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Some Abbreviated but Important Thoughts on Housing

November 29, 2017 3 comments

I posted this chart yesterday to my Twitter feed (@inflation_guy, or @inflation_guyPV through PremoSocial for some additional content), but didn’t have time to write very much about it. This is the Shiller 20-City Home Price Index year/year change (Source: Bloomberg).

My observation was that when you take out the housing bubble, it looks more ominous. It’s actually really the bubble and bust, which makes the recent trend look uninteresting. This is what the chart looks like if you go further back like that.

So it actually looks calm and stable, because the axis explodes to -20% to +20%. The volatility of recent years has caused us to forget that for decades before that, the behavior of home prices was actually pretty sedate. Although residential real estate over very long time periods has only a slightly positive real return, adjusted for the maintenance and other required expenditures, that means the ratio of home prices to median income has tended to be fairly stable. We have historically valued homes as a consumption good only, which meant that the home price traded as a multiple of rents or incomes within a pretty narrow range. Here’s a chart of median home prices to median household income going back to the 1970s (Source: Bloomberg, Enduring Intellectual Properties calculations).

This is true even though there have been important tax changes along the way which changed the value of the home as a tax shelter, changes in the structure of the typical family unit, and so on. Despite that, homes were pretty stable investments – really, they were more savings vehicles than investments.

The fact that home prices are now accelerating, and are rising faster than incomes, implies several things. First, as the last chart above shows, the ‘investment value’ of the home is again inflating to levels that, in 2005-2008, proved unsustainable. The bubble in housing isn’t as bad as it was, and not as bad as stocks are now, but the combination of those two bubbles might be worse than they were when they were mostly independent (in 2000 there wasn’t a housing bubble and in 2007 the bubble in stocks wasn’t nearly as bad as in 2000 and now).

The second implication is that as home prices rise, it isn’t just the value of the investment in the home that is rising but also its cost as a consumption item. Because shelter to rent is a substitute for shelter that you own, rising home prices tends to imply that rents also accelerate. Recently, “Owner’s Equivalent Rent” has been decelerating somewhat, although only coming back to our model. But the gradual acceleration in the home price increase implies that shelter inflation is not going to continue to moderate, but rather should continue to put upward pressure on core inflation, of which 42% consists of “Rent of Shelter.”

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Higher Wages: Good for You, Not Good for Stocks

November 27, 2017 2 comments

The documentation of the endless march of asset markets higher has become passé; the illustration of the markets’ overvaluation redundant and tiresome. After years in which these same arguments have been made, without any discernable correction, the sober voices of warning have been discredited and discounted. The defenders of higher valuations have grown more numerous, more vocal, and more bulletproof.

I recently commented in a forum on cryptocurrencies…something to the effect that while I see blockchain as being a useful technology – although one which, like all technologies, will be superseded someday – I don’t expect that cryptocurrency in any of its current forms will survive because they don’t offer anything particularly useful compared to traditional money, and moreover have a considerable trust hurdle to overcome due to the numerous errors, scandals, and betrayals that have plagued the industry periodically since MtGox. Whatever you say about ‘traditional’ money, no one worries that it will vanish from your bank account tomorrow due to some accident. I don’t see anything particularly controversial about that statement, although reasonable people can disagree with my conclusion that cryptocurrency will never gain widespread acceptance. However, the reaction was aggressive and unabashed bashing of my right to have an opinion. I hadn’t even uttered an opinion about whether the valuation of bitcoin is a bubble (it obviously is – certainly there’s no sign of the stability you’d want in a currency!), and yet I almost felt the need to run for my life. The bitcoin folks make the gold nuts look like Caine in the TV show “Kung Fu”: the epitome of calm reasonableness.

But, again, chronicling the various instances of bubble-like behavior has also become passé. It will all make sense after it’s over, when the crowd recovers its senses “slowly, and one by one” as Mackay had it about 170 years ago.

Today though I want to address a quantitative error that I hope is hard to argue with. It has become de rigeur throughout this…let’s call it the recent stages of an extended bull market…to list all of the reasons that a continued rally makes sense. I always find this fascinating because such enumeration is almost never conducted with reference to whether these things are already “in the price.” On the weekend money shows I heard several pundits opine that the stock market’s rally was likely to continue because “growth is pretty good, at around 3%; interest rates are relatively low; inflation is relatively low; government has become more business-friendly, and wages seem to be going up again.” As I say, it seems to me that most of this should already be in the market price of most securities, and not a cause for further advance. But one of those items is in fact a bearish item.

Make no mistake, wages going up is a great thing. And it’s nice to hear that people are finally starting to note that wages are rising (I pointed this out in April of 2016, citing the Atlanta Fed’s macroblog article on the topic, here. But not everyone reads this column, sadly). The chart below shows the Atlanta Fed’s Wage Growth Tracker, against Median CPI.

So wages are going up for continuously-employed persons, and this is good news for workers. But it’s bad news for corporate earnings. Corporate margins have been very high for a very long time (see chart, source Bloomberg), and that’s partly because a large pool of available labor was keeping a lid on wages while weak global demand was helping to hold down commodity input prices.

Higher wages are, in fact, a negative for stocks.

The argument for why higher wages seem like they ought to be a positive for stocks goes through consumption. If workers are earning more money, the thinking goes, then they can buy more stuff from companies. But this obviously doesn’t make a lot of sense – unless the worker is spending more than 100% of his additional wages in consumption (which can happen if a worker changes his/her savings pattern). If a worker earns $10, and spends $9 buying goods, then business revenues rise by less than wage expenditures and business profits fall, all else being equal.

This shows up in the Kalecki profits equation, which says that corporate profits equal Investment minus Household Savings minus Government Savings minus Foreign Savings plus Dividends. (Look up Kalecki Profit Equation on Wikipedia for a further explanation.) Rearranging, Kalecki profits equal Investment, minus Government Savings (that is, surplus…so currently the deficit contributes to profits), minus Foreign Savings, plus (Dividends minus Household Savings). So, if workers save some of their new, higher earnings then corporate profits decline. The chart below shows how the Kalecki decomposition of profits tends to track pretty well with reported business profits (source: Bloomberg).

Now, profit margins have been high over the last year despite the rise in wages (not because of it) because the personal savings rate has been declining (see chart, source Bloomberg).

If wages continue to grow, and workers start to save more of their earnings (paying off credit cards perhaps?), then it means that labor is taking a larger portion of the pie compared to the historically-large portion that has been going to capital. This is good for workers. It is not good for stocks.

Categories: Stock Market, Theory, Wages

Summary of My Post-CPI Tweets (Nov 2017)

November 15, 2017 Leave a comment

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guyPV by going to PremoSocial 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. 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 or get it a little cheaper on our site here.

  • Consensus is for a soft 0.2% m/m on core CPI, keeping the y/y figure at 1.7%. I think the consensus works out to about 0.16%.
  • We are dropping off, from y/y numbers, last October’s 0.147% print. The last two months we’ve seen are 0.25% in Sept, and 0.13% in Oct.
  • The upshot is that to get the y/y to round up to 1.8%, we need 0.201%
  • We will be paying attention to cars and trucks. Today the Daily Shot caught on to something I pointed out a while ago:

  • That chart is actually out of date; the Mannheim used car index has risen further. Floods lead to car price increases. Only Q is when.
  • I don’t spend a lot of time on headline CPI forecasts – they obv matter more to TIPS holders in the near-term but they’re all gasoline vol.
  • Still, the consensus of 0.1% m/m looks low to me given the rise in gasoline prices. To me, gasoline should be additive this month.
  • Does seem like everyone talking about upside risk, which scares me a bit. Guess we’ll know in 6 minutes.
  • 10y breakevens -1bp on the day. Investors concerned they’re out over their skis at 1.89% breakevens!!
  • 1%/0.2%. But it’s a hefty 0.2%, 0.225% to three decimals.
  • y/y to 1.774%, rounding up to 1.8%.
  • Last 12 months. Is high the aberration or low?

  • 10y breaks back positive.
  • New and Used cars and trucks are NOT the culprit so we will have to see.
  • Medical Care broad category 1.68% from 1.56%, so the breakdown there will be interesting.
  • Core goods stayed at -1.0%; core services rose to 2.7%. Three months ago core services y/y was 2.4%; a year ago it was 3.2%.
  • y/y core cpi. BUY THE DIP!! Well, something like that. Those dips were one-offs, and those one-offs are fading (I think…calculating now)

  • OK, breakdown…housing was unch at 2.786% y/y. But primary rents dropped again, to 3.695%. OER rose slightly, to 3.196% from 3.182%.
  • Those two effects don’t quite offset, actually a net drag.
  • So new vehicles (3.68% of CPI) was -1.38% vs -1.00%; used cars (1.99% of CPI) was -2.89% vs -3.79%. So used cars contributed a tiny bit.
  • But still….wayyyyy lower than it should be. Unless the Manheim index is just plain wrong, and BLS is right, this is all in future.
  • In Medical Care, always fun: Drugs dropped further to 0.88% from 1.01%. So crazy. But Prof Services, and Hospitals, both rose:
  • Prof services 0.38% vs 0.23%, hospital services 4.54% vs 4.27%. Not big increases, but changing the direction.
  • Health insurance still basically zero: 0.15% vs 0.06% y/y. This should change if my latest renewal is any indication.
  • Professional Services y/y. A bounce, but don’t get too excited!

  • @pearkes: doesn’t CPI HI measure profit margins, not gross premiums?
  • Replying to @pearkes: Well, sort of, tho not exactly. But if all of the pieces of medical care are low, and insurance rises sharply, gotta show up somewhere.

[Editor’s note: I don’t usually put comments and responses in this summary but that was an important question]

  • College tuition & Fees: 2.17% vs 2.08%. Tuition increases have been moderating because endowments are flush thanks to the bull market.
  • Core inflation ex-housing: 0.71% vs 0.58%. The sudden drooping in primary rents is really the main story now.
  • Oddly, CPI for shelter in Houston has decelerated from 2.6% to 1.5% the last two months. That’s at odds with what happened after Ike.
  • But this may be another delayed effect.
  • 10y breakevens spiked 1-2bps on the print, but are fading. Word on Street is “used cars, shelter, airfares…this was all expected.”
  • Apparently not so expected that they could have forecast it. And primary rents were down, not up.
  • and used cars were not up more than the seasonal expectation so the y/y didn’t change. So really, no.
  • Early guess at median is 0.24%-0.26%…median category looks like one of the OER subindices and the BLS doesn’t release the seasonal adj.
  • This is our model for OER. So I think Primary Rents’ decline is the outlier.

  • And here are primary rents.

  • I think the real story here is that medical was not the drag it has been recently. But the one-offs still haven’t really reversed hard yet.

  • Speaking of one-offs…the most famous one is wireless telecom. This will all smooth out over 12 months.

  • OK, inflation in four pieces: First Food & Energy.

  • Next less-volatile piece: Core goods. Deflation here surprisingly persistent, given dollar’s retreat.

  • Core services less rent of shelter bounces for 2nd month in a row. This is where medical care shows up.

  • And rent of shelter we have already discussed. It’s where it should be and probably accelerates marginally from here.

  • Last one: weight of categories above 3% still hanging out just below 50%. Still some very long left tails separating core from median.

  • Thanks for tuning in.
  • As a bonus for my private followers – if you’d like a copy of the Quarterly Inflation Outlook (out today or tomorrow), DM me your email.

Thanks again to everyone who tuned in. If you want to get these tweets in real time so you can impress and amaze your friends, then please go to the PremoSocial signup page and contribute a ten-spot.

This data is going to get increasingly important as the one-offs fade and the next upswing in inflation happens. And we don’t need anything really weird to happen in order to get that upswing. The cell phone aberration will gradually exit the data, and make year-on-year comparisons of cell phone service very easy (actually, we might have inflation in cell phone services, simply because after unlimited data it’s hard to have any more big quality improvements!). Autos will eventually respond to the heightened demand post-flood. Medical Care is unlikely to be flat forever, once all of the compositional shifts have happened (and, if Obamacare is gutted, as the Republicans keep trying to do, then the compositional shifts back could make medical care inflation seem illusorily high, just as now it is illusorily low).

The next few months see difficult year-ago comparisons for CPI: 0.18%, 0.22%, 0.31%, 0.21% are the m/m figures for November and December 2016 and January and February 2017. That averages 0.23%, compared to 0.20% for the last three months we have seen. Ergo, rises in the y/y figures will happen slowly if at all, until March’s data in April. March/April/May/June/July averaged 0.05%, so in that time frame the y/y will be rising 0.1%-0.2% every month. And that’s when alarm will set in in the bond market, even though this is totally foreseeable.

Inflation is rising globally. The only place this isn’t really clear is in Europe, where it’s rising but from such a low level that the wiggles change the visceral appearance of the chart every month. This will keep the US central bank tightening, and other central banks will gradually exit QE. This is very bad for asset markets, and as rates rise and money velocity perks back up, the vicious cycle may well be ignited. 2018 is going to be very, very interesting.

Categories: CPI, Tweet Summary

Summary of My Post-CPI Tweets (Oct 2017)

October 13, 2017 Leave a comment

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guyPV 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. 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 or get it a little cheaper on our site here.

  • Friday the 13th and a heavy data day. What could go wrong?
  • 10y breakevens at local highs of 1.90% – but that’s the biggest spread over core CPI in several years.
  • …yet we still have 10y TIPS 50bps to fair at this level of interest rates.
  • Economist expectations are for 0.21% on core and 1.78% y/y. Interesting given how low it has been recently.
  • I don’t usually look at headline but the y/y number is forecast to jump to 2.3% from 1.9%. That will get some attention.
  • I think the market forecasts are about right for core, but there’s a wide range of upside risks. Autos are due to catch up, e.g.
  • But that’s why the forecasts make sense. 0.15% for trend plus 0.05% for expected value of risks.
  • …in turn, that means the point forecasts are not the most likely prints. They’re in between the most likely prints.
  • Core +0.13%, 1.69% y/y.
  • Breakdown will be interesting. Housing broad category went to 2.79% y/y from 2.91%. Medical Care fell to 1.56% from 1.81%.
  • Used cars/trucks went to -3.7% vs -3.8% y/y, so that rebound is still ahead of us. Surveys of car prices are up a lot, just not in BLS yet.
  • pulling in the breakdown now…core services 2.6% from 2.5%, but core goods deflation deepens to -1.0% from -0.9%.
  • Core goods deflation, however, ought soon to be rising again after the lagged effect of the dollar’s decline passes in.
  • In Housing, Primary Rents plunged to 3.78% from 3.88%. That’s huge. OER dropped to 3.18% from 3.27%. Also huge. There’s your story.
  • Core ex-housing rose to 0.58% vs 0.52% y/y, so there’s more going on here but the housing. Wow.
  • A few months ago we had y/y OER fall by more, but that was when OER was overextended.
  • Here is primary rents y/y. I guess this isn’t DRAMATIC – just quite contrary to my own expectations for a continuation of the rebound.

  • In Medical Care, Medicinal Drugs fell to 1.01% from 2.51%. Wow! But Professional Services and Hospital Services accelerated slightly.
  • Here’s CPI for pharma. Think we’ve discussed this before – likely compositional in nature, more generics thanks to worse insurance.

  • Professional services (doctors) bounced;not significant. Also somewhat compositional as old doctors quit rather than take ins. headaches.

  • College Tuition 2.08% vs 1.89%. Have I mentioned the new S&P Target Tuition Inflation Index recently? 🙂
  • Just b/c …who can get enough of wireless telecom services? Bounced, mostly base effect of course. Bottom line was that dip was a 1-off.

  • New cars also still deflating, BTW. -1.0% vs -0.68%. Obviously this will change with Houston buying loads of new cars.
  • Speaking of Houston: core CPI in Houston y/y ended June: 1.31%. For y/y ended Aug: 1.90%. But that’s actually before Harvey.
  • In Miami, 2.01% vs. 2.26% (June vs August). Have to wait a bit to get October numbers – they’ll come out in Dec.
  • Bottom line on the storms is that we haven’t seen the impact yet on CPI. Still to come.
  • My early estimate of Median CPI is 0.20%, bringing y/y up to 2.17% from 2.15%.
  • Housing and Medical Care still keeping pressure on core.

  • Interestingly, these other categories, including Food, and Energy too, all saw acceleration this month (except for other).

  • distribution of changes getting more spread out…

  • Percentage of basket over 3% hasn’t changed much, ergo median didn’t change much.

  • Does this change the Fed’s calculus? I don’t think so, especially with wages accelerating. Still waiting for one-offs to unwind.
  • The doves will argue that the unwind of a one-off is itself a one-off and we should therefore look thru and see 0.12-0.14 as the trend.
  • They’re unlikely to carry the day in Dec, even if the data don’t bounce higher. But if core stays weak the mkt will unwind the 3 in 2018.
  • 10y breakevens -3bps since the number. Market had seemed a little long but this is still too low for breakevens.
  • Four pieces. Piece 1: Food & Energy

  • Piece 2: core goods. Won’t go down forever with the dollar well off its highs.

  • Core services less ROS. A bounce. Sustainable? We’ll have to see.

  • Piece 4, Rent of Shelter. Seemingly ignoring continued rise in home prices. Back to model but weaker than I expected.

  • Last chart. here is the argument: do we cheer the weak consumer inflation or worry about higher wages?

  • Yes, wages follow inflation rather than lead…but the Fed doesn’t believe that.

Thanks to everyone who followed my new “premium” (but cheap) channel. I wrote on Wednesday about the reason for changing my Tweet storm; in a nutshell, it’s because research is starting to be priced a la carte at the major dealers and hopefully this means that quality but off-Street analysis might finally be competing on an even footing rather than competing with “free.” If you think there’s value in what I do, I’d appreciate a follow. If not…well, if the market tells me that what I’m producing isn’t worth anything, then I’ll stop producing it of course!

But in the meantime, here is the story of CPI this month. A continuing regression of rents and OER to model levels held core down to recent-trend levels. But there are many one-off and temporary effects that are due to be reversed, and relationships that suggest certain components are due to catch up to underlying realities. For example, here is the picture of Used Cars and Trucks CPI, compared to the Manheim Used Vehicle Value Index 4 months prior.

According to the relationship between these series over the last decade, CPI for Used Cars and Trucks should be growing about 5% faster than it is presently, and rise another 3-4% in the next few months. New and Used Motor Vehicles inflation is about 8% of core CPI, so this effect alone could add 0.7% to core CPI! Or, put another way, right now core CPI is about 0.4% lower than it would be if the CPI was measuring the actual price of vehicles the same way that Manheim does it. That’s a big number when the entire core CPI is only 1.7%.

The continued, and actually extended weakness in core goods is also due to reverse. I don’t mean that core goods inflation will go from -1% to +3% but only to 0.5%. But that 150bp acceleration, in one-quarter of the core CPI, would also raise core CPI by 40bps or so. To be sure, there is some double-counting since a third of core commodities is new and used vehicles, but that merely reinforces the message.

So, too, are the effects in medical. Volatility in those series should persist, which means that since they are at a low ebb there’s a better bet that the next volatile swing is to higher prices.

All of which is to say that the hawks on the Federal Reserve Board actually have it right, in a sense. Prices are headed higher, and inflation is accelerating. It would be a truly shocking development if core inflation one year from now was unchanged from the current level. Indeed, I think there is a better chance that core inflation is above 2.7% than below 1.7%. On another level, the hawks aren’t quite right though. By hiking rates before draining excess reserves, the Fed risks kicking off the vicious cycle I have mentioned before: higher rates cause higher money velocity, which causes higher inflation, which causes higher rates etc. Without control of reserves at the margin, the Fed cannot control money supply growth and so the normal offset to rising monetary velocity in a tightening cycle, slowing money growth, comes down to chance. Either way, the Fed is very likely to tighten in December, but beyond that it probably matters more who ends up in the Chairman’s seat than anything economic data.

The Mystery of Why There’s A Mystery

October 10, 2017 Leave a comment

We have an interesting week ahead, at least for an inflation guy.

Of course, the CPI statistics (released this Friday) are always interesting but with all of the chatter about the “mystery” of inflation, it should draw more than the usual level of attention. That’s especially true since the mystery will cease to be a mystery fairly soon as even flawed indicators of inflation’s central tendency, such as the core CPI, turn back higher. This is not particularly good news for many pundits, who have declared the mystery to be solved with some explanation that implies inflation will stay low.

  • “Amazon effect”
  • Globalization
  • “competition”
  • Etc

The first of these I have addressed previously back in June (“The Internet Has Not Killed, and Will Not Kill, Inflation”). The second is a real effect, but it is a real effect whose effect peaked in the early 1990s and has been waning since then. I wrote something in our quarterly in Q4 last year, which is partly summarized here.

The “competition” objection is a weird one. It seems to posit that competition was pretty lame until recently, which is pretty strange. One argument along these lines is in this article by Steve Wunsch, who considers the increase in airline fees “stark evidence of a deflationary spiral in those ticket prices caused by antitrust-induced competition.” This is odd, since airlines were deregulated in 1978 and have in recent years become less competitive if anything with the mergers of Delta/Northwest in 2009, United/Continental in 2010, Southwest/AirTran in 2011, and US Airways/American Airlines in 2013. A flaccid antitrust response from the Justice Department has allowed quasi-monopolies to develop in some travel hubs, which has tended to push fares higher rather than lower. The chart below shows the relationship between Jet Fuel prices and the CPI for airfares (both seasonally adjusted) for the 20 years ended in 2014, along with the most-recent point from last month.

The highly-explanatory R-squared of 0.81 suggests that there is not much wiggle room in airline pricing. Airfares are, as you would expect under a competitive industry, roughly cost-plus with the main source of variance being jet fuel prices. This is true even though we would expect that spread to vary over time. As Mr. Wunsch would argue, the highly competitive nature of the industry is holding down the non-commodity price pressures in airfares.

The only problem is that if you extend this graph to include the last three years, the R-squared drops about 10 points:

In case it isn’t clear from that chart, the last three years have seen airfares increasingly above what we would expect from the level of jet fuel prices. The next chart makes that clear I hope by plotting the residual (and 12-month moving average to smooth out seasonal issues such as one that evidently happened last month) between the actual CPI-airfare and the level that would be predicted from the 1994-2014 relationship. As you can see, prices have been higher, and increasingly so, than we would have thought, until this last month or two – and I wouldn’t grab a lot of comfort from that yet.

Not only is this not “stark evidence of a deflationary spiral in those ticket prices caused by antitrust-induced competition,” it seems to be stark evidence of inflation in ticket prices caused by a reduction in competition thanks to airline mergers.

In reading these many articles, it always is somewhat striking to me: everybody thinks their answer is “the” answer to the mystery. But most of these authors really don’t sufficiently understand how inflation works, and what the data is showing. This is apparent to those who do understand these nuances, as an author might discuss (as the one mentioned above did) an “aberration” in cell phone inflation as if the experts are stupid for expecting inflation when cell phone services only go down. The author clearly misunderstands what the “aberration” referred to even is; in this case the aberration was an enormous one-month collapse in prices that had never been seen and has not been repeated since. (For those who are curious about the aberration, and why it occurred, and why it is likely a methodology issue rather than sign of spiraling deflation in wireless services you can see my discussion of it here.)

The mystery is simple – the Fed’s models don’t work, and don’t take into account the fact that lower interest rates cause lower money velocity. They rely on a Phillips Curve effect that they think is broken because they don’t understand that the Phillips Curve relates wages and unemployment, not consumer prices and unemployment. They focus on a flawed measure like PCE rather than on something like Median CPI which, coincidentally, is a lot higher and suggests more price pressures. The mystery isn’t why inflation isn’t rising yet – the mystery is why they think there’s a mystery.

Summary of My Post-CPI Tweets (Sep 2017)

September 14, 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 or Enduring Intellectual Properties. 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 or get it a little cheaper on our site here.

  • 15 minutes to go to CPI. Consensus on core is for 0.17% or so. But due to tough year-ago comparison, y/y should drop to 1.6%
  • Hurricane effects may boost headline a bit, though most of that will be later. Shouldn’t see core effects yet.
  • Core effects may potentially be seen (eventually) in shelter and vehicles; both were destroyed in large amounts in Harvey/Irma
  • well well well. Core +0.249%, ALMOST 0.3% rounded. y/y to 1.69%
  • Turnabout is fair play. Highest core CPI in 8 months, and haven’t seen hurricane effect yet.

  • Note the easy comparisons from year ago for the next couple of months, too. Might just have seen the lows in core.
  • housing up, medical care down again. Drilling down now…
  • core services was up to 2.5% from 2.4%…core goods down to -0.9% from -0.6%! With dollar weakening that’s going to change.
  • Housing 2.91% from 2.83% y/y. Primary rents 3.88% from 3.81%; OER 3.27% vs 3.21%.
  • Lodging Away from Home +0.23% vs -2.36% y/y. That was one of those one-offs. Poof.
  • Motor vehicles -1.57% vs -1.72%. No hurricane effect yet but as I said on Bloomberg today…that’s likely to be a big + going forward
  • 81% vs 2.58% last month on Medical Care as a whole. Medicinal Drugs: 2.51% v 3.84%. Hospitals 4.09% v 5.31%. Insurance 0.17% v 1.24%
  • Professional services (medical) unch at just +0.2% y/y.
  • Figure out whether this medical care pricing collapse is temporary or real and you have the big story.
  • medicinal drugs:

  • Housing and medical care. I think the Medical Care move is mostly a composition change, catching more self-pay from insurance-pay.

  • Does this change anything for the Fed? Not with the hurricanes. Expect movement to reduce balance sheet, while holding rates down.
  • Enough for today. Will put up my summary article later. If you want the chartbook go to https://store.enduringip.com
  • [later:] Median CPI was 0.247%, y/y at 2.15% up from 2.13%, basically stable since June between 2.13% and 2.18%.

This was a shorter string of tweets than I usually produce. Part of the reason for that was that I was in a car careening down the highway returning from my appearance on Bloomberg TV to talk about the Phillips curve and auto inflation, and partly it was because this one was pretty easy.

Lodging Away from Home jumped. But it had previously plunged inexplicably, so this is just a reversal. I didn’t tweet about that one, but it is symptomatic – there are a number of one-offs, and some of them are going to reverse.

Rents rose a bit, but again that is partly just a retracement of the recent slide. As I pointed out last month, that slide merely put rents back on the model where they had been running ahead of the model, so this isn’t terribly surprising.

The really surprising part was and is the Medical Care part. All subcomponents of that index are now decelerating, although pharmaceuticals are doing so in a slightly less-dramatic fashion than medical professional services. This is very outside of anyone’s forecast ranges. It is possible this is just payback for the rises the previous year, but if that’s the case then it’s not going to continue. Is it possible that we suddenly have reined in the price of medical care by making it hard to acquire? I suppose that’s possible, but I would think the better bet is that the composition of services is changing as people are paying for more out of pocket – so we buy the band-aid rather than the tourniquet, and that looks like lower prices. It is, however, really hard to tell at this point and that’s the main remaining conundrum.

I said up top that the important hurricane effects, notably in Motor Vehicles but also in Shelter, have not been felt yet. (Read more about these upcoming effects in my column “Some Effects on Inflation from Harvey and Irma”). Moreover, the next few months will see core CPI comparisons of 0.12%, 0.15%, and 0.18% from last year. Accordingly, I think core which is currently at 1.69% will be at 1.77% next month, 1.82% the following month, and 1.84% the month after that. Importantly, none of that is enough to scare the Fed into hiking again, and with the hurricane damage I think they’ll eschew further rate hikes for a while. However, they will probably start reducing the balance sheet, and if they can manage to sustain that – reverse QE, but holding policy rates down – then they will have lucked into the “right” policy that could keep inflation’s peak in the 3%-4% range rather than the 5%+ trajectory that many of their other paths have. I am skeptical they will stay the course, because reverse QE will have bad effects on asset prices. But it’s a start.

Categories: CPI, Tweet Summary

Some Effects on Inflation from Harvey and Irma

September 11, 2017 3 comments

It has been a rough few weeks. First, Hurricane Harvey drenched Houston and south Texas with feet of rain, turning millions into temporary refugees and tens of thousands of them into longer-term refugees as 40,000 homes were destroyed along with a million automobiles. Then, Hurricane Irma battered Miami and Tampa Bay, which is a rare feat, and seems likely to make it the fourth most-damaging hurricane in nominal dollar terms in US history (behind Katrina, Sandy, and Harvey).

And of course, there’s the memorial of September 11th. I once thought that this day would someday become less raw, but remarkably the passage of time has not applied the usual salve in this case. I don’t know why. But the terrorist attacks of that day no longer affect the markets, so we nod and somberly reflect, and move on.

But those other two events will have an impact on markets and on data. Interestingly, the initial response to Irma was a strong rally in equity markets, as the damage was not as great as originally feared – perhaps $50bln, rather than $250bln, in damages. Aside from the human toll, whose value is beyond accounting, this is potentially a large figure for insurance companies and owners of catastrophe bonds (or what is left of them) but a mere scratch on the GDP of the nation as a whole. The total cost of the two hurricanes will be something in the neighborhood of 1% of GDP – although very unevenly distributed.

It is de rigeur in times like these to point out that GDP will increase over time with the expenditure of rebuilding, but of course the nation is not better off and so this is not good for the economy. More thoughtful models note that the national accounts gain that 1% back over the next few years, but local production from the affected areas is at least temporarily reduced so that the net effect is actually somewhat negative over the next several years. The net effect overall is small…but very unevenly distributed.

Some of the upward inflation pressure from the hurricanes comes from the additional pressure in commodities markets. Demand for steel and wood are likely to be elevated as these areas rebuild. For a short time, there will be higher prices for these things locally, and for gasoline, due to the difficulty of delivery to the affected communities. The additional demand might even cause some marginal pressure in commodities markets for industrial metals (e.g.). But in the longer-term there will be no shortage of these items because these goods are bought and sold on international markets and are easily delivered to ports in Houston, Miami, and Tampa Bay. It just takes some time to get the logistics train running. But the uneven distribution of the damage will matter in other ways. For example, there is no way to take a surplus of shelter in one area of the country and move it to another area (mobile homes excepted). Those 40,000 homes in Texas and thousands of others in Florida will need to be rebuilt in situ. Many others will need significant repairs to be nominally habitable. This will not happen overnight, which means that there is an abrupt shelter shortage in Houston and in Florida, and this can be expected to affect inflation.

It is very hard to assess just how much shelter inflation can be expected to follow from these storms. There aren’t many major hurricanes, and for each data point there are lots of other effects that get entangled so that my thoughts here are clearly speculative. But consider the chart below (Source: BLS), which shows Houston-area Shelter CPI (year/year) and compares it to the national Shelter CPI.

In September 2008, when Hurricane Ike hit Texas, housing prices nationally were already decelerating. They had remained elevated in Houston up to that point – thanks in part to $120/bbl oil – but probably would have rolled over almost immediately when the global financial crisis smashed energy markets along with housing markets. Yet, in Houston home prices actually accelerated over the next year before finally declining in late 2009. This is likely to be a side-effect of Ike, and I think we will see similar effects in the cost of shelter in Houston, Miami, and Tampa Bay this time too. This will likely provide a small upward lift to national Shelter prices and hence core CPI over the next year.

The other way that the hurricanes will help push core CPI higher is by helping to alleviate the recent pressure on motor vehicle prices. As the chart below (Source: BLS) shows, new and used vehicle inflation has not been a significant contributor to inflation since early 2012, thanks partly to years of channel-stuffing by manufacturers offering 0% financing along with great lease terms for those who don’t want to buy.

But consider late 2009. The “Cash for Clunkers” program, which took effect in mid-2009, provided cash rebates for consumers to swap used cars for new cars. While largely considered a failure as a stimulus plan, it did produce a sharp increase in motor vehicle prices overall. Prior to C4C, motor vehicle prices were stagnant; by the program’s end prices were rising and they kept rising for some time, at a rate of about 5% per annum between late 2009 and late 2010 – about 4% faster than core inflation at the time. Cash-for-Clunkers took about 700,000 cars off the road. Harvey is taking out about a million. Though those are all in Texas cars, unlike houses, are mobile and surplus inventories will surely be shipped southward with alacrity.

I don’t know why this is a bullish thing for the equity market. But I understand why inflation swaps are at three-month highs and headed higher.

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