Summary of My Post-CPI Tweets

January 18, 2017 Leave a comment

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy or sign up for email updates to my occasional articles here. Investors with interests in this area be sure to stop by Enduring Investments. Plus…buy my book about money and inflation, published in March 2016. The title of the book is What’s Wrong with Money? The Biggest Bubble of All; order from Amazon here.

  • Last CPI of 2016…fire it up!
  • Core +0.23%, a bit higher than expected. Market was looking for 0.16% or so.
  • y/y core CPI rises to 2.21%. The core print was the second highest since last Feb.
  • For a change, the BLS has the full data files posted so brb with more analysis. Housing subcomponent jumped, looking now.
  • Just saw this. Pretty cool. Our calculator https://www.enduringinvestments.com/calculators/cpi.php … pretty cool too but not updated instantly.
    • BLS-Labor Statistics @BLS_gov: See our interactive graphics on today’s new Consumer Price Index data http://go.usa.gov/x9mMG #CPI #BLSdata #DataViz
  • As I said, housing rose to 3.04% from 2.90% y/y. Primary Rents jumped to 3.96% from 3.88%; OER 3.57% from 3.54%.
  • Household energy was also higher, so some of the housing jump was actually energy. But the rise in primary rents matters.
  • Will come back to that. Apparel y/y slipped back into deflation (dollar effect). Recreation and Education steady. “Other” up a bit.
  • In Medical Care, 4.07% vs 3.98%. That had recently retraced a bit but back on the + side. Drugs, Prof. Svcs, and Hospital Svcs all +
  • Medicinal drugs. Not a new high but maybe the retracement is done.

drugs

  • Core services up to 3.1% from 3.0%; core goods -0.6% vs -0.7%.
  • That’s consistent with our view: stronger USD will keep core goods in or near deflation but it shouldn’t get much worse.
  • The dollar is just not going to cause core deflation in the US. Import/export sector is too small.
  • Core ex-housing rose to 1.20% from 1.12%. Still not exactly alarming!
  • Not from this report, but wages are worrying people and here’s why:

atlfedwages

  • However, wages tend to follow inflation, not lead it. I always add that caveat. But it matters for Fed reaction function.
  • Next few months are the challenge for renewed upward swing in core CPI – Jan and Feb 2016 were both high and drop out of the y/y.

corecpi

  • Early guess at Median CPI, which I think is a better measure of inflation…my back of envelope is 0.24% m/m, 2.61% y/y…new high.
  • CPI in 4 pieces. #1 Food & Energy (about 21%)

fande

  • CPI in 4 pieces. #2 Core Goods (about 20%)

coregoods

  • CPI in 4 pieces. #3 Core Services less Rent of Shelter (about 27%)

coresvcslessros

  • CPI in 4 pieces. #4 Rent of Shelter (about 33%)

ros

  • This is why people are worried re’ inflation AND why people dismiss it. “It’s just housing.” Yeh, but that’s the persistent part.
  • Scary part about rents is that it’s accelerating even above our model, and we have been among the more aggressive forecast.
  • OK, that’s all for this morning. Anyone going to the Inside ETFs conference next week? Look me up.

We end 2016 with the outlook in limbo, at least looking at these charts – unless January and February print 0.3% on core inflation, core CPI will be hanging around 2% for at least the next few months. Median inflation is more worrisome, as it will probably hit a new high when it is reported later today, but it doesn’t get the ink that core CPI or core PCE gets.

To my mind, the underlying trends are still very supportive of a cyclical (secular??) upswing in core inflation. Here’s a summary of two of the pieces that people care about a lot. Housing is much bigger, but slower; Medical Care is more responsive, but smaller.

lastchart

I suspect that chart is enough to keep most consumers jittery with respect to inflation, but as long as retail gasoline prices stay below $3/gallon there won’t be much of an outcry. But that doesn’t matter. M2 money growth accelerated throughout 2016 as the economy improved, and ended the year at 7.6% y/y. Interest rates are rising, which will help push money velocity higher. It’s hard to see how that turns into a disinflationary outcome.

