%. The January Home Price Index from FHA also came out; the 6.46% year-on-year rate of increase in that index is also the highest post-2007.

There are long lags between both of these indices and the appearance of price pressures in the Consumer Price Index, but at the moment all indicators of housing point the same direction: Owner’s Equivalent Rent should be in the 2.75% neighborhood by year-end, and could be as high as 3%. This is a key part of our forecast that core CPI should reach 2.6%-3.0% by year-end, and accelerate further in 2014.

The amazing recent run in home prices – which I suspect is driven in part by institutional investor interest in real estate – has caused existing home prices as a multiple of household income to move above levels that prevailed for the last quarter-century of the 20th century. The housing industry likes to present charts of housing affordability, which takes into account the current level of interest rates, because currently those interest rates make even the relatively high home prices look more affordable.

Yes, I said “relatively high home prices.” The median sales price of existing homes averaged 3.36x median household income from 1975 to 2000, with a relatively small range of values around that average. Even including the bubble, when the multiples reached 4.8x, the average through 2011 only rose to 3.54. As of year-end 2012, the multiple was back to approximately 3.48 and if median prices rise “only” 8% this year (remember, the current pace is 11.3% and rising) the multiple will be around 3.6x by the end of the year (see chart, source U.S. Census Bureau, National Association of Realtors, Enduring Investments).

medpricevsincome

Notice that even at the depths of the crisis, home prices were only slightly cheap by pre-2000 standards. Similarly, equity prices at the lows only reached approximately fair value by pre-2000 standards. There are two interpretations of this fact set. It could mean that the pre-2000 era valuations were too low, and that modern financial markets and structures make higher valuation multiples permanently viable. Or it could mean that the Federal Reserve continues to artificially support markets at multiples that are not likely to be sustainable in the long run. I suspect the latter point is more accurate, although I am open-minded about whether the former point might have some validity.

This isn’t necessarily a bad strategy, if the idea is to let the market stair-step down to equilibrium rather than letting it crash there all at once. But I don’t see anything that suggests the Federal Reserve has the slightest idea how to value assets. I understand that they don’t want to substitute their own analysis for the market’s judgment (at least, that would be the counterargument), but that’s what they’re doing anyway – with no indication that they plan to back off anytime soon. The Fed is just more comfortable in the bubble, and afraid to leave it entirely. But don’t we have to, eventually?

The VIX returned to 14 today, which makes a bit more sense to me than the 12.7 level of yesterday. It still seems low to me, but at least there is a way for long-vol positions to actually lose.

Honest, Abe?

November 15, 2012 4 comments

Today was CPI day, which after Christmas and Thanksgiving is one of my most favorite of days. Here is what I tweeted earlier today (and there’s lots more commentary below):

  • unrounded core CPI at +0.18%, a bit higher than what dropped off. Not exactly alarming, but higher than Street expectations.
  • y/y core to almost exactly +2.000%. Apparel rose again after the recent rise had slowed in the last couple of months.
  • Subindices: ACCEL: Housing, Apparel, Transp, Food/Bev (75.2% of basket). DECEL: Med Care (6.9% of basket). UNCH: Recreation, Comm/Ed, Other
  • OER was unch…rise in Housing came from primary rents (that is, you actually pay rent) and lodging away from home.
  • Core goods inflation stayed stable at +0.7% y/y; core services stable at +2.5%. I think the former number is going to rise.

This was actually something less than the most exciting CPI report in history. It was better than the Street expected, and although the year/year figure barely nudged higher the components of the number were strong. The rise came from Housing, which ought to continue to accelerate for a while given rental tightness and other forward-looking indicators, and Apparel resumed its rise as well. See the chart below (source: Bloomberg) for the update to what is rapidly becoming one of my favorite inflation-related charts.

The Cleveland Fed’s Median CPI dropped just enough to round down to +2.2% on a y/y basis, and the Atlanta Fed’s “Sticky” CPI is also at 2.2%. These measures are other ways to look at the central tendency of the inflation figures, and suggest that the current 2.0% from the traditional Core CPI is likely to converge higher rather than vice-versa.

But today didn’t change any inflation paradigms.

There was other news, however, that struck me as inflation-related and worth commenting on.

One was a story in the UK Daily Mail citing the case of a Denny’s franchisee (he owns a few dozen Denny’s restaurants) who is planning to add a 5% “Obamacare surcharge” to customer dining checks.

Now, the sum of all of the sales of this man’s Denny’s restaurants is a tiny part of the CPI category “Food away from home,” which is itself a small part of CPI, so it won’t have any impact on the numbers. Even if lots of restaurants followed suit, it wouldn’t have much of an impact since “Food away from home” is only 5.6% of the consumption basket (so a 5% surcharge on all checks would cause a rise in CPI of 0.28%), but it serves as a good reminder of one important point.

The higher taxes and other costs of doing business that are going to be targeted at business is going to show itself to individuals one way or the other. The higher cost of Obamacare compliance, and any other increased business taxes, will not be paid by businesses for the simple reason that businesses are pass-through entities. That is, businesses don’t make money; people who own businesses (partners or shareholders) make money. So whether the higher costs show up as higher prices to the consumer (in which case the government’s attempt to raise revenue from business will result in higher inflation prints, as the transition takes place) or as lower profits to the businesses themselves, the cost will end up being borne by real humans.

At the end of the day, how much of these costs is absorbed by the owners and how much is paid by the consumers is determined by the elasticity of supply and demand for the product. For example, if the elasticity of demand is infinite, then the owners will bear the entire cost; if the elasticity is zero, then consumers will pay it all. My personal guess is that given the current level of gross margins, more of these taxes and higher costs will be paid by owners – implying lower equity earnings – than by consumers, but we will see. But notice that either way, you get lower real earnings. Either nominal earnings fall, or prices rise. Not good for stocks in either case; bad for bonds in the latter case, too.

Then there are the actions of several central banks in the other hemisphere. A story in the Wall Street Journal,  and echoed elsewhere such as in this Australian news outlet, suggests that the Reserve Bank of Australia has adopted a form of QE by allowing its foreign currency reserves to rise in order to push down the currency. The RBA has been one of the bastions, at least relatively, of ‘hard money’ in a world of central banks that have gone wild, so this isn’t a positive development unless you’re long inflation-related assets.

And also hard to miss were the comments by the leader of Japan’s main opposition party, Shinzo Abe, who may become the next prime minister quite soon. Abe suggested that the Bank of Japan should target 3% inflation, rather than 1% inflation, and threatened to revise the law that (supposedly) insulates the BOJ from politics.  Note that 5-year Japanese inflation swaps are near all-time highs, but still only at 0.77%, and 10-year inflation swaps are at only 0.48%. Under Abe’s pressure, we would likely see a substantial acceleration in QE by the BOJ, which has already succeeded in pushing core inflation in Japan from -1.6% to -0.6% over the last two years (see chart, source Bloomberg).

We are increasingly moving into a one-way street for central bank policy. Central bankers are essentially engaging in a sophisticated version of competitive devaluations. The Fed does QE, the BOE does QE, the ECB does QE (but claims it doesn’t), the SNB and BOJ and now the RBA does QE. It is a one-way street because whoever stops printing first will see his currency shoot higher as investors flock to the harder currency. The chart below shows what has happened to the Aussie dollar over the last decade versus the USD. While the strengthening trend was interrupted by the 2008 flight-to-quality, it quickly resumed. Since that time, it has risen roughly 50% (and 100% overall since 2001).

Now, a strong currency is good. It makes foreign goods cheaper and raises the standard of living overall. However, it also hurts exports, which slows the economy and results in visible layoffs while the economy adjusts. There’s only so much of this a country’s politicians are willing to take, and it seems Australia may have reached its limit.

If everyone is printing, exchange rates may not move at all. It has frustrated many dollar bears that the greenback hasn’t declined under the profligate printer Bernanke; printing money is supposed to destroy a currency. It has done so repeatedly over the course of history, and it happens for obvious reasons: when you get a bumper crop of something, its price tends to fall. More supply induces lower prices. In this case, it induces a lower price of a currency unit in terms of other currency units.

But that only happens if the relative supply of a currency is changing. If everyone is printing at roughly the same pace, there is no reason that currencies should move at all relative to each other. They should all fall relative to non-printers, or to hard assets. And that’s why it’s even more incredible that commodities are not shooting higher. Yet.

Those effects, in my view, absolutely swamp in importance the weak growth news we’re getting these days. Today, the Philly Fed report and Initial Claims were both quite weak, but the data is going to be polluted by hurricane Sandy for a while and hard to interpret. I don’t think the hurricane had anything to do with this story, or its timing for that matter:

FHA Needs Bailout From Treasury to Plug Budget, Bachus Says

“Nov. 15 (Bloomberg) — The Federal Housing Administration will need billions of dollars in aid from the U.S. Treasury before the end of the year to fill a financial hole caused by defaults on mortgages it insures, House Financial Services Committee Chairman Spencer Bachus said today.

“… The agency is “burning through” its last $600 million and FHA officials have briefed him that they will need a financial backstop within a month, the Alabama Republican said during a press conference in Washington.”

So, we are trying to figure out how to raise a trillion dollars over ten years to start closing the budget gap, but it helps to remember that there are other groups who are going to be bellying up to the bar for a hit of government help. The FHA, the postal service (-$15.9bln this year, although they expect to lose only $7bln next year), probably California before long. We’d better get our act together quickly…but as yet, there is no sign of it. Nice of Bachus to wait until less than a month before the FHA runs out of money to mention this, by the way.

And I haven’t even mentioned the sudden explosion of violence in Israel, which doesn’t give the impression of a fire that will quickly burn out. It may not spin out of control, either, but it bears watching very closely since our influence in the region has significantly ebbed since the change of control in Egypt, our exit from Iraq, and our distancing from Israel.

I don’t think 2013 is shaping up to be a very fun year. But we’re not there yet!

A Summary Of My Post-CPI Tweets

October 16, 2012 Leave a comment

This is a summary of my Post-CPI tweets today. You can follow me @inflation_guy.

  • Core CPI +0.146%, just barely missing the soft +0.2% people were looking for. But y/y still rose to 2.0%.
  • that dip in core is over – next several months have easy year-ago comps.
  • Services inflation +0.3%, as is Housing. It’s only core commodities that’s a drag now (+0.0% after -0.1% last month).
  • Rents (both primary and OER) rose +0.2% and the y/y rise matches core inflation at 2.1%. The inflation-sapping bust is over.
  • unrounded y/y core CPI: 1.988%.
  • Y/Y core services inflation is 2.5%. Y/Y core goods is +0.7%. It was services that dragged core down in 2009-10. That’s over. [Note: see Chart, source BLS, below]
  • accelerating subgroups: Housing, Apparel, Transport, Recreation (66.2%). Decelerating: Food&Bev, Other (20.2%). Med Care & Educ/Comm unch.
  • Both primary rents (+2.7% y/y) and OER (+2.1% y/y) are accelerating – by which I mean they are inflating at a faster y/y pace.
  • Median CPI from the Cleveland Fed was +0.2%, and the y/y rate steady at 2.3%. The recent disinflation is an illusion.

The first supplementary chart is for core goods and core services. The sum of these two (weighted, of course) is core CPI. As you can see, it was the decline in the core services component (notably housing) that drove the decline in core CPI in the late ‘Aughts; the overall core number was temporarily kept afloat by the rise in core goods, but the crisis caused that to collapse as well.

Over the last couple of years, core services have returned to 2.5%, and core inflation is only as low as 2% now because core goods prices have begun to decline again. However, taking a broader view, it appears to me that the disinflation in goods from the early 90s to the early 00s is over and that goods prices are gradually taking a higher track. I’ve written previously about the possibility that the “globalization dividend” in terms of disinflationary pressures has shown some signs of ebbing. Obviously, should core goods inflation return to the levels it achieved a year ago (2.2% in November and December), overall core inflation would be comfortably above 2% even if core services inflation did not continue to accelerate.

In a non-CPI related note, New York Fed President Bill Dudley said today that the Fed won’t be “hasty” to pull back easy money: “If we were to see some good news on growth I would not expect us to respond in a hasty manner.” This confirms what we already knew – the Fed is willing to risk letting the inflation genie out of the bottle. Now, faster growth is not actually causal of inflation, as I frequently point out, so not responding to growth is ironically the right strategy, but it’s important to consider the reasons he gives for this policy. He is not saying that the Fed will not respond to growth because growth is not something they can affect; what he’s actually saying is that (since the Fed believes they can affect growth meaningfully) there is a very high hurdle to tightening even if prices accelerate somewhat further as long as growth remains slow.

So in what I think is the most likely case, continued slow growth with rising inflation, the Fed wouldn’t likely start to tighten the screws until core inflation was near 3% (and more importantly, until the economists who are modeling inflation as a function of growth decide they’re wrong, and stop forecasting a decline from whatever level we are at today). Since there is a significant delay of at least 6 months from Fed action to any effect on prices, this means that core inflation could easily get comfortably above 3% before any Fed action took effect – and, with the amount of money they’d need to withdraw, and the likelihood that they would start timidly, I have no idea how long it would take for them to stop an inflationary process which, at that point, would have considerable momentum.

So, in summary, this will not be the last uptick we see in core inflation.

CPI: Summary Of My Tweets

May 15, 2012 2 comments
Tweets from @inflation_guy on the CPI release, and added detail:
  • Core CPI was +0.24%, barely missing an +0.3% print (interestingly, Bloomberg no longer calculates beyond the 1st decimal).
  • Y/Y core 2.31%, which is “as expected”…except that economists were looking for a round UP to 2.3%.
  • Core ex-housing is no longer as important as it was…since housing is close to fair now…but it’s 2.36% y/y.
  • …that’s actually the highest Core CPI y/y print yet. We’ve had 2.3%, 2.2%, 2.3% and 2.3%, but the first two 2.3% were up-rounders.
  • …and means 17 of last 18 months we’ve seen y/y core CPI increase.
  • Accelerating groups: Apparel, Educ/Comm, Other (15.4%). Decelerating: Food/Bev, Transport, Recreation (37.4%). Unch: Med Care, Housing

The hurdle next month to push year-on-year core CPI higher for the 18th of the last 19th months is challenging. In May 2011, core CPI threw the highest print since 2008: +0.252% (rounded to +0.3%). That being said, this month’s print was the third-highest since 2008, so it’s not a complete reach.

Some observers will focus on the last 3 months of core CPI, which were +0.098%, +0.230%, and +0.242%, projecting to a relatively-calming 2.3% annualized – which is what it appears we’ve done, stabilize right on the Fed’s target. But it appears the February number was the aberration. Annualizing the last four months would give us 2.4% (January’s change was +0.218%), and annualizing just these last two months gives us 2.8%. I don’t recommend playing around too much with annualization, but I point this out because popular opinion will try and pretend the +0.098% was wasn’t an outlier.

Another way you can get a sense for the acceleration of inflation, and the easy potential for further inflation, is to look at the median monthly print and annualize. (This isn’t the same as the Cleveland Fed’s “Median CPI” - that indicator is looking at the median one-month change of all of the goods and services prices collected by the BLS.) What I am doing in the chart below is looking at the median month-on-month print from the last 12 monthly releases, and annualizing that figure. You can see that the number no longer looks like it has leveled off.

What that suggests is that the recent failure of inflation to continue rising on a year-on-year basis is due to the low prints that are “tail events” on the downside, and not because the overall process of inflation has somehow been magically arrested at the Fed’s target.

Inflation: As ‘Contained’ As An Arrow From A Bow

February 17, 2012 5 comments

Is 15 months in a row of rising core inflation ‘contained?’

Year-on-year core CPI has now risen for 15 consecutive months. At some point, it will seem reasonable to let it have a month off, but until now it hasn’t needed it. Fifteen months in a row. That’s impressive. It’s so impressive, in fact, that it hasn’t happened since 1973-1974, when prices were catching up from the failed experiment of price controls imposed by President Nixon in 1971-73. Core inflation has never, in the history of the data (which exists since 1957), accelerated for 16 consecutive months. So, next month we have a chance for a record!

Headline inflation was softer-than-expected by 0.1%, even as the NSA CPI index itself came in higher-than-expected. As I pointed out yesterday,  that was a semi-predictable consequence of the change to new seasonal adjustment factors. Core inflation was 0.218% month-on-month, however, which actually generated a rise in the rounded year-on-year index to 2.3% (2.277% to three decimal places). The table below shows the evolution of the year-on-year changes for the eight major subgroups from 6 months ago to 3 months ago to last month, to now.

Weights y/y change prev y/y change 3m y/y chg 6m y/y chg
 All items

100.0%

2.925%

2.962%

3.525%

3.629%

  Food and beverages

15.0%

4.212%

4.452%

4.470%

4.001%

  Housing

40.2%

1.876%

1.874%

1.869%

1.453%

  Apparel

3.5%

4.664%

4.573%

4.194%

3.056%

  Transportation

16.5%

4.961%

5.197%

9.185%

11.980%

  Medical care

6.9%

3.605%

3.491%

3.116%

3.199%

  Recreation

5.9%

1.372%

1.027%

0.253%

-0.173%

  Education and communication

6.7%

1.838%

1.670%

1.371%

0.982%

  Other goods and services

5.3%

1.740%

1.701%

1.660%

0.847%

Compared to last month, Apparel, Medical Care, Recreation, and Education/Communication accelerated, groups which total 23% of the consumption basket. Transportation and Food & Beverages both decelerated, and they total 31.5% of the basket. Now, notice that Transportation and Food & Beverages are the two groups that are most affected by direct commodity costs – energy and food, respectively. So…don’t get too excited by the deceleration there, although new and used motor vehicles and other components of Transportation also decelerated and that doesn’t have much to do with energy prices. In Food & Beverages, “Food at home” is decelerating (about 57% of the Food & beverages category) while “Food away from home” and “Alcoholic beverages” (the balance of the category) are accelerating.

Yes, you can get eyestrain looking too closely at these figures, but doing so does help.

For example, one theme I think the Fed is counting on is that the “Housing” component of CPI is expected to decelerate due to the still-high inventory of unsold homes and the fact that foreclosure sales can now proceed. It has been a conundrum why rents have been rising while home prices stagnate (actually, not much of a conundrum: there is an underlying inflation dynamic that in the case of the housing-asset market is being overwhelmed by a decline in multiples. But this is a conundrum to the Fed, and to be fair I also expected Housing inflation to be lower than it has been recently). And in this month’s data, you can see that the year-on-year increase in Housing CPI flattened out. But, as the table below shows, the Shelter component wasn’t what flattened out. Housing only went sideways because the “Fuels and Utilities” component declined – again, a commodity effect.

Weights y/y change prev y/y change 3m y/y chg 6m y/y chg
  Housing

40.2%

1.876%

1.874%

1.869%

1.453%

   Shelter

30.92%

1.983%

1.905%

1.792%

1.399%

   Fuels and utilities

5.27%

1.941%

2.432%

3.483%

3.201%

   Household furnishings and operations

4.03%

1.035%

1.000%

0.561%

-0.224%

I still expect Housing inflation to level out and probably to decline, but so far those expectations have been dashed. It will be uncomfortable for the Fed if it remains this way; a significant part of their expectations for a visually-contained core inflation number is (mathematically) due to the expectation that housing inflation isn’t going to keep rising. As you can see in the chart below (Source: Enduring Investments http://www.enduringinvestments.com), the rest of core inflation outside of Shelter is continuing to rise. Inflation is not ‘contained’, except maybe for housing. Maybe.

I am fairly confident, though, that if Housing inflation does not decelerate as expected, then the Fed will find some other reason to ignore the very clear acceleration in inflation. The economists at the FRB are for the most part true believers in the notion that the output gap constrains any possible acceleration in inflation, despite ample evidence that output gaps don’t matter (or, anyway, matter far less than monetary variables). For another view of this proposition, see the Chart below, taken from this article by economist John Cochrane.

Fed economists also feel strongly that “well-anchored inflation expectations” means that they can ignore 15-month trends in core inflation, despite the fact that by Chairman Bernanke’s own admission we aren’t really very good at measuring inflation expectations (to be kind).

They have time. The Fed has recently begun to treat 2% (on core PCE, not core CPI) as more of a floor than a target, so it will be some months, even if core inflation doesn’t pause for a month or two pretty soon, before the Committee starts getting at all warm under the collar about inflation. Even then, they are extremely unlikely to take steps to reduce liquidity while Unemployment remains high. The Fed is in a political bind, and the only easy path for them is to “see no evil” on inflation while hoping that Unemployment drops swiftly enough for them to act before prices really get out of hand. We will see.

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