Archive

Author Archive

COVID-19 in China is a Supply Shock to the World

February 25, 2020 2 comments

The reaction of much of the financial media to the virtual shutdown of large swaths of Chinese production has been interesting. The initial reaction, not terribly surprising, was to shrug and say that the COVID-19 virus epidemic would probably not amount to much in the big scheme of things, and therefore no threat to economic growth (or, Heaven forbid, the markets. The mere suggestion that stocks might decline positively gives me the vapors!) Then this chart made the rounds on Friday…

…and suddenly, it seemed that maybe there was something worth being concerned about. Equity markets had a serious slump yesterday, but I’m not here to talk about whether this means it is time to buy TSLA (after all, isn’t it always time to buy Tesla? Or so they say), but to talk about the other common belief and that is that having China shuttered for the better part of a quarter is deflationary. My tweet on the subject was, surprisingly, one of my most-engaging posts in a very long time.

The reason this distinction between “supply shock” and “demand shock” is important is that the effects on prices are very different. The first stylistic depiction below shows a demand shock; the second shows a supply shock. In the first case, demand moves from D to D’ against a stable supply curve S; in the latter case, supply moves from S to S’ against a stable demand curve D.

Note that in both cases, the quantity demanded (Q axis) declines from c to d. Both (negative) demand and supply shocks are negative for growth. However, in the case of a negative demand shock, prices fall from a to b; in the case of a negative supply shock prices rise from a to b.

Of course, in this case there are both demand and supply shocks going on. China is, after all, a huge consumption engine (although a fraction of US consumption). So the growth picture is unambiguous: Chinese growth is going to be seriously impacted by the virtual shutdown of Wuhan and the surrounding province, as well as some ports and lots of other ancillary things that outsiders are not privy to. But what about the price picture? The demand shock is pushing prices down, and the supply shock is pushing them up. Which matters more?

The answer is not so neat and clean, but it is neater and cleaner than you think. Is China’s importance to the global economy more because of its consumption, as a destination for goods and services? Or is it more because of its production, as a source of goods and services? Well, in 2018 (source: Worldbank.org) China’s exports amounted to about $2.5trillion in USD, versus imports of $2.1trillion. So, as a first cut – if China completely vanished from global trade, it would amount to a net $400bln in lost supply. It is a supply shock.

When you look deeper, there is of course more complexity. Of China’s imports, about $239bln is petroleum. So if China vanished from global trade, it would be a demand shock in petroleum of $240bln (about 13mbpd, so huge), but a bigger supply shock on everything else, of $639bln. Again, it is a supply shock, at least ex-energy.

And even deeper, the picture is really interesting and really clear. From the same Worldbank source:

China is a huge net importer of raw goods (a large part of that is energy), roughly flat on intermediate goods, and a huge net exporter of consumer and capital goods. China Inc is an apt name – as a country, she takes in raw goods, processes them, and sells them. So, if China were to suddenly vanish, we would expect to see a major demand shock in raw materials and a major supply shock in finished goods.

The effects naturally vary with the specific product. Some places we might expect to see significant price pressures are in pharmaceuticals, for example, where China is a critical source of active pharmaceutical ingredients and many drugs including about 80% of the US consumption of antibiotics. On the other hand, energy prices are under downward price pressure as are many industrial materials. Since these prices are most immediately visible (they are commodities, after all), it is natural for the knee-jerk reaction of investors to be “this is a demand shock.” Plus, as I said in the tweet, it has been a long time since we have seen a serious supply shock. But after the demand shock in raw goods (and possibly showing in PPI?), do not be surprised to see an impact on the prices of consumer goods especially if China remains shuttered for a long time. Interestingly, the inflation markets are semi-efficiently pricing this. The chart below is the 1-year inflation swap rate, after stripping out the energy effect (source: Enduring Investments). Overall it is too low – core inflation is already well above this level and likely to remain so – but the recent move has been to higher implied core inflation, not lower.

Now, if COVID-19 blossoms into a true global contagion that collapses demand in developed countries – especially in the US – then the answer is different and much more along the lines of a demand shock. But I also think that, even if this global health threat retreats, real damage has been done to the status of China as the world’s supplier. Although it is less sexy, less scary, and slower, de-globalization of trade (for example, the US repatriating pharmaceuticals production to the US, or other manufacturers pulling back supply chains to produce more in the NAFTA bloc) is also a supply shock.

Summary of My Post-CPI Tweets (February 2020)

February 13, 2020 1 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 (updated site coming soon). Plus…buy my book about money and inflation. The title of the book is What’s Wrong with Money? The Biggest Bubble of All; order from Amazon here.