Categories: CPI, Tweet Summary

The Yield Curve is Critical of Fed Credibility

I was planning to write an article today about the shape of the yield curve. Since the Global Financial Crisis, the Treasury curve has been very steep – in early 2010 the 2y/10y spread reached almost 300bps, which is not only unprecedented in absolute terms but especially in relative terms: a 300bp spread when 2-year yields are below 1% is much more significant than a 300bp spread when 2-year yields are at 10%.

2s10s

But what I had planned to write about was the phenomenon – well-known when I was a cub interest-rate strategist – that the yield curve steepens in rallies and flattens in selloffs. The chart below shows this tendency. The 5-year yield is on the left axis and inverted high-to-low. The 2y/10y spread is on the right axis. Note that there is substantial co-movement for the recession of the early 1990s, throughout the ensuing expansion (albeit with a general drift to lower yields), in the recession of the early 2000s, the ensuing expansion, and the lead-up to the GFC.

and5yyields

I was ready to point out that the steepening and flattening trends tend to be steady, and I was going to illustrate that they feed on themselves partly for this technical reason: that when the curve is steep, steepening trades (selling 10-year notes and buying duration-weighted 2-year notes, financing both in repo) tend to be positive carry and therefore easier to maintain, while on the other hand when the curve is flat the opposite tends to be true. So the actual causality of the relationship between steepening and rallies is more complex than it seems at first blush.

It would have made a very good article, but then I noticed that since 2010 or so the tendency has in fact reversed!

Specifically, from 1987-1995 the correlation of the level of the 5-year spread to the level of the 2s/10s spread was -0.78. From 1995-1999, the correlation flipped to +0.48 (but I didn’t bother to de-trend the data and I suspect that correlation stems more from the strong, 350bp decline in interest rates from 1995-1999). From 1999-2009, the correlation was -0.81. Since 2010, the correlation is +0.60: the curve has tended to flatten in rallies and steepen in selloffs. And, in the recent bond market selloff, the curve steepened as long rates rose further than short rates.

This is interesting. Clearly, carry dynamics cannot explain why the relationship is inverted. I think the answer, though, is this: since 2010, the overnight has been anchored. That isn’t different than in the past – from late 1992 to early 1994, the Fed funds target was anchored at 3%. But the difference is that back then, traders acted as if the Fed might eventually move the overnight rate in a meaningful way. Since 2010, investors and traders have attributed no credibility to the Fed, with virtually no chance of a substantial move over a short period of time. Accordingly, while short interest rates historically have tended to be the tail wagging the dog, while longer-term interest rates move around less as investors assume the Fed will remain ahead of the curve and keep longer-term inflation and interest rates in a reasonable range…in the current case, short term rates don’t move while longer-term rates reflect the market belief that rates will eventually reach an equilibrium but over a much longer period than 2 years as the Federal Reserve is dragged kicking and screaming.

I happen to agree, but it isn’t a great sign. I suppose it was destined, in a way – “open mouth” operations can only work in the long run if the Fed is credible, and the Fed can only be credible in the long run if it delivers on its promises. But it hasn’t. This is probably because the Fed’s forecast have been worse than abysmal, meaning its promises were based on bad forecasts. In such a case, changing one’s mind when the data changes is the right thing to do. But even more important, if your forecasts are frequently wrong, is to shut up and stop trying to move markets where you want them with “open mouth” operations. I have said it for 20 years: the worst thing Greenspan ever did was to make “transparency” a goal of the Fed. They’re just not good enough at what they do to make their activities transparent…at least, if they want to maintain credibility.

* * *

Administrative Note: On Monday I will be conducting the third and final in a series of webinars on inflation and inflation investing. This series will be done on the Shindig platform, sponsored by Enduring Investments, in cooperation with Investing.com. This webinar is on “Inflation-Aware Investing.” You can sign up directly with Shindig here, or find the webinar link at Investing.com.

A (Very) Long History of Real Interest Rates

December 23, 2016 2 comments

One of the problems that inflation folks have is that the historical data series for many of the assets we use in our craft are fairly short, low-quality, or difficult to obtain. Anything in real estate is difficult: farmland, timber, commercial real estate. Even many commodities futures only go back to the early 1980s. But the really frustrating absence is the lack of a good history of real interest rates (interest rates on inflation-linked bonds). The UK has had inflation-linked bonds since the early 1980s, but the US didn’t launch TIPS until 1997 and most other issuers of ILBs started well after that.

This isn’t just a problem for asset-allocation studies, although it is that. The lack of a good history of real interest rates is problematic to economists and financial theoreticians as well. These practitioners have been forced to use sub-optimal “solutions” instead. One popular method of creating a past history of “real interest rates” is to use a nominal interest rate and adjust it by current inflation. This is obvious nonsense. A 10-year nominal interest rate consists of 10-year real interest rates and 10-year forward inflation expectations. The assumption – usually explicit in studies of this kind – is that “investors assume the next ten years of inflation will be the same as the most-recent year’s inflation.”

We now have plenty of data to prove that isn’t how expectations work – and, not to mention, a complete curve of real interest rates given by TIPS yields – but it is still a popular way for lazy economists to talk about real rates. Here is what the historical record looks like if you take 10-year Treasury rates and deflate them by trailing 1-year inflation:

dumbrealThis is ridiculously implausible volatility for 10-year real rates, and a range that is unreasonable. Sure, nominal rates were very high in the early 1980s, but 10%? And can it be that real rates – the cost of 10-year money, adjusted for forward inflation expectations – were -4.6% in 1980 and +9.6% in 1984? This hypothetical history is clearly so unlikely as to be useless.

In 2000, Jay Shanken and S.P. Kothari wrote a paper called “Asset Allocation with Conventional and Indexed Bonds.” To make this paper possible, they had to back-fill returns from hypothetical inflation-linked bonds. Their method was better than the method mentioned above, but still produced an unreasonably volatile stream. The chart below shows a series, in red, that is derived from their series of hypothetical annual real returns on 5-year inflation-indexed bonds, and backing into the real yields implied by those returns. I have narrowed the historical range to focus better on the range of dates in the Shanken/Kothari paper.

skreal

You can see the volatility of the real yield series is much more reasonable, but still produces a very high spike in the early 1980s.

The key to deriving a smarter real yield series lies in this spike in the early 1980s. We need to understand that what drives very high nominal yields, such as we had at that time in the world, is not real yields. Since the real yield is essentially the real cost of money it should not ever be much higher than real potential economic growth. Very high nominal yields are, rather, driven by high inflation expectations. If we look at the UK experience, we can see from bona fide inflation-linked bonds that in the early 1980s real yields were not 10%, but actually under 5% despite those very high nominal yields. Conversely, very low interest rates tend to be caused by very pessimistic real growth outcomes, while inflation expectations behave as if there is some kind of floor.

We at Enduring Investments developed some time ago a model that describes realistically how real yields evolve given nominal yields. We discovered that this model fits not only the UK experience, but every developed country that has inflation-linked bonds. Moreover, it accurately predicted how real yields would behave when nominal yields fell below 2% as they did in 2012…even though yields like that were entirely out-of-sample when we developed the model. I can’t describe the model in great detail because the method is proprietary and is used in some of our investment approaches. But here is a chart of the Enduring Investments real yield series, with the “classic” series in blue and the “Shanken/Kothari” series in red:

endreal

This series has a much more reasonable relationship to the interest rate cycle and to nominal interest rates specifically. Incidentally, when I sat down to write this article I hadn’t ever looked at our series calculated that far back before, and hadn’t noticed that it actually fits a sine curve very well. Here is the same series, with a sine wave overlaid. (The wave has a frequency of 38 years and an amplitude of 2.9% – I mention this for the cycle theorists.)

endrealsine

This briefly excited me, but I stress briefly. It’s interesting but merely coincidental. When we extend this back to 1871 (using Shiller data) there is still a cycle but the amplitude is different.

endreallong

So what is the implication of this chart? There is nothing predictive here; about all that we can (reasonably) say is what we already knew: real yields are not just low, but historically low. (Current 10-year TIPS yields are higher than our model expects them to be, but not by as much as they were earlier this  year thanks to a furious rally in breakevens.) Money is historically cheap – again, we knew this – in a way it hasn’t been since the War effort when nominal interest rates were fixed by the Fed even though wartime inflation caused expectations to rise. With real yields that low, how did the war effort get funded? Who in the world lent money at negative real interest rates like banks awash in cash do today?

That’s right…patriots.

1986-004-223Frankly, that makes a lot more sense than the reason we have low real interest rates today!

Categories: Good One, Investing, Theory, TIPS

Add Another Uncomfortable First for Stocks

December 15, 2016 1 comment

It hasn’t happened yet, but it is about to.

Not since just before the financial crisis has the expected 10-year real return from stocks been below the 10-year TIPS yield. But with TIPS selling off and stocks rallying, the numbers are virtually the same: both stocks, and TIPS, have an expected real return of about 0.70% per annum for the next 10 years.

A quick word about my method is appropriate because some analysts will consider this spread to already be negative. I use a method similar to that used by Arnott, Grantham, and other well-known ‘value’ investors: I add the dividend yield for equities to an estimate of long-run real economic growth, and then assume that cyclical multiples pull two-thirds of the way back to the long-run value, over ten years. (By comparison, Grantham assumes that multiples fully mean-revert, over seven years, so he will see stocks as even more expensive than I do – but the important point is that the method doesn’t change over time).

Somewhat trickier is the calculation of 10-year real yields before 1997, when TIPS were first issued. But we have a way to do that as well – a method much better than the old-fashioned approach of taking current ten-year yields and subtracting trailing 1-year inflation (used by many notables, including such names as Fama). That only matters because the chart I am about to show goes back to 1956, and so I know someone would ask where I got 10 year real yields prior to 1997.

The chart below (Source: Enduring Investments) shows the “real equity premium” – the expected real return of stocks, compared to the true risk-free asset at a 10-year horizon: 10-year TIPS.

realequityprem

The good news is that in this sense, stocks are not as expensive relatively as they were in the late 1990s, nor as expensive (although much closer) relatively as they were prior to the global financial crisis. Nor even as they were (although even closer) just prior to the 1987 stock market crash. Yay.

The bad news is that they are every bit as expensive as they were in early 1973, just before the ten-year bear market that was, in real terms, every bit as bad as the 2000-2009 bear market. From 1973 to mid-1982, stocks lost roughly 60% of their value in real terms – just about what they lost in real terms between 2000 and 2009. The chart below (Source: Bloomberg) shows the S&P 500 divided by CPI, on a log scale so you can see the similar percentage moves.

realsp

The parallels with 1999 don’t scare me. There isn’t the same exuberance over companies with no earnings[1] and “new world” “new paradigm” chatterings. But the parallels with the late 1960s/early 1970s frighten me quite a bit more. The hippies are out protesting, and everything! The interest rate cycle in 1973 had already long-since bottomed, as had core inflation – although in 1972 and 1973 inflation had actually come back down from the Vietnam War-induced bump of the late 1960s. In 2016, we also face an interest rate cycle that has turned, and core inflation that bottomed more than six years ago. In 1973, a Republican President had just been (re-)elected and stocks rallied into the inauguration. And that, my friends, was that. Poor central bank policy – encouraged by a certain Chairman of the Council of Economic Advisers named Alan Greenspan – ensured that even when stocks bottomed in nominal terms in 1974, they continued to lose value to accelerating inflationary dynamics.

I could go on, but these are merely my own qualms. The quantitative fact, and not the story, is what matters: stocks now no longer offer an expectation of return in excess of the risk-free return. They may keep rallying for years since the US dollar is the high-yielding currency and money needs to go somewhere, but we are into the realm of speculative finance. For a while, the argument for stocks was “sure, they’re expensive, but with yields this low they are still relatively better.” They’re no longer even relatively better.

[1] With the exception of Tesla.

Categories: Stock Market, TIPS

Not So Fast on the Trump Bull Market

December 1, 2016 4 comments

**NOTE – please see the announcement at the end of this article, regarding a series of free webinars that begins next Monday.**


Whatever else the election of Donald Trump to be President of the United States has meant, it has meant a lot of excitement in precincts that worry about inflation. This is usually attributed, among the chattering classes, to the faster growth expected if Mr. Trump’s expressed preference for tax cuts and spending increases obtains. However, since growth doesn’t cause inflation that isn’t the part of a Trump Presidency that concerns me with respect to a continuing rise in inflation.

In our latest Quarterly Inflation Outlook, I wrote a short piece on the significance of the de-globalization movement for inflation. That is an area where, if the President-Elect delivers on his promises, a lot of damage could be done in the growth/inflation tradeoff. I have written before about how a big part of the reason for the generous growth/inflation tradeoff of the 1990s was the rapid globalization of many industries following the end of the Cold War. Deutsche Bank recently produced a research piece (I don’t recall whether it had anything to do with inflation, weirdly) that contained the following chart (Source: as cited).

freetradeagreementsperyearThis chart is the “smoking gun” that supports this version of events, in terms of why the inflation dynamic shifted in the early 1990s. Free trade helped to restrain prices in certain goods (apparel is a great example – prices are essentially unchanged over the last 25 years), by allowing the possibility of significant cost savings on production.

The flip side of a cost savings on production, though, is a loss of domestic manufacturing jobs; it is this loss that Mr. Trump took productive advantage of. If Mr. Trump moves to increase tariffs and other barriers to trade, and to reverse some of the globalization trend that has driven lower prices for the last quarter-century, it is potentially very negative news for inflation. While there was some evidence that the globalization dividend was beginning to get ‘tapped out’ as all of the low-hanging fruit had been harvested – and such a development would cause inflation to be higher than otherwise it would have been – I had not expected the possibility of a reversal of the globalization dividend except as a possible and minor side-effect of tensions with Russia over the Ukraine, or the effect the Syrian refugee problem could have on open borders. The election of Mr. Trump, however, creates the very real possibility that the reversal of this dividend might be a direct consequence of conscious policy choices.

I don’t think that’s the main reason that people are worried about inflation, though. Today, one contributor is the news that OPEC actually agreed to cut production, in January, and that some non-OPEC producers agreed to an additional cut. U.S. shale oil producers are clicking their heels in delight, because oil prices were already high enough that production was increasing again and they are more than happy to take more market share back. Oil prices are up about 15% since the announcement.

But that’s near-term, and I don’t expect the oil rally has legs much beyond current levels. Breakevens have been rallying, though, for weeks. Some of it isn’t related to Trump at all but to other initiatives. One correspondent of mine, who owns an office-cleaning business, sent me this note today:

“Think of you often lately as I’m on the front line out here of the “instant” 25% increase in min wage.  Voters decided to move min wage out here from 8.05 to $10 jan 1.  Anyone close to 10/hr is looking for a big raise.  You want to talk about fast dollars, hand a janitor a 25% pay bump and watch the money move.  Big inflation numbers pending from the southwest.  I’m passing some through but market is understandably reacting slower than the legislation.”

Those increases will definitely increase measured inflation further, though by a lot less than it increases my friend’s costs. Again, it’s an arrow pointing the wrong way for inflation. And, really, there aren’t many pointing the right way. M2 growth continues to accelerate; it is now at 7.8% y/y. That is too fast for price stability, especially as rates rise.

All of these arrows add up to substantial moves in inflation breakevens. 10-year breaks are up 55bps since September and 30bps since the election. Ten-year inflation expectations as measured more accurately by inflation swaps are now at 2.33%. Almost all of that rise has been in expectations for core inflation. The oft-watched 5y5y forward inflation (which takes us away from that part of the curve which is most impacted by energy movements) is above 2.5% again and, while still below the “normal” 2.75%-3.25% range, is at 2-year highs (see Chart, source Bloomberg).

5y5y

So what is an investor to do – other than to study, which there is an excellent opportunity to do for the next three Mondays with a series of educational webinars I am conducting (see details below)? There are a few good answers. At 0.46%, 10-year TIPS still represent a poor real return but a guaranteed positive 1/2% real return beats what is available from many risky assets right now. Commodities remain cheap, although less so. You can invest in a company that specializes in inflation, if you are an accredited investor: Enduring Investments is raising a small amount of money for the management company in a 506(c) offering and is still taking subscriptions. Unfortunately, it is difficult to own inflation expectations directly – and in any event, the easy money there has been made.

What you don’t want to do if you are worried about inflation is own stocks as a “hedge.” Multiples move inversely with inflation.

Unlike prior equity market rallies, I understand this one. It is plausible to me that a very business-friendly President, who cuts corporate and personal taxes and reduces regulatory burdens, might be good for corporate earnings and even for the economic growth rate (although the bad things coming on trade will blunt some of that). But before getting too ebullient about the potential for higher corporate earnings, consider this: if Trump is business-friendly, then surely the opposite must be said about President Obama who did essentially the reverse. But what happened to equities? They tripled over his eight years (perhaps they “only” doubled, depending on when you measure from). That’s because lower interest rates and the Fed’s removal of safe securities in search of a stimulus from the “portfolio balance channel” caused equity multiples to expand drastically. So, valuations went from low, to extremely high. Multiples matter a lot, and right now even if you think corporate earnings over the next four years might be stronger than over the last four you still have to confront the fact that multiples are more likely to move in reverse. In short: if stocks could triple under Obama, there is no reason on earth they can’t halve under a “business-friendly” President. That’s not a prediction. (But here is one: equities four years from now will be no more than 20% higher than they are now, and might well be lower.)

Also, remember Ronald Reagan? He who created the great bull market of the 1980s? Well, stocks rallied in the November he was elected, too. The S&P closed November 1980 at 140.52. Over the next 20 months, the index lost 24%. It wasn’t until almost 1983 before Reagan had a bull market on his hands.


An administrative announcement about upcoming (free!) webinars:

On consecutive Mondays spanning December 5, December 12, and December 19 at 11:00ET, I will be doing a series of one-hour educational seminars on inflation. The first is “How Inflation Works;” the second is “Inflation and Asset Classes;” and the third is “Inflation-aware Investing.” These webinars will also have live Q&A. After each session, a recording will be available on Investing.com.

Each of these webinars is financially sponsored by Enduring Investments.

Who Keeps Selling These Free Options?

November 22, 2016 Leave a comment

It seems that recently I’ve developed a bit of a theme in pointing out situations where the market was pricing one particular outcome so completely that it paid to take the other side even if you didn’t think that was going to be the winning side. The three that spring to mind are: Brexit, Trump, and inflation breakevens.

Why do these opportunities exist? I think partly it is that investors like to be on the “winning side” more than they like ending up with more money than they started. I know that sounds crazy, but we observe it all the time: it is really hard (especially if you are a fund manager that gets paid quarterly) to take losses over and over and over, even if one win in ten tries is all you need to double your money. It’s the “wildcatter” mindset of drilling a bunch of dry holes but making it back on the gusher. It’s how venture capital works. There are all kinds of examples of this behavioral phenomenon. I am sure someone has done the experiment to prove that people prefer many small gains and one large loss to many small losses and one large gain. If they haven’t, they should.

I mention this because we have another one.

December Fed Funds futures settled today at 99.475. Now, Fed funds futures settle to the daily weighted average Fed funds effective for the month (specifically, they settle to 100 minus the average annualized rate). Let’s do the math. The Fed meeting is on December 14th. Let’s assume the Fed tightens from the current 0.25%-0.50% range to 0.50%-0.75%. The overnight Fed funds effective has been trading a teensy bit tight, at 0.41% this month, but otherwise has been pretty close to rock solid right in the middle except for each month-end (see chart, source Bloomberg) so let’s assume it trades in the middle of the 0.50%-0.75% range for the balance of the month, except for December 30th (Friday) and 31st (Saturday), where we expect the rate to slip about 16bps like it did in 2015.

fedl01

So here’s the math for fair value.

14 days at 0.41%  (December 1st -14th)

15 days at 0.625% (December 15th-29th)

2 days at 0.465% (December 30th-31st)

This averages to 0.518%, which means the fair value of the contract if the Fed tightens is 99.482. If the Fed does not tighten, then the fair value is about 99.60. So if you buy the contract at 99.475, you’re risking…well, nothing, because you’d expect it to settle higher even if the Fed tightens. And your upside is 12.5bps. This is why Bloomberg says the market probability of a 25bp hike in rates is now 100% (see chart, source Bloomberg).

fedprob

There is in fact some risk, because theoretically the Fed could tighten 50bps or 100bps. Or 1000bps. Actually, those are all probably about equally likely. And it is possible the “turn” could trade tight, rather than loose. If the turn traded at 1%, the fair value if the Fed tightened would be 99.448. So it isn’t a riskless trade.

But we come back to the same story – it doesn’t matter if you think the Fed is almost certainly going to tighten on December 14th. Unless you think there’s a chance they go 50bps or that overnight funds start trading significantly higher before the meeting, you’re supposed to be long December Fed funds futures at 99.475.

The title of this post is a question, because remember – for everyone who is buying this option at zero (or negative) there’s someone selling it too. This isn’t happening on zero volume: 7207 contracts changed hands today. That seems weird to me, until I remember that it has been happening a lot lately. Someone is losing a lot of money. What is this, Brewster’s Millions?

*

An administrative announcement about upcoming (free!) webinars:

On consecutive Mondays spanning December 5, December 12, and December 19 at 11:00ET, I will be doing a series of one-hour educational seminars on inflation. The first is “How Inflation Works;” the second is “Inflation and Asset Classes;” and the third is “Inflation-aware Investing.” These webinars will also have live Q&A. After each session, a recording will be available on Investing.com.

Each of these webinars is financially sponsored by Enduring Investments.

Summary of My Post-CPI Tweets

November 17, 2016 Leave a comment

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy or sign up for email updates to my occasional articles here. Investors with interests in this area be sure to stop by Enduring Investments. Plus…buy my book about money and inflation, published in March 2016. The title of the book is What’s Wrong with Money? The Biggest Bubble of All; order from Amazon here.

  • CPI consensus is for a “soft” 0.2% on core. With 2 of the last 3 months quite low for one-off reasons, I am a little skeptical.
  • Rolling off an 0.196% m/m core from Oct 2015. Need about 0.23% to get y/y to tick back up to 2.3% on core.
  • Wow, 0.1% m/m on core and y/y goes DOWN to 2.1%! But not as impressive as that. To 3 decimals it’s 0.149% and 2.144%. Still, soft.
  • The doves just got another bullet.
  • Component breakdown very slow coming in….bls hasn’t posted data yet.
  • The overall number doesn’t mean much without the breakdown…still waiting on BLS.
  • Well, this is anticlimactic. BLS just not putting up the data. No data, no analysis.
  • Looks like a sharp fall m/m in some medical care commodities, but BLS report itself only gives 1-decimal rounding and no y/y comparisons.
  • BLS a half hour late now. Wonder if they’re all in “safe spaces” today.
  • Well, I see one reason. Apparently the BLS made an error in prescription drugs and actually revised all of the indices back to May.
  • …including the headline NSA figure. That’s an error with huge implications. It means the Tsy made wrong int payments on some TIPS.
  • NSA was 240.236, 241.038, 240.647, 240.853, and 241.428 for May-Sep. Now 240.229, 241.018, 240.628, 240.849, 241.428
  • Market guys telling me Tsy will use the old numbers for TIPS and derivatives. And hey! Look at that. BLS decided to release figures.
  • Gonna be an interesting breakdown actually. Surge in Housing and jump in Apparel, but plunge in Medical Care, Rec, & Communication.
  • Core services 3% from 3.2% y/y, core goods -0.5% from -0.6%.
  • OK! Housing 2.87% from 2.70%. BIG jump. Apparel 0.68% from -0.09%. Medical 4.26% from 4.89%. All big moves.
  • Primary Rents: 3.79% vs 3.70%; Owners’ Equiv Rent 3.45% vs 3.38%. Lodging away from home 4.37% vs 3.73%. All big jumps.
  • In Apparel (@notayesmansecon ), Women’s 0.27% vs -0.35%, but it was 1.57% 3 months ago. Girls tho: 3.06% vs 1.95%, vs -4.73% 3mo ago.
  • In Med Care: Drugs 5.24% vs 5.38% ok. Med Equip -0.79% vs -0.61% ok. Hospital Svcs 4.06% vs 5.64% !, Health Ins 6.93% vs 8.37% !.
  • Median should be about 0.16%, but median category looks like Midwest Urban OER so there’s seasonal adj I am just estimating.
  • That would keep Median at 2.49%, down from 2.54%. But all this looks temporary.
  • Core ex-housing dropped to 1.20%, lowest since last Nov. But it was as low as 0.87% last year.
  • Here is the summary: Rent of Shelter continues to rise, and actually faster than our traditional model. Services ex-Shelter decelerated.
  • Core goods continues to languish. But here’s the thing: Housing is stickier than the rest of Core Services.
  • So unless somehow hospital prices just started to drop, this isn’t as soothing as the headline.
  • That said, this is the most dovish Fed in history. If the market continues to price 90+% chance of hike, they will…but…
  • …but if we get more weak growth figures, the 2-month moderation in inflation will be enough for them to wait one more meeting.
  • Employment numbr is key. Meanwhile, infl is going to keep rising. Housing worries me. Higher wages might keep housing momentum going.
  • Here are the two categories that constitute 50% of CPI. Housing and Medical Care. Not soothing.

50pct

  • Here’s another 30%. Volatile categories we usually look through.

30pct

  • Last 20% of CPI are these 4 categories. They’re the ones to watch. Nothing too worrisome yet.

20pct

  • Here’s the FRED inflation heat map. Yeah, these were all charts that were SUPPOSED to be in my de-brief.

picture1

  • Compare distributions from last month (smaller bar on far left) and this month (bigger bar on far left).

picture2 picture3

  • More negatives, but some of the longest bar shifted higher too. More dispersion overall.

I keep coming back to the housing number. That jump is disturbing, because most folks expected housing to start decelerating. I thought it would level out too (though at a higher level than others felt – roughly where it is now, 3.5% on OER, but it’s showing no signs of fading). Here’s the reason why. It’s a chart of a model of Owners’ Equivalent Rent:

nominalhsng

This nominal model is simply the average of models based on lags of various measures of home prices. We were supposed to level off and decline some time ago…but certainly by now. And so far there’s no sign of that.

Our model is a bit more sophisticated, but if you rely on lags of nominal variables you’re going to get something like this because housing price increases have leveled off (that is, housing prices are still rising, but they’re rising at a constant, and slightly slower, rate than they were).

Now, here’s the worry. All of these models are calibrated during a time when inflation in general was low, so there’s a real chance that we’re not capturing feedback effects. That is to say, when broad inflation rises it pushes wages up faster, and that tends to support a higher level of housing inflation. We have a pretty coarse model of this feedback loop, and the upshot is that if you model housing inflation as a spread compared to overall or core inflation, rather than as a level, you get different dynamics – and dynamics that are more in tune with what seems to be happening to housing inflation. Now, it’s way too early to say that’s what’s happening here, but with housing at our forecast level and still evidently rising, it’s time to start watching.

*

An administrative announcement about upcoming (free!) webinars:

On consecutive Mondays spanning November 28, December 5, and December 12, at 11:00ET, I will be doing a series of one-hour educational seminars on inflation. The first is “How Inflation Works;” the second is “Inflation and Asset Classes;” and the third is “Inflation-aware Investing.” These webinars will also have live Q&A. After each session, a recording will be available on Investing.com.

Each of these webinars is financially sponsored by Enduring Investments.

 

Categories: CPI, Tweet Summary
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