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Summary of My Post-CPI Tweets

September 16, 2016 5 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. Plus…buy my book about money and inflation, published in March 2016. The title of the book is What’s Wrong with Money? The Biggest Bubble of All; order from Amazon here.

  • OK, 8 minutes to CPI. Street forecast is 0.14-0.15%, so a “soft” 0.2% or a “firm” 0.2% on core.
  • y/y core wouldn’t fall with that b/c last August’s core CPI was 0.12%. In fact, a clean 0.2% would cause the y/y to round up to 2.3%.
  • Either way, Fed is at #inflation target based on historical CPI/PCE spread. And arguably above it if you rely (as we do) on median.
  • Quick commercial message: our crowdfunder site for the capital raise for Enduring Investments closes in 2 weeks.
  • Commercial message #2: sign up for my articles at https://mikeashton.wordpress.com! And #3: my book!
  • Fed’s job just got a lot harder, with weaker growth but a messy inflation print. 0.25% on core, y/y rises to 2.30%.
  • And looking forward BTW, for the balance of the year we’re rolling off 0.19, 0.20, 0.18, and 0.15 from last year.
  • …so it wouldn’t be hard to get a 2.4% or even 2.5% out of core by year-end.
  • Housing rose to 2.58% y/y from 2.45%. Medical Care to 4.92% from 3.99%. Yipe. The big stories get bigger.
  • checking the markets…whaddya know?! they don’t like it.
  • starting to drill down now. Core services 3.2% from 3.1%; core goods -0.5% from -0.6%.
  • Core goods should start to gradually rise here because the dollar has remained flat for a while.
  • also worth pointing out, reflecting on presidential race: protectionism is inflationary. Unwinding the globalization dividend=bad.
  • Take apparel. Globalizing production lowered prices for 15 years 1994-2009.

apparel

  • Drilling down. Primary rents were 3.78% from 3.77%, no big deal. OER 3.31% from 3.26%, Lodging away from home 3.31% from 1.57%.
  • Lodging away from home was partly to blame for last month’s miss low. Retraced all of that this month.
  • Motor vehicles was a drag, decelerating further to -0.95% from -0.75%.
  • Medical Care: Drugs 4.67% from 3.77%. Professional svcs 3.35% from 2.86%. Hospitals 5.81% from 4.41%. Insurance 9.13% vs 7.78%
  • Insert obvious comment about effect of ACA here.
  • y/y med care highest since spike end of 2007.

medcare

  • CPI Medical – professional services highest since 2008.

prof

  • On the good news side, CPI for Tuition declined to 2.53% from 2.67%. So there’s that.
  • Bottom line: can’t put lipstick on a pig and make it pretty. This is an ugly CPI report. It wasn’t one-offs.
  • I STILL think the Fed doesn’t raise rates next week. But this does make it a bit harder at the margin.
  • Core ex-housing was 1.52%. It was higher than that for one month earlier this year (Feb), but otherwise not since 2013.

coreexshelter

As I noted, this is an ugly report. The sticky components, the ones that have momentum, continue to push inexorably higher (in the case of housing), or aggressively higher (in the case of medical care). The rise in medical care is especially disturbing. While core was being elevated mainly by shelter, it was easier to dismiss. “Yes, it’s a heavily-weighted component but it’s just one component and home-owners don’t actually pay OER out of pocket.” But medical care accelerating (especially a broad-based rise in medical care inflation), makes the inflation case harder to ignore. It is also really hard to argue – since there is a clearly-identifiable cause, and a strong economic case for why medical care prices are rising faster – that medical care inflation is resulting from some seasonal quirk or one-off (like the sequester, which temporarily pushed medical inflation down).

What makes this even more amazing is that inflation markets are priced for core and headline inflation to compound at 1.5%-1.75% for basically the next decade. That’s simply not going to happen, and the chance of not only a miss but a big miss is nonzero. I continue to be flabbergasted at the low prices of TIPS relative to nominal bonds. Sure, a real return of 0% isn’t exciting…but your nominal  bonds are almost certainly going to do worse over the next decade. I can’t imagine why anyone owns nominal bonds at these levels when inflation-linked bonds are an option.

Now, about the Fed.

This report helps the hawks on the Committee. But there aren’t many of them, and the central power structure at the Federal Reserve and at pretty much every other central bank around the world is very, very dovish. Arguably, the Fed has never been led by a more dovish Chairman. I have long believed that Yellen will need to be dragged kicking and screaming to a rate hike. Recent growth data show what appears to be a downshift in growth in an expansion that is already pretty long in the tooth, so her position is strong…unless she cares about inflation. There is no evidence that Yellen cares very much about inflation. I think the Fed believes inflation is low; if it’s rising, it isn’t going to rise very far because “expectations are anchored,” and if it does rise very far they can easily push it lower later. I think they are wrong on all three counts, but I haven’t recently held a voting position on the Committee. Or, actually, ever. Ergo, a Fed hike in my view remains very unlikely, even with this data.

Looking forward, Core and Median inflation look set to continue to rise. PCE will continue to drag along behind them, but there is no question inflation is rising at this point unless everything except PCE is wrong. In the US, core inflation has not been above 3% for twenty years. That is going to change in 2017. And that is not good news for stocks or bonds.

allup

Summary (and Extension) of My Post-CPI Tweets

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

  • 5 minutes to CPI. Consensus is for core to barely round to 0.2%, and for y/y core to remain at a soft 2.3%
  • I have the “over” there, but the “under” against my friend who thinks it’s gonna be 0.24%.
  • Core CPI +0.09%, y/y drops to 2.20%.
  • Waiting for the breakdown to dig deeper. Housing accelerated y/y, as did Medical care, but Apparel, Rec, Educ/comm all lower.
  • …Housing and Medical care are the big longer-term concerns so the internals might not be as weak as the headline. Taking a look now.
  • Meanwhile Dudley on the tape saying “probably don’t have to do a lot of tightening over time.” Echoes Williams. When doves cry.
  • At the same time Dudley says rate hike is possible in September. Sure, anything is possible. But not with core printing 0.1% m/m.
  • ..in Housing, Primary Rents fell to 3.77% from 3.81% y/y. OER rose to 3.26% vs 3.25%, continuing flat patterns.
  • Those are the biggest parts of housing. Lodging away from home plunged y/y. Where did the rise in housing come from? Household energy.
  • HH energy -1.37% y/y vs -3.02%. That’s 3.8% of the CPI, but not in core obviously. So housing ex-energy was basically flat.
  • Overall Medical Care category rose to 3.99% from 3.65% and 3.17% the month before that. Jumps in every category:
  • Drugs 3.77% (vs 3.40%). Equipment/supplies 0.1% (-0.62%). Prof Svcs 2.86% (2.60%). Hospital 4.41% (4.12%). Health Ins 7.78% (7.10%)
  • Large jumps everywhere in Medical Care. *Discuss.*
  • Apparel still rising y/y, at 0.35%, but won’t really take off until the dollar declines.
  • Overall, core services +3.1% (was 3.2%) and core goods -0.6% (unch).
  • Popular number is core ex-housing. 1.36% y/y vs 1.37%.
  • So overall, despite the weak m/m core number, the big trends remain in place. Housing flat to higher. Medical Care starting to ramp up.
  • A broad array of volatile components dragged m/m CPI down. But 59% of the basket is still accelerating faster than 3%.
  • Biggest monthly falls: motor fuel, car and truck rental, public transp, lodging away from home, and misc pers goods. All <-20% m/m
  • Only category over 20% annualized m/m increase was Infants and toddler’s apparel.
  • These last few facts mean that MEDIAN inflation, a better measure of inflation, will be up 0.24% or so m/m. 2.48% y/y.
  • Ugly pic #1: Health Insurance y/y

insurance

  • Ugly picture #2: medicinal drugs y/y.

drugs

  • ugly picture the worst: Medical Care overall, y/y

medicaltot

  • Owners’ Equiv Rent, largest part of CPI. Certainly high and stable. Maybe tapering? But at 3.3%! Ugly or no?

oer

  • FWIW our forecast is for OER to rise a little bit further, but less dramatically unless core ex-housing starts to move.
  • I’m not sure it’s comforting to have rents up “only” 3-4% in context of rising med care. In any event: core ain’t falling soon.
  • note that in August 2015, core was +0.12% m/m. So we’ll see some re-acceleration (and possible catch-up) next month.
  • I actually think there’s a chance for an 0.3% print next month. which would make the FOMC more interesting.
  • Right now, it’s not interesting. With m/m core at 0.09% and 3 quarters of 1% GDP, Fed not tightening in Sept.
  • Thanks for all the new follows and the re-tweets. Good time to mention a couple of things:
  • I’m thrilled to be on “What’d You Miss?” on Bloomberg TV at 3:30ET today. With @scarletfu @thestalwart and @OJRenick
  • Here’s my book: What’s Wrong With Money? The Biggest Bubble of All
  • My company, Enduring Investments, is raising a small amount of capital in the management co. Details here: https://www.crowdfunder.com/enduring-investments-llc/

So, while PPI is not usually much of a predictor of CPI, in this case it gave early warning that we were about to see a weak print from the more-important indicator. But that weakness came from a couple of smaller categories. I have shown this chart a number of times before, but I think it’s especially instructive this time. Compare the distribution of price changes in categories (by the weight in the category) this month…

distrib

To the same distribution from last October.

cpidist

Note that the left tail, which holds the laggards, has more weight this time. There is not quite as much weight in the deep deflation tail, but there are more 0% and 0.5% categories. Yes, there is also one really big increase on the right although it still doesn’t add up to much. The biggest piece of the upper tail is Health Insurance – which as you can tell from the chart above is fairly persistent. In short, I think there’s a better chance of the lower tail reverting to the mode of the distribution than there is of the upper tail doing the same. (This is why Median CPI is a better measure).

The bottom line for markets in the near-term is that nothing about this number scares policymakers. While Dudley says that September is still on the table for an FOMC tightening, the reality is that the data will present them with no urgency – even if, as I think likely, next month’s core CPI corrects for this month’s weakness. And Williams’ ridiculous paper gives them academic cover to ignore the fact that median CPI is at 2.5% and likely will continue to rise. Moreover, LIBOR has been rising because of changes in money market regulations, so FOMC members can argue that financial conditions are tightening automatically. In short, it is very unlikely in my opinion that the Fed hikes rates in September. Or November. Or December.

Homes Are Where the Heat Is

July 26, 2016 1 comment

This week’s main event is supposed to be the FOMC meