Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy or sign up for email updates to my occasional articles here. Investors with interests in this area be sure to stop by Enduring Investments. Plus…buy my book about money and inflation, just published! The title of the book is What’s Wrong with Money? The Biggest Bubble of All; order from Amazon here.
- In prep for CPI: Econs forecasting about 0.15% core; Cleveland Fed’s Nowcast is 0.18%; avg of last 4 months is 0.20%.
- So, econs which have been too bullish on econ for a year (see citi surprise index) are bearish on CPI.
- If we get any m/m core less than 0.20% (even 0.19%), y/y will round to 2.1% b/c dropping off high 2015 April.
- But after that, next 8 months from 2015 were <0.20% so any downtick wouldn’t be start of something new.
- Hard to tell but the core CPI print was SLIGHTLY above expectations. 0.195%, so y/y was 2.147%.
- In other words, if someone charged another nickel for a candy bar somewhere we would have had 2.2% again. <<hyperbole
- That 0.195% m/m was lower than April 2015, but higher than May, June, July, Aug, Sep, Nov, and Dec.
- Core services unch at 3.0%; core goods downticked to -0.5% y/y.
- y/y Medical Care decelerated for second month in a row, down to 2.98% y/y; still looks to be in a broad uptrend from 2% in 2014. [ed note: chart added for clarity]
- Within Medical Care, medicinal drugs accelerated, prof svcs was flat. Hospital svcs dropped from 4.33 to 3.15% y/y
- Hospital services oscillates – we’ll probably get that back to 4%-4.5% which will push med care back up.
- Primary Rents 3.73% from 3.66%. OER 3.15% from 3.12%. Some were expecting deceleration there. Not us!
- Lodging Away from Home dropped to 1.32% from 2.27%. That, and various home furnishings, is why Housing subcat went to 2.12 vs 2.14.
- But Rents and OER are the stable measures…not Lodging, not furnishings.
- Core ex-housing fell to 1.39% from 1.48%, but again that’s due to elements of med care and housing that are likely to rebound.
- Lots of movement within Apparel but overall nothing. The February pop looks like a one-off.
- Overall, a more buoyant number than expected and the stuff holding core CPI down are the transient things.
- Biggest m/m declines: infants’/toddlers’ apparel (-26.5% annualized), fresh fruits & veggies; women’s apparel; Lodging away from home.
- Biggest m/m outliers: Motor Fuel (+152.3% annualized), Fuel Oil, Processed Fruits & Veggies; Motor Vehicle Insurance.
- My estimate of median CPI is actually 0.28% m/m and 2.46% y/y. But…
- …but the median category this month may be affected by regional housing, and I don’t have the BLS factors. So grain of salt needed.
- This summarizes the inflation story. Rents and Services ex-rents both rising ~3%. Core goods is the anchor.
Discussion: after last month’s surprising m/m core CPI print of +0.07%, many were questioning whether that was the outlier, or whether the +0.29% and +0.28% of January and February were the outliers. The answer might be that they are all outliers, as this month’s print was very close to the 4-month average. But even so, +0.2% m/m would produce a 2.4% core inflation number by the year’s end. That’s consistent with what we are being told by Median inflation. Both figures would suggest core PCE, after all of the temporary effects are removed, is essentially at or slightly above the Fed’s 2% target.
There are two pertinent questions at this juncture. The first is whether the Fed will feel any urgency to raise rates more quickly because of this data. The answer to that, I think, is clearly “no.” This Federal Reserve’s reaction function seems to be overly (and overtly) tilted towards growth indicators – and even more than that, their forecast of growth indicators. The majority of the Committee also believes that inflation expectations are “anchored” and so inflation can’t really move higher very quickly. They only pay lip service to inflation concerns, and honestly they aren’t even very good at the lip service.
The second question is where inflation goes next. Whether the Federal Reserve raises the target overnight rate or not, the question of inflation is relevant for markets. And the indicators seem to be fairly clear: the larger and more persistent categories are seeing price increases of around 3% or more, while the main drag comes from a “core goods” component that is highly influenced by the lagged effect of dollar strength (see chart, source Bloomberg).
Recently, the dollar has been weakening marginally but still is in a broad uptrend (looking at the broad, trade-weighted dollar). But if the buck merely goes flat, core goods will start to move higher. And that means even if core services remain steady, core inflation should push towards 3% later this year.
This doesn’t sound like much but it would be highly significant (and surprising) for many observers, investors, and consumers. Core inflation has not been above 3% for two decades (see chart, source Bloomberg).
This means – incredibly – that many students in college today have never seen core inflation above 3%, and more importantly many investors have not seen core inflation above 3% during their investment lives. When core inflation breaches that level, it will feel like hyperinflation to some people! And I do not think markets will like it.
The Employment report was weak, with jobs coming in below consensus with a downward revision to prior months. It wasn’t abysmally weak, and not enough to change the a priori trajectory of the Fed. If the number had been 125k below expectations or 125k above it, then it may have had implications for the FOMC. But this is a number that has big swings and is revised multiple times. Getting 160k rather than 200k isn’t cause for celebration, but neither is it cause for panic. So whatever the Fed was getting ready to do didn’t change because of this number.
To be sure, no one knows what the Fed was planning to do, so this mainly has implications for the day’s volatility…which is to say that the market quickly went to sleep for the day.
Now, interestingly the Average Hourly Earnings number ticked higher to 2.5%, continuing the post-crisis upswing. At 2.5%, hourly earnings growth is slightly higher than median inflation and thus potentially “supportive of the inflation dynamic” from the standpoint of the Committee. Yes, wages follow inflation but not in the Fed models – so, while I don’t think this has any implications for future inflation it will eventually have implications for Fed policy. But this is a dovish Fed, and 2.5% earnings growth is not going to scare another tightening out of them…unless they were already planning to tighten.
Wages are actually a bit higher than that. Back in April I highlighted the Atlanta Fed’s Wage Growth Tracker and summarized how this measures is better than Hourly Earnings. I hadn’t been aware of this index previously but I follow it now. It stands at 3.2%. The difference between average hourly earnings and the Atlanta Fed Wage Tracker is summarized below (Source: Bloomberg). Again, though: I don’t think we have seen anything today which will change the Fed’s collective opinion about the need for different monetary policy.
Earlier this week, I promised that I would revisit the question of how we can have both deflation and inflation, and how these concepts are confused. I first posted an article summarizing this point in January 2014, and in re-reading it I think it is good enough to pretty much cut-and-paste with only mild edits. So here it is:
How Inflation and Deflation Can Peacefully Coexist
In the discussion about whether the economy is exhibiting “inflationary tendencies” or “deflationary tendencies,” I find that many, many observers grow confused by the fact that we measure prices in dollars, which are themselves subject to changes in relative value due to supply and demand.
It helps to forget about dollars as the unit of measure. Just because it says “One Dollar” does not mean that it is an ever-fixed mark. With apologies to Shakespeare, dollars are not the star to every wandering bark, whose worth’s unknown although its dollar price be taken. There are two ways to look at the “inflation/deflation” debate. Depending on which one you are referring to, deflationary tendencies are not inconsistent with price inflation, and price inflation is not inconsistent with deflationary tendencies.
One is the question of dollar price; and here we are mainly concerned with the supply of dollars and the number of times they are spent, compared to the amount of stuff there is to buy. More dollars chasing the same goods and services imply higher prices. Of course, this is just another way of stating the monetarist equation: P ≡ MV/Q. This is an identity and true by definition. Moreover, it is true in practice: rapid money growth over some moderate length of time always corresponds with rapid deterioration in the purchasing power of the money unit – in other words, inflation. At least, we have no examples of (a) extremely high money growth without high inflation, or (b) extremely high inflation without high money growth.
But this is not the same discussion as saying that “the aging demographic [or debt implosion in a recession] means we will have deflation,” as many economists will have it. Deflation, in that sense, can still happen: if you have fewer workers making the same amount of GDP, then goods (and services) prices will fall relative to wages, which would be deflation the way we typically mean it if the overall price level was otherwise unchanged. However, if the money supply increases by a factor of 10, then nominal prices will increase no matter what else is going on. It may be, though, that in this case wages will increase slightly more than prices, so that there will be “deflation” in the unitless sense.
So, these are not inconsistent statements: (a) there will be increasing inflation next year, and (b) large amounts of private debt and demographic “waves” around the world are a deflationary force. The resolution to the seeming inconsistency is that (b) causes downward pressure on certain prices relative to other prices or, if you ignore the unit of exchange, it causes downward pressure in the ratio of one good that can be exchanged for another. Yet at the same time (a) implies that the overall increase in output in goods and services will be outstripped by the number of dollars spent on them, driving prices higher.
So you should cheer for the “good” sort of deflation. At least, you should cheer for it if you are still earning wages. But do not confuse that concept with the notion that prices in dollar terms will fall. That is wholly different, and unless central banks screw up pretty badly it is not going to happen. Indeed, despite all of the so-called “deflationary tendencies” – most of which I agree are important – I believe prices are going to rise in dollar terms and in fact they are going to rise at increasing rates (higher inflation) over the next few years.
P.S. Don’t forget to buy my book! What’s Wrong with Money: The Biggest Bubble of All. Thanks!
 I kept this sentence…it was true in January 2014, as median inflation moved from 2.06% in Dec 2013 to 2.4% today, but I also believe this to be still true. Only the next leg will probably be faster.
Durable goods orders, ex-transportation, showed a negative print today for the second time in a row. This was expected, in most senses of the word, but while I don’t put too much weight on short-term wiggles in Durables it is hard to ignore the fact that the year/year change in Durables has now been negative for more than a year (see chart, source Bloomberg).
So the weakness in Durables is not new. But it bears noting that the last time core Durables went negative, in August 2012, the Fed followed with QE3 almost immediately. To be sure, at the time core inflation was all the way down at 1.9%, whereas today it is a heady 2.2%…
Look, any Fed watcher right now is and should be confused. Conditions which provoked QE just four years ago are now apparently spurring a tightening bias. Bill Gross can be excused for thinking that the Fed will go back to the old playbook and employ new QE, as he apparently did in his latest Investment Outlook – it is harder to excuse his saying that the Fed should drop money, given that it hasn’t worked yet.
But clearly, something is different in the way the central bank is approaching monetary policy. After all, nothing about this weakness is new. As noted, Durables have been negative on a year-over-year basis for a full year, and the Citi Economic Surprise index shows that economists have managed to be surprised on the negative side for an unprecedented fifteen months in a row (see chart, source Bloomberg).
Okay, the index technically turned positive once or twice for a day or two, but this is still the longest run of persistently optimistic errors that economists have had in a very long time. So this isn’t new – the economy is weak.
Unless…unless what is different is that in 2012, economists were pessimistic (the Citi Economic Surprise index turned positive right before the Fed started QE, which means that either the data was too strong or economists were too negative) whereas today they are more generally optimistic? It would be entirely consistent with how the Fed has been run for the last couple of decades if monetary policy was not being guided by actual data, but by forecasts of data. (See my book for more on monetary policy errors!)
Evidence is pretty clear that recently economists as a whole have not only been wrong, but wrong in a biased way, which is much worse. If you are merely a bad shot, you miss the target in all kinds of directions. But if you persistently miss the target in one direction, then it may well be that your weapon sights are not properly calibrated. The first sort of unbiased miss is not as dangerous, even if too much confidence is placed on the shot, because the errors will even out over time. You might eventually hit the target, by accident. But if the target sights are biased, then you will never hit the target until you realize you’re wrong. You would be tightening when you should be easing. A broken clock is right twice per day, but only if it is stopped and not just systematically two hours off.
Now, regular readers of these columns will understand that I don’t think the Fed should be easing. I don’t think the Fed can fix what ails growth, since monetary policy only affects the price variable, and easy money has only created the conditions for the inflationary upswing we are currently experiencing (Gross also acknowledges this, but sees the inflationary upswing somewhere in the unthreatening future while in fact it is here now). The Fed should have eschewed QE2 and QE3, and have long since begun to drain excess reserves. But what I think the Fed should do and forecasting what I think they will do are two very different things.
I suspect Gross is close to right. Absent some recovery in the real economy – something other than payrolls, which as we know lag – it strikes me as unlikely the Fed will be hiking rates again. Ironically, that may help keep inflation leashed for longer since it will help keep monetary velocity constrained – but I am not confident of that, given how low interest rates already are. Since inflation is very unlikely to wane any time soon, I think we are more likely to see the yield curve steepen from these levels, rather than flatten. A yield curve inversion is not a prerequisite for recession. Inverted yield curves tend to precede recessions only because the Fed is typically slow to lower interest rates in response to obvious weakness. In this case, rates are already low and the Fed isn’t likely to raise them and force a curve inversion. Yield curve inversions are not causal! This next recession may catch some people wrong-footed because they keep waiting for the inversion that never comes.
In my next article, I am going to revisit an issue I first addressed a couple of years ago and which might be especially relevant as recession possibilities increase: the question of how we can have both deflation and inflation, and how these concepts are often confused by those people who are stuck in the nominal world.
Today the 1-year CPI swap rate closed at 1.77%, the highest rate since 2014 (see chart, source Bloomberg).
The CPI swap (which, as an aside, is a better indicator of expected inflation than are breakevens, for technical reasons discussed here for people who truly have insomnia) indicates that headline inflation is expected to be about 1.77% over the next year. That’s nearly double the current headline inflation rate, but well below the Fed’s target of roughly 2.3% on a CPI basis. But at least on appearances, investors seem to be adjusting to the reality that inflation is headed higher.
Unfortunately, appearances can be deceiving. And in this case, they are. The headline inflation rate is of course the combination of core inflation plus food inflation and energy inflation; as a practical matter most of the volatility in the headline rate comes from the volatility endemic in energy markets. I’ve observed before that this leads to unreasonable volatility in long-term inflation expectations, but in short-term inflation expectations it makes perfect sense that they ought to be significantly driven by expectations for energy prices. The market recognizes that energy is the source of inflation volatility over the near-term, which is why the volatility curve for inflation options looks strikingly like the volatility curve for crude oil options and not at all like the volatility curve for LIBOR (see chart, source Enduring Investments).
The shape of the energy futures curves themselves also tell us what amount of energy price change we should include in our estimate of future headline inflation (or, alternatively, what energy price change we can hedge out to arrive at the market’s implied bet on core inflation). I am illustrating this next point with the crude oil futures curve because it doesn’t have the wild oscillations that the gasoline futures curve has, but in practice we use the gasoline futures since that is closer to the actual consumption item that drives the core-headline difference. Here is the contract chart for crude oil (Source: Bloomberg):
So, coarsely, the futures curve implies that crude oil is expected to rise about $4, or about 9%, over the next year. This will add a little bit to core inflation to give us a higher headline rate than the core inflation rate. Obviously, that might not happen, but the point is that it is (coarsely) arbitrageable so we can use this argument to back into what the market’s perception of forward core inflation is.
And the upshot is that even though 1-year CPI swaps are at the highest level since 2014, the implied core inflation rate has been steadily falling. Put another way, the rise in short inflation swaps has been less than the rally in energy would suggest it should have been. The chart below shows both of these series (source: Enduring Investments).
So – while breakevens and inflation swaps have been rallying, in fact this rally is actually weaker than it should have been, given what has been happening in energy markets. Investors, in short, are still irrationally lugubrious about the outlook for price pressures in the US over the next few years. Remember, core CPI right now is 2.2%. How likely is it to decelerate 1.5% or more over the next twelve months?
(**Administrative Note: Get your copy of my new book What’s Wrong with Money: The Biggest Bubble of All! Here is the Amazon link.)
Following is a concatenation of my post-CPI tweets. You can follow me @inflation_guy. Due to scheduling issues, I don’t have any further development of the observations highlighted below.
- OK, 4 minutes until CPI. If I had to guess what a theme, I would say the question of whether apparel and medical care trends continue.
- Is apparel the canary in the coal mine from recent jumps? And is CPI or PPI right about medical care? The latter has been softer.
- Weak CPI number! 0.1%/0.1% and y/y core slipped to 2.2%!
- even weaker than that…+0.07%, 2.20% exactly y/y on core. That’s a really big surprise.
- first glance – medical care y/y slipped, and apparel y/y plunged. getting more detail
- core services slipped to 3.0% from 3.1%; core goods dropped to -0.4% from +0.1%
- while i’m waiting for more detail…this CPI doesn’t mean it’s done going up; just that we can’t reject the hypothesis that it’s not.
- have to remember these are experiments – underlying inflation rate not knowable so we can only reject hypotheses.
- my suspicion: we may be able to lean more to the “apparel was seasonal” hypothesis but jury is out on medical care normalization.
- ok – apparel -0.64% from +0.89% y/y. medical care 3.29% from 3.50%. housing up small, recreation, education/comm, other all up small.
- within apparel: Mens suits/sportcoats/outerwear -7.6% from -4.6%. Mens furnishings -1.2% from +2.2%. Mens pants/shorts -5.8% from +2.4%
- but WOMENS outerwear 5.5% from 3.2%; suits & separates +0.2% from -0.3%. Dresses down though, -6.3% from -4.3%.
- so could be seasonal…but we will have to wait to know for sure. weird, anyway.
- in housing: Primary rents 3.66% vs 3.68%; OER 3.12% vs 3.16%. lodging away from home 2.27% v 4.19%. so rise in housing was HH energy.
- In Medical: drugs 2.49% v 2.34%. Prof svcs 2.27% vs 2.54%. hospital 4.33% v 4.90%. Insuance 6.20% v 5.97%. Similar read to PPI.
- PPI and CPI don’t have much overlap, or we would rely more on the earlier PPI. So hard to read much.
- does mean core PCE not likely to converge as quickly with core/median CPI.
- ok last tweet: early estimate on median still looks like +0.17%, 2.39%, down vy slightly from 2.43% y/y.
None of this changes the underlying focus: median at 2.4% and core converging upward to it. And there’s still no sign that housing is about to weaken. Core goods had been strengthening; this has been arrested but it may be a function of the early Easter (however, Easter occurred for men, too…). As I suspected early – this is a holding-pattern number, certainly weaker than inflation bulls expected but it doesn’t dash the underlying trends…yet. This makes the April number, released next month, more important!
And none of this changes the underlying points I made in a Marketwatch opinion article that appeared yesterday. You can read that article here.
Last week I mentioned something about what Keynes said in the General Theory, and promised to expand on that a bit this week. I will do so, in the form of a book review.
I can’t remember who it was, and I’m sorry, but one of the people who read my articles suggested a book to me a year or so ago published in 2009 and called Where Keynes Went Wrong: And Why World Governments Keep Creating Inflation, Bubbles, and Busts by Hunter Lewis, and I finally got around to reading it. I am very glad I did – this book is terrific, and is a must-read if you are either pro-Keynes or anti-Keynes.
Of course, readers will know from my articles that I am anti-Keynes, although more precisely I am anti-Keynesian in the modern sense of that word. I never read very much of the General Theory, because honestly it is poorly written in the sense of its prose, and I always assumed that Keynes probably had some great insights and it was the later Keynesians that screwed up what he said.
Oh, I was so wrong. Keynes was looney tunes. A bona fide lunatic. He proved masterful in manipulating the cult of personality that existed at the time he was writing, however; he was adept at destroying his opponents in ways that sounded erudite and like certain later personalities the media adored him. All of this is well-documented by Mr. Lewis, although the looney tunes conclusion is my own.
The book is put together brilliantly. The author quotes passages from Keynes, using actual quotes interspersed with paraphrasing – which is necessary because, as I said above, the General Theory is poorly written and opaque. But it isn’t the paraphrasing that is damning. When Mr. Lewis wants to indict Keynes, he does it with his own words. For example, in unraveling the absurd (and often self-contradictory) prescriptions that Keynes had for managing the macro economy, Mr. Lewis declares that Keynes thought government should never raise interest rates. That’s right, never. But you needn’t take Lewis’ word for it. Here’s Keynes, cited in the book:
“The remedy for the boom is not a higher rate of interest but a lower rate of interest! For that may enable the boom to last. The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom.”
If you are anything like me, that sent a shiver down your spine right now. Does that sound at all familiar? Keep in mind that Lewis wrote this book in 2009. He could not possibly have anticipated that interest rates would not move away from zero for seven years (and counting, in some countries). And yet this quote sounds to me so much like what the Mount Rushmore of Fed speakers seemed to be suggesting last week. “It worked,” Bernanke was saying. “We’re not in a bubble economy,” said Yellen. None of them saw any signs of serious imbalances, except Volcker (and he was fairly circumspect about how worrisome they were).
In my own book, I indict Keynesianism in the simplest way: I simply point out that the prescription of the Keynesians hasn’t only not worked, it also has failed in every major prediction since, basically forever. But Lewis attacks Keynes himself, with his own words, from the original source. He explains, very clearly, where Keynes went wrong. If you wonder why world governments keep screwing up economies…you should read this book.
 Apparently elsewhere Keynes said different things but in the General Theory he was consistent on this point.
 Keynes, General Theory, p. 322; quoted on page 20 of Where Keynes Went Wrong by Hunter Lewis.
In yesterday’s article, I neglected to mention one remark by a former Fed chair that bothered me at the time. However, I didn’t mention it because I thought the reason it bothered me was that it was vacuous – the sort of throw-away line that someone uses to stall while thinking of the real answer to the question. Since then, I’ve realized what specifically annoyed the subconscious me about the remark.
When Bernanke was asked about whether a recession is coming at some point; he glibly replied “Expansions don’t die of old age,” as if that was obvious and the questioner was being a dolt. Like so much of what Bernanke says, this statement is both true, and irrelevant.
Human beings, also, don’t die of old age. There is a cause of death – something causes a person to die; it isn’t that their library card of corporeality became overdue and they expired. The cause may be a heart attack, a slip-and-fall in the bathtub, cancer, pneumonia, complications from surgery, or the flu, but death is the result of a cause. It just happens that as a person gets older, the number of potential causes multiplies (a newborn rarely has a heart attack) and the number of causes that become fatal to an old person, where they would be merely inconvenient to a hale person, increases as well. As we age, parts of our bodies and immune systems weaken – and that’s where death sneaks in.
Think of those weaknesses as…let’s call them imbalances that have accumulated.
The statement that expansions don’t die of old age is literally true. Something causes them to die. It may be monetary error, but as Volcker pointed out last night in answer to a different question, there were recessions long before there was a Federal Reserve. Expansions also can die from a diminution of credit availability, from energy price spikes, from malinvestment, from an overextension of balance sheets that leads to bankruptcies…from a myriad of things that may not kill a young, vibrant expansion.
The parallel is real, and the point is that while this expansion was never very vibrant the current imbalances are legion. The Fed may not see them, or may believe them to be small (like Bernanke’s Fed felt about the housing bubble and Greenspan’s Fed felt about the equity bubble). But the Fed has a fantastic record on one point: they are nearly flawless at misdiagnosing a patient who is sickening.