  • Welcome to CPI day! Before we get started, note that at about 9:15ET I will be on @TDANetwork with @OJRenick to discuss the inflation figures etc. Tune in!
  • In leading up to today, let’s first remember that last month we saw a very weak +0.11% on core CPI. The drag didn’t seem to come from any one huge effect, but from a number of smaller effects.
  • The question of whether there was something odd with the holiday selling calendar, or something else, starts to be answered today (although I always admonish not to put TOO much weight on any single economic data point).
  • Consensus expectations call for +0.2% on core, but a downtick in y/y to 2.2% from 2.3%. That’s not wildly pessimistic b/c we are rolling off +0.24% from last January.
  • Next month, we have much easier comparisons on the y/y for a few months, so if we DO drop to 2.2% y/y on core today that will probably be the low for a little while. Feb 2019 was +0.11%, March was +0.15%, April was +0.14%, and May was +0.11%.
  • So this month we are looking to see if we get corrections of any of last month’s weakness. Are they one-offs? We are also going to specifically watch Medical Care, which has started to rise ominously.
  • One eye also on core goods, though this should stay under pressure from Used Cars more recent surveys have shown some life there. Possible upside surprise because low bar. Don’t expect Chinese virus effect yet, but will look for signs of it.
  • That’s all for now…good luck with the number!
  • Small upside surprise this month…core +0.24%, and y/y went up to 2.3% (2.27% actually).
  • We have changes in seasonal adjustment factors and annual and benchmark revisions to consumption weights this month…so numbers are rolling out slowly.
  • Well, core goods plunged to -0.3% y/y. A good chunk of that was because Used Cars dropped -1.2% this month, down -1.97% y/y.
  • Core services actually upticked to 3.1% y/y. So the breakdown here is going to be interesting.
  • Small bounce in Lodging Away from Home, which was -1.37% m/m last month. This month +0.18%, so no big effect. But Owners Equivalent Rent jumped +0.34% m/m, to 3.35% y/y from 3.27%. Primary Rents +0.36%, 3.76% y/y vs 3.69%. So that’s your increase in core services.
  • Medical Care +0.18% m/m, 4.5% y/y, roughly unchanged. Pharma fell -0.29% m/m after +1.25% last month, and y/y ebbed to 1.8% from 2.5%. That goes the other way on core goods. Also soft was doctors’ services, -0.38% m/m. But Hospital Services +0.75% m/m.
  • Apparel had an interesting-looking +0.66% m/m jump. But the y/y still decelerated to -1.26% from -1.12%.
  • Here is the updated Used Cars vs Black Book chart. You can see that the decline y/y is right on model. But should reverse some soon.

  • here is medicinal drugs y/y. You can see the small deceleration isn’t really a trend change.

  • Hospital Services…

  • Primary Rents…now, this and OER are worth watching. It had been looking like shelter costs were flattening out and possibly even decelerating a bit (not plunging into deflation though, never fear). This month is a wrinkle.

  • Core ex-housing 1.53% versus 1.55% y/y…so no big change there. The upward pressure on core today is mostly housing.
  • Whoops, just remembered that I hadn’t shown the last-12 months’ chart on core CPI. Note that the next 4 months are pretty easy comps. We’re going to see core CPI accelerate from 2.3%.

  • So worst (core) categories on the month were Used Cars and Trucks and Medical Care Commodities, which we’ve already discussed. Interesting. Oddly West Urban OER looks like it was down m/m although my seasonal adjustment there is a bit rough.
  • Biggest gainers: Miscellaneous Personal Goods, +41% annualized! Also jewelry, footwear, car & truck rental, and infants/toddlers’ apparel.
  • Oddly, it looks like median cpi m/m will be BELOW core…my estimate is +0.22% m/m. That’s curious – it means the long tails are more on the upside for a change.
  • Now, we care about tails. If all the tails start to shift to the high side, that’s a sign that the basic process is changing.
  • One characteristic of disinflation and lowflation…how it happens…is that prices are mostly stable with occasional price cuts. If instead we go to mostly stable prices with occasional price hikes, that’s an inflationary process. WAY too early to say that’s what’s happening.
  • Appliances (0.2% of CPI, so no big effect) took another big drop. Now -2.08% y/y. Wonder if this is a correction from tariff stuff.
  • Gotta go get ready for air. Last thing I will leave you with is this: remember the Fed has said they are going to ignore inflation for a while, until it gets significantly high for a persistent period. We aren’t there yet. Nothing to worry about from the Fed.

Because I had to go to air (thanks @OJRenick and @TDAmeritrade for another fun time) I gave a little short shrift on this CPI report. So let me make up for that a little bit. First, here’s a chart of core goods. I was surprised at the -0.3% y/y change, but it actually looks like this isn’t too far off – maybe just a little early, based on core import prices (see chart). Still, there has been a lot of volatility in the supply chain, starting with tariffs and now with novel coronavirus, with a lot of focus on the growth effects but not so much on the price effects.

It does remain astonishing to me that we haven’t seen more of a price impact from the de-globalization trends. Maybe there is some kind of ‘anchored inflation expectations’ effect? To be sure, it’s a little early to have seen the effect from the virus because ships which left before the contagion got started are still showing up at ports of entry. But I have to think that even if tariffs didn’t encourage a shortening of supply chains, this will. It does take time to approve new suppliers. Still I thought we’d see this effect already.

Let’s look at the four pieces charts. As a reminder, this is just a shorthand quartering of the consumption basket into roughly equal parts. Food & Energy is 20.5%; Core Goods is 20.1%; Rent of Shelter is 32.8%; and Core services less rent of shelter is 26.6%. From least-stable to most:

We have discussed core goods. Core Services less RoS is one that I am keeping a careful eye on – this is where medical care services falls, and those indices have been turning higher. Seeing that move above 3% would be concerning. The bottom chart shows the very stable Rents component. And here the story is that we had expected that to start rolling over a little bit – not deflating, but even backing off to 3% would be a meaningful effect. That’s what our model was calling for (see chart). But our model has started to accelerate again, so there is a real chance we might have already seen the local lows for core CPI.

I am not making that big call…I’d expected to see the local highs in the first half of 2020, and that could still happen (although with easy comps with last year, it wouldn’t be much of a retreat until later in the year). I’m no longer sure that’s going to happen. One of the reasons is that housing is proving resilient. But another reason is that liquidity is really surging, so that even with money velocity dripping lower again it is going to be hard to see prices fall. M2 growth in the US is above 7% y/y, and M2 growth in the Eurozone is over 6%. Liquidity is at least partly fungible when you have global banks, so we can’t just ignore what other central banks are doing. Over the last decade, sometimes US M2 was rising and sometimes EZ M2 was rising, but the last time we saw US>7% and EZ>6% was September 2008-May 2009. Before that, it happened in 2001-2003. So central banks are providing liquidity as if they are in crisis mode. And we’re not even in crisis mode.

That is an out-of-expectation occurrence. In other words, I did not see it coming that central banks would start really stepping on the gas when global growth was slowing, but still distinctly positive. We have really defined “crisis” down, haven’t we? And this isn’t a response to the virus – this started long before people in China started getting sick.

So, while core CPI is currently off its highs, it will be over 2.5% by summertime. Core PCE will be running up on the Fed’s 2% target, too. If the Fed maintains its easy stance even then, we will know they are completely serious about letting ‘er rip. I can’t imagine bond yields can stay at 2% in that environment.

I Dream of GINI – Is Inequality a Function of Longevity?

January 31, 2020 Leave a comment

Before I get into a distinctly non-inflation thought, I want to add another non-inflation thought and offer my congratulations to the UK on the occasion of her independence. Congratulations for throwing off the oppressive yoke of her Continental overlords. We did that once, and it worked out really well. I heartily believe that every society should refresh its independence at least every thousand years or so. So good job, mates! Sorry about that Rugby World Cup, but after all this was more important.

I should also point out that the sky does not seem to be falling in the UK, or elsewhere for that matter for any reason related to Brexit. I should also point out that I told you so.

Now, on an wholly different topic – inequality. I had a thought a few days ago and after mulling it for a bit I concluded that there might be something useful in the concept so I thought I would share it. I first discussed it briefly with an eminent retired economist of my acquaintance, and he thought the proposition was intriguing, so here goes…

There has been a lot of teeth-grinding and navel-gazing about the idea that societal inequality seems to be growing worse over time. One way to measure this is with the GINI Coefficient, which ranges from 0 (everyone in society shares income, or wealth, depending on what is measured, equally) to 100 (one household gets all the income for the society).  The calculation of the coefficient isn’t important for my purposes, nor is dwelling on its imperfections. Clearly it is an imperfect measure, but for my musing it suffices. The GINI coefficient has been rising steadily for some time in the US, and in most other countries in fact.

But consider this: does the fact that lifespans are also lengthening have anything to do with the growing measurement of inequality? After all, the longer someone is in the workforce the higher we would expect their income to be and, assuming any savings discipline at all the more wealth we would expect them to have. If the average lifespan is 50, then the oldest in society have less time to accumulate than if the average lifespan is 80. (Hey, look at all the billionaires. None of them are spring chickens.) Moreover, when a wealthy old person dies their wealth gets distributed and diluted, rather than remaining concentrated – the Vanderbilts and Carnegies are not as wealthy now as they were in the 1800s. So my hypothesis is that while I don’t claim this explains all of the apparent increase in inequality, I suspect it explains part of it.

Further, I wonder if the increased concentration of corporate value and power in larger and larger megacorporations might also be related to the relatively longer lifespans of corporations – the diminished frequency with which companies are broken up by antitrust crusaders or corporate raiders, or allowed to go bust (see GM et. al. in the Global Financial Crisis) allows them to accumulate “value” over longer and longer periods of time. I’m not talking market cap – Tesla, Facebook, Amazon, etc are all worth far more in the market than their actual economic heft. But a lot of the big banks might fall into this category today – heck, big finance companies on both sides: e.g. Blackrock! In short, I wonder if a lot of the problems with corporate ‘greed’ that Bernie Sanders and his ilk decry could be solved by the simple expedient of making the system more capitalist rather than less. Break them all up!

Of course, I wouldn’t argue for killing people at their retirement parties, so the same solution doesn’t exactly apply. But here, too, there might be merit in an alternate prescription that is essentially the opposite of the socialist path. Rather than trying to suck up all of a millionaire’s wealth when he/she dies, preventing him/her from passing along wealth to another generation, give more incentives for distributing wealth earlier. Give larger deductions for charitable contributions, larger gift exemptions, and so on. Distribute earlier and the concentration at the top won’t be as large.

One final point, and that is about inflation. Greater inflation also tends to cause wealth to concentrate more at the top since the wealthy tend to own more real property and consume a smaller proportion of their incomes. And autocratic regimes tend towards higher inflation. So I suppose what I am saying (and I didn’t know I was going to say this when I started to write this column) is that the prescription for less inequality is to have more creative destruction and for society to lean more towards freedom and capitalism than towards government intervention and socialism. I might even argue that this country’s lurch away from true capitalism, especially since the Global Financial Crisis, is a key reason that income and wealth has become less well-distributed. (And, as I wrap up with that statement, I do one more Google search and discover that others have already made some of these points. See this article for some historical perspective of inequality under non-capitalist regimes).

Discuss.


P.S. I feel like I ought to give some credit here to my teenage son, Andy, whose flirtations with questions of inequality has caused me to ruminate on these issues more than I might otherwise have done. Keep on questioning, son!

Categories: Economy, Government Tags: ,

Summary of My Post-CPI Tweets (January 2020)

January 14, 2020 3 comments

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 or Enduring Intellectual Properties (updated sites coming soon). Plus…buy my book about money and inflation. The title of the book is What’s Wrong with Money? The Biggest Bubble of All; order from Amazon here.

  • The first CPI day of 2020! Although technically, this is the last print from the 20-teens.
  • The next decade ought to be very different from the last decade, from an inflation perspective. No more wondering if deflation is sneaking up on us, which is how 2010 began. I suspect we will spend more time worrying about how to put the inflation genie back in the bottle.
  • As the saying goes, letting the cat out of the bag is a heck of a lot easier than gettin’ him back in.
  • But let’s be more myopic for now: month on month. Consensus on core CPI is for +0.18% or so, which would keep y/y at 2.3% unchanged from last month.
  • To tick y/y core back to rounding to 2.4%, we only need 0.22% m/m on core CPI, so that’s more likely than the weakness we would need to see it tick down to 2.2%.
  • Last month in fact we saw 0.23%, which is right on the 6-month average core print. The only reason y/y is as low as it is, is because Feb-May last year were all 0.11-0.15% prints. Which is to say that the comps get easier starting in March (with Feb’s number).
  • Last month’s +0.23% came with softish housing, too. So there are some underlying upward pressures beyond housing. Medical Care has been getting the most attention so we will be attentive to any continued upward pressure there.
  • Also watch this month for an apparel bounce-back. Big drop last month, most likely due to the placement of Thanksgiving and the BLS’s new methodology which has induced lots of volatility to the series.
  • Downwardly, Used Cars remain a risk with private surveys showing softness there. And we’ll watch housing again. A sea change in housing would be a big deal. No real sign of that yet, and in fact housing has been running hotter than our forecasts by a tiny bit.
  • That’s all for now…good luck with the number. 5 minutes.
  • Weak CPI print, +0.11% on core…y/y just barely rounded up to 2.3% y/y. I said a downtick would be hard…but this was weak enough that it was very close.

  • Used Cars was quite weak, at +0.76% m/m, but that’s not super-surprising. The y/y at -0.68% (from -0.44%) is roughly in line.
  • Another usual suspect, Lodging Away from Home, plunged -1.75% m/m, putting the y/y to -0.28% from +3.26%. So a big, anti-seasonal move there. But LAfH is only 1% of CPI.
  • Overall housing was okay…OER +0.24% and Primary Rents +0.23% m/m, meaning that they upticked slightly y/y to 3.28% (vs 3.26%) and 3.69% (vs 3.66%) respectively. So it isn’t the big components there.
  • Yet Housing as a whole subgroup was only +0.10%. Was that all LAfH? Need to check.
  • Medical Care accelerated further, +0.57% m/m.

  • Medical care jump led by a large +1.25% m/m rise in Pharma (Medicinal Drugs).

  • The increases in the broad medical care components tends to support my prior suspicions that the big rise in CPI for health care insurance was a case of BLS not catching what was actually moving, so it appeared to show up in the insurance residual. That residual is still high…

  • Struggling finding anything (other than used cars and lodging away from home) that was really weak. Apparel was +0.40% m/m, so we got some of the bounceback. Recreation was a little weak, +0.15% m/m, and “Other” was -0.13% m/m…I need to dig deeper in housing though.
  • Overall core goods was steady at +0.10% y/y; overall core services was steady at +3.0% y/y. So no super clues there.
  • Here’s supporting chart for what I said about the weakness in Used Cars. Weak, but not surprisingly weak.

  • Well, in Housing…Shelter, which includes rents but also includes Lodging Away from Home, decelerated to 3.25% from 3.32% y/y. Fuels and Utilities is -0.23% y/y vs +0.74%. And Household Furnishings/Operations +0.98% vs 1.61%.
  • Looks like major appliances were heavy, down 1% m/m or so. But we’re talking a pretty small weight.
  • So biggest m/m decliners (and annualized changes) were Lodging AfH (-19.1%), Public Transport (-16.3%), Car and Truck Rental (-14.7%), and Personal Care Products (-12.9%). Cumulatively that’s only 2.8% of the CPI, but big changes.
  • Biggest m/m gainers aren’t in core: Motor Fuel (+39.6%) and Fuel Oil/Other Fuels (+27.4%). Medical Care Commodities (drugs) were +19.3%, and are in core, but as we have seen probably not a one-off. Then Meat, Poultry, Fish, and Eggs (can we just call this “protein?”) +16.7%.
  • So we’re talking about a lot of left-tail things in core especially. Median looks to be over 0.2% again, though a little hard to say because one of the regional OERs looks like the median category. But y/y Median CPI should stay roughly steady at 2.92% is my guess.
  • So core ex-shelter dropped a bit to 1.55% from 1.61% y/y. Still well off the lows. But if these left-tail one-offs are really one-offs, we would expect to see that rebound next month. Bottom line though is that 1.55% from non-housing isn’t very alarming yet.
  • To kinda state the obvious, nothing here will have the slightest impact on the Fed. They’ve basically said they don’t care about inflation at these levels. “Wake me when it hits 3% on core PCE, then hit the snooze button for a year.”
  • “In order to move rates up, I would want to see inflation that’s persistent and that’s significant. A significant move up in inflation that’s also persistent before raising rates to address inflation concerns: That’s my view.” – Powell, Dec 11 2019
  • Let’s look at the four pieces charts in order from most-volatile to least. First, Food and Energy.

  • Second, Core goods. This includes pharma, but also used cars, so right now the cars are beating drugs. (Don’t drink and drive, kids.)

  • Core Services less Rent of Shelter. Now, this month overall was weak but this is starting to look more concerning thanks to Medical Care. I think we might be seeing this over 3% before long, given the signals from health care.

  • And 4th piece: rent of shelter. So, flip side of the other core services is that rents might be softening..but at least aren’t showing an urgency to accelerate further. This was the reason I thought we’d see core peak in the 1st part of this year. I’m no longer confident.

  • Ever feel like inflation was giving you the finger? Here is the distribution of price changes. The big one in the middle is OER. The one at the far right is gasoline. You can see there are a lot of left tail events still.

  • Last one. Same data as the last chart, but this just sums all the categories over 3% y/y inflation. Obviously, when this goes over 50%, median is at least 3%. Because of rents, this is going to be close to 50%…but enough other categories are starting to scooch it there.

  • Scooch being a technical term.
  • OK, that’s all for today. The summary is that while the monthly number was soft, the underlying pressures are if anything getting a little firmer. Of course, the summary if you’re on the FOMC is, “CPI came out today? Really?”

As I said, nothing here will affect the Fed, at least for a while. I am sure some of them still pay attention to the CPI but they’ve made very clear that the only way inflation would affect monetary policy is if it went a lot higher, or a little bit lower. It may go a lot higher, but it won’t get there quickly. And core PCE, which is what the Fed supposedly focuses on (insider tip: they focus on whichever index is confirming their thesis), is more likely to accelerate from here since it overweights medical care – which is now trending higher – and underweights housing – which is looking soft – compared to private consumption. So, write off the Fed.

However, the “cyclical” ebbing of inflationary pressures that I had been expecting in Q1-Q2, mainly because I expected more softening in rents and I thought bond yields would be declining more in reaction to the slowdown in growth, aren’t apparent. It looks as if inflation might peak later than I had expected. Now, I never thought such a peak would mean inflation rolls over and goes to the lows of the last recession. Absent another collapse in housing, which does not appear to be in the offing, that isn’t going to happen. I thought inflation would stage a small retreat and then move to new highs when rates headed back up again. So far, though, I don’t even see much reason to think the peak is about to happen. Yes, rents are squishier than they were but it appears that medical care is moving fairly aggressively higher and interest rates don’t appear to be responding to the global slowdown in growth. So we might well be looking at a recession where inflation doesn’t slow very much.

In any event, the Fed’s response function make potential tail events a mostly one-way affair right now. They’ve warned you. Take appropriate precautions – which is relatively easy now as most inflation hedges (exception precious metals) are quite cheap!

Summary of My Post-CPI Tweets (December 2019)

December 11, 2019 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 or Enduring Intellectual Properties (updated sites coming soon). Plus…buy my book about money and inflation. The title of the book is What’s Wrong with Money? The Biggest Bubble of All; order from Amazon here.

  • Okay, about 10 minutes to CPI showtime so let’s review last month.
  • We have had a couple of soft prints (<0.2% before rounding, one all the way to 0.1%, on core), but those followed 3 months of 0.3% monthly core prints. This month, consensus is for a soft 0.2% on core, something around 0.18%.
  • last month, we saw weak core goods, a lot of that being vehicles and NOT surprising but general softness outside of vehicles mildly surprising.
  • the bigger surprise was in housing, where Lodging Away from Home was very soft and both Primary and Owners’ Equivalent Rents were soft. That was the main story from last month.
  • But of course we are also watching Medical Care carefully. The prior rise in Medical Insurance inflation, because of the way the BLS measures, might (or might not) be a proxy for as-yet-unsurveyed strength in other medical subcomponents.
  • Those other medical care subcomponents HAVE been seeing some recent strength. So Core-Services-ex-Rents is something we are very interested in.
  • Two other points. The first is that November had a very late Thanksgiving, so depending on when retailers adjusted prices for the retail season (generally lowering them) and when the survey mostly happened, there could be some seasonal volatility.
  • If they did not lower their prices as early in the month, because Black Friday was later, that COULD mean we see strength that’s not seasonally expected. Don’t know but something to keep in mind. Built-in caveat for today.
  • Second point is: the Fed doesn’t care. Powell says they’re not going to tighten unless inflation goes significantly higher and stays there a long time. So, you’re on your own!
  • That’s all – grab a coffee and see you in 3 min.
  • 2% on core, but stronger than expected…really 0.23% before rounding. Y/Y core stays at 2.32%
  • Here are the last 12 core prints. Funny how one print can make the whole chart look more ominous.

  • OK, first housing. Lodging Away from Home was +1.1% m/m after -3.84% last month, so as-expected bounce. Primary Rents were +0.26% vs 0.14% last mo and OER was +0.24% vs +0.18%. So softness was not repeated in housing.
  • That said, the y/y figures in housing still declined, with Primary going to 3.66% vs 3.74% and OER 3.26% vs 3.31% prior. So those are big effects holding down y/y core. But core was unchanged y/y. So where were the gains?
  • I should say those are the effects holding down further acceleration in core. Drippy housing means th other parts need to pick up the slack.
  • Some of that is Medical Care. This month overall Medical Care CPI was +0.32% m/m, 4.24% y/y. That’s with soft Pharma CPI, -0.16% m/m and a scant 0.58% y/y.
  • You can see Pharma is still rising, this is y/y.

  • Doctors’ Services and Hospital Services also softer this month than last, but not huge.
  • Core Goods overall slumped to +0.1% y/y from 0.8% just a few months ago. This month, the weakness in pharma helped but the y/y for Used Cars also fell to -0.44% from +1.43% previously. Expected some weakness, but that might be a bit overdone.
  • Here is core commodities vs lagged import prices. Not super surprising that it is slowing.

  • Core inflation ex-shelter basically unchanged, at 1.61% vs 1.60%.
  • Unfortunately having some computer “issues” that is preventing my usual deeper dive in some of these categories.
  • Oh, Apparel -2.29% y/y vs -0.34%. Again, the BLS’s new survey methodology is introducing IMO a lot of extra volatility in this series.
  • Well, found the computer issue but it’s really that the BLS posted the subcomponents a little later than usual today. Won’t be fixed in the next few minutes and I have to go meet clients in Minneapolis. So I’ll wrap it up, a little short this month – sorry.
  • I think the bottom line is that there isn’t anything super surprising here. The softness we had seen in housing took at least a temporary hiatus. Overall core was stronger than expected, but hard to be sure that’s meaningful.
  • As I said up top, there’s no real reason to think that the Fed cares…so from a markets perspective, TODAY and this month, these numbers don’t mean much. Except for you, because the Fed isn’t going to try and restrain inflation so you better make sure you’re prepared.

Late post of today’s summary, since I had customer meetings during the day. Up above, I sort of flippantly commented about how the chart of monthly changes looks totally different when you add the latest point. I’m always fascinated about examples like this. Clearly, we didn’t add 12 monthly points, but only one today. So there is no more information in that chart than we had new today – what happens is that we change the context a little bit. Prior to today’s figure, the question was “are the three high numbers the aberration, or are the last two points an aberration from a higher trend?” The latest point makes it seem more likely that the two low ones are the aberration, but I’d be cautious about reading too much into that. First, there’s a ton of noise in any economic series. Second, I mentioned in my walk-up to the number in the bullet points above that there’s some chance the late Thanksgiving could result in a higher-than-expected CPI if retailers lowered their prices for the Christmas season later than normal. And third, there wasn’t anything super-alarming about this data.

By the same token, “nothing super-alarming” could also be read as “no big outliers, just a generally faster pace of inflation.” So if you’re bullish on inflation, you might read the composition that way. Moreover, it should be pointed out that while the consensus forecast was for +0.2% on core CPI, and we got +0.2%, there was actually a pretty decent miss: the consensus was more like +0.18% before rounding up, and core CPI was +0.23% before rounding down. Economists were further off than they appear to be if you just look at the rounded figures.

My view continues to be that inflation ought to peak early next year, but that the cyclical low won’t be that low. However, I am becoming a bit less confident that the peak is that near, especially given how Medical Care is behaving. The key point though is the last one I raised today. The Fed has changed the rules of the game…or I guess a better analogy is that it has changed which team it is playing for in a very vocal way. It is one thing for the Fed to say “we want inflation higher and are going to push it higher,” which implies a level of control (to be sure, it is control they don’t actually have), but something else entirely to say “we really don’t care if it goes up,” which implies abdication of responsibility for the results. Investors should beware of this. I don’t think it is the small thing it sounds like.

Categories: CPI, Tweet Summary

Summary of My Post-CPI Tweets (November 2019)

November 13, 2019 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 or Enduring Intellectual Properties (updated sites coming soon). Plus…buy my book about money and inflation. The title of the book is What’s Wrong with Money? The Biggest Bubble of All; order from Amazon here.

  • Another CPI day dawns bright and cold. But will inflation get heated up again, with a fourth 0.3% print on core, out of five? Or stay cold like last month’s +0.13% on core?
  • Last month, core goods was pressured a little bit, although still +0.7% y/y, by softness in Used Car prices and a big drop in pharma prices.
  • Apparel also fell as the new methodology is adding more volatility to that series than we had previously seen.
  • I suspect we will see more softness from Used Cars (maybe not as much as last month), as sales surveys have been consistently soggy recently.
  • I also continue to wait for the other shoe to drop with Medical Care. The Health Insurance part, which is a residual, has been running really hot. But that probably just signals that survey prices of the other parts need to catch up with reality. At least that’s my speculation.
  • Although core CPI was soft last month, Median was +0.25% and a new cycle high of 2.97% y/y. So the underlying pressures are steady and that probably means we aren’t about to see a major turn lower yet.
  • Really, the major change since last month has been the Fed’s tone – Powell saying that the Fed won’t even consider addressing higher inflation until they see “a really significant move up in inflation that’s persistent.”
  • That changes the calculation for investors and we have seen a meaningful move higher in breakevens recently as a result.
  • Consensus for today’s number is +0.3% headline, +0.2% on core, with the y/y core staying at 2.4%. And they’re really calling for an 0.2% or above, not a ‘soft’, rounded-up, core figure.
  • We are rolling off 0.196% from last October, so to have the y/y rise we need another pan-0.2% print. And to keep y/y at 2.4% on core it can’t be much softer than that.
  • That’s all for now. Except for this: after the figure I will be on @TDANetwork with @OJRenick. About 9:15ET is when we are scheduled to go to air. Tune in! And good luck today.
  • Soft one, +0.16% on core that rounds up to +0.2%. The y/y core dripped from 2.36% to 2.32%, which caused the rounded figure to go 2.4% to 2.3%.
  • So, what happened in June-July-August? Three months is a lot for an outlier.

  • OK, wow, -3.84% m/m drop in Lodging Away from Home. Looks like a seasonal distortion as the prior month was +2.09%. LAfH is only 1% of consumption, but that means it’s ~4bps of the m/m figure.
  • Used Cars and Trucks rebounded to 1.32% m/m, but the y/y dropped to 1.44% from 2.61%. It may have a little further to drop but that’s not surprising.
  • Apparel -1.8% m/m, so again more volatility from the new methodology. Core goods y/y dropped from +0.7% to +0.3%, but some part of that was Apparel going from -0.3% y/y to -2.3% y/y.
  • In the big pieces, Primary rents were +0.14%, a little soft (y/y to 3.74% from 3.83%) and Owner’s Equivalent +0.19%, also soft, to 3.32% from 3.40% y/y. Along with Lodging Away from Home it meant the Housing subindex, 42% of CPI, decelerated to 2.89% from 3.03%.
  • That’s potentially big on a couple of fronts, if it indicates actual slowing in rent inflation. As a big piece of CPI, a modest slowing there will help turn Median too.
  • Belated but here’s the chart on used cars and trucks. You can see the y/y is back in line, but some more softness likely.

  • So, core inflation ex-housing actually rose to 1.60% from 1.55%. Pretty minor move but it hasn’t been higher since Feb 2016, with the exception of two months ago when it hit 1.70%.

  • So the spread of shelter inflation over core, non-shelter inflation, has been extreme and one question has been whether housing inflation would slow or other inflation would rise. Answer this month is: both.

  • Not to belabor Lodging Away from Home but here is the y/y. The monthly volatility is not helpful, but at least it’s only 0.9% of CPI.

  • Weirdly, I haven’t mentioned Medical Care. M/M, Medicinal Drugs rose 1.05% after declining -0.79% last month. Y/y rose to +1% from -0.3%. Doctors’ Services rose to 1.16% y/y from +0.93%. But Hospital Services jumped to 3.46% from 2.08% y/y.
  • Hospital Services is 2.2% of consumption, and that +1.38% m/m jump is the reason that Core Services rose to 3% y/y from 2.9% DESPITE the deceleration in housing.
  • y/y hospital services. So is that part of what wasn’t being captured and thus showing up in the health insurance residual? Maybe, but Health Insurance still went to +20.1% y/y from 18.8%. Even knowing that’s a residual doesn’t keep it from being scary.

  • It’s measuring a REAL COST INCREASE, it’s just not really in the price of insurance policies that Americans are paying. Yes, they’re rising, but not at 20% y/y.
  • Insurance chart

  • Early guess on Median is that it will be a softish +0.19%, which will keep y/y basically unch.
  • Biggest annualized declines this month were Lodging Away from Home, Women/Girls’ Apparel, Infants’/Toddlers’ Apparel, and Men’s/Boys Apparel. Biggest increases: Car/Truck Rental, Motor Fuel, Misc Personal Goods, Energy Services, Used Cars/Trucks, Med Care Commodities.
  • Those are biggest annualized MONTHLY declines, Sorry.
  • About to get ready to air on @TDANetwork, so four-pieces charts might have to wait until later.
  • Summary today is that as usual there are lots of moving pieces but the interesting bit is the big housing pieces. They’re slow but there’s some anecdotal signs of softness developing and if that’s real, it could cap core inflation for now. Not sure of that yet.
  • I still think inflation is likely to peak for this cycle in early 2020, but again I admonish that the downside won’t be nearly as low as we have seen downsides and the next upside will be worse than this one. Higher highs and higher lows from here.

I still owe you the four-pieces charts, so here they are. First, Food & Energy.

Next, Core Goods. It suffered a big setback today but it still looks generally uptrending. I don’t think this is about to go to 4, but something between 0.5% and 1.0% for a while is not hard to imagine especially if pharma prices stabilize.

Core services, ex rent-of-shelter. Now, this starts to look a little more interesting? Medical Care showing some perkiness and as the second-most-stable piece here, core services less rent of shelter is worth monitoring for the longer-term macro inflation picture.

Finally, Rent of Shelter. Still in the same general vicinity, but there are starting to be some anecdotal reports of softness in home prices in certain areas so it’s worth monitoring. It’s not about to plunge as in 2007-09, but it just needs to back off a little to change how concerned we are about inflation.

That said, inflation seems to be broadening a bit and also becoming more volatile. The volatility is partly because the BLS is changing the way they do certain things but it’s also a consequence of fractious trade relationships where firms are changing their sourcing, prices are responding to tariffs and tariff threats, etc. To the average consumer who encodes price increases as inflation and price decreases as good shopping, volatility in prices feels very much like inflation so if this continues then inflation expectations could rise just on the volatility (unless it’s all measurement volatility, of course).

I do think that the investment implication of today’s inflation numbers is muted compared to the implication of what the Fed has said about the inflation numbers. To wit, the Fed won’t even consider hiking to restrain inflation unless they see “a really significant move up in inflation that’s persistent.” So far we haven’t seen that, and in fact recently the upper tails have been coming down just as the fast as the lower tails have been going up. The chart below shows what proportion of the CPI is inflating faster than 4% y/y.

But from an investor’s standpoint and more importantly from an advisor’s standpoint, the Fed stance changes how you approach a portfolio if you are a professional-risk-minimizer (as most advisors are). In the old days, an uptick in inflation that caught an advisor flat-footed might be forgiven because we assumed the Fed was working hard in our direction – to keep inflation low. But now, even if you don’t think inflation is going to rise, the professional risk on the downside is bigger because clients will say to the advisor “why didn’t we have any inflation hedges? The Fed told you they wanted expectations to go higher!” Maybe this is too subtle, but breakevens are up 20-25bps over the last few weeks and I think no small part of that is because investors and advisors are now on their own with respect to inflation. In my experience, people who think they might be shot at can usually be trusted to dig their own foxholes.

A Generous Fed Isn’t Really the Good News it Sounds Like

October 31, 2019 12 comments

I understand why people are delighted about Powell’s remarks yesterday, about how the Fed would need to see a significant and sustained increase in inflation before hiking rates again. This generation, and the last, does not see inflation as a significant threat, nor a significant cost should it get going, and believes firmly that the Fed can easily squelch it if it gets going. (They believe this because, after all, the Fed told them so).

Older investors might be more reticent to believe that there’s a pony in there somewhere, since the evidence suggests that not only does inflation erode purchasing power (thereby demanding even more nominal return be provided by portfolios that are already overstretched valuation-wise) but it also ruins the diversification effect of bonds relative to stocks. The main reason that 60:40 is a dramatically lower risk portfolio (and more efficient in an investing sense) than 100% stocks is that stock and bond returns have tended to be inversely correlated for a long time. When stocks go up, bonds go down, in general (and vice-versa). But that’s because they have inverse sensitivities to the economic growth factor. In recent years, that has been the only factor that matters, but stocks and bonds have the same sensitivity to the inflation factor: when inflation goes up, both stocks and bonds tend to decline (and vice-versa). Consequently, when inflation becomes an important element in investors’ calculations the correlation of stocks and bonds tends to be positive and in the immortal words of Billy Joel in “Goodnight Saigon,” “We would all go down together.” Along these lines I recently prepared this chart for Real Asset Strategies,[1] illustrating that when inflation is over about 2.5%, correlations tend to flip. This is a 3-year average of y/y inflation (and shown on the chart as inflation minus 2.5% so the zero line is what matters, not the line at 2.5%) versus 3-year correlations; the point is that you don’t need 4% inflation to drastically change the value of the 60:40 portfolio.

I also think that people give the Fed much more credit for their ability to squelch inflation – which after all they haven’t had to do for more than 30 years after spending 15 years squelching the last round – than they deserve. But that’s a ‘show me’ situation and it’s hard to prove my suspicion that they won’t be so successful when push comes to shove.

So, I understand why people are partying about a Fed that is even looser than it had been. I don’t think that’s the correct response, but I understand it.

I also understand why people are somewhat morose about trade frictions. It isn’t for the right reason, that in the long run it will hurt real growth a smidge and increase inflation a smidge-and-a-half, but because they think it will have a drastic effect on near-term growth. That’s why everyone gets so excited about any inkling the US and China are nearing a trade détente and so depressed when it looks like they aren’t. We are told that the current global slowdown is being caused largely by the trade war.

In my view that’s nonsense. The global economy has been expanding for a decade on exceptionally loose liquidity but no tree grows to the sky. The global economy was slowing well before the trade frictions could possibly have had any impact. But it is hard to convince people of that, because everyone knows that:

GDP = C + I + G + (X-M),

or consumption plus investment plus government spending plus trade. And we learned in school about Ricardian comparative advantage and how trade enriches (or anyway, can enrich) both parties at the same time. So if China doesn’t import anything from the US and doesn’t export anything to the US, growth is going to be crushed, right?

But that’s not how trade works. Frankly, that’s not how anything in the GDP equation works. If you remove the final term, you don’t reduce GDP by (X-M). Sure, if this was an algebra problem you would, but it’s not. In the real world, what you lose from trade gets partially replaced by an increase in consumption, investment, or government. Just as I pointed out last year with soybeans, if China buys zero from us it means they have to buy them from someone else, which means that supplier doesn’t have them to sell to one of their traditional customers…who then buys them from us. Incidentally, neither beans nor corn went to zero after mid-2018 (see chart, source Bloomberg, normalized to December 2017=100).

The rest of trade works the same way if the two parties are “internal customers” and “external customers.” Though there will always be winners and losers, if we don’t have international trade then we won’t have a destination for our merchandise overseas…but we will also have consumers who don’t have Chinese goods to buy and so need to buy something from a domestic producer instead. This is not a zero sum game; it clearly results in a loss for all players. But the order of magnitude of this loss in the short run is not very big at all, especially for a country with a large fraction of its domestic production going to domestic consumption, as in the US but not even for the world at large. The world economy has lots of reasons to slow and go into recession, and trade frictions are one of those reasons, but certainly not the only one and not even the largest reason.

An overreaction by markets to anything in a stream of economic news is not unique or new, of course; those overreactions won Robert Shiller a Nobel Prize after all for his work pointing out the “excess volatility puzzle” as an early highlight of the nascent field of behavioral economics. But there’s a good reason to ignore most of these wiggles and focus on the long-term effect of these developments. Which, in the case of both the general climate of trade and the Fed’s reaction function to inflation, are negatives for both stocks and bonds.


[1] As part of Enduring Intellectual Properties’ investment in Real Asset Strategies, I serve as Director of Research for the firm. Real Asset Strategies LLC offers liquid real asset strategies focused on diversification benefits and inflation protection at reasonable fees.

%d bloggers like this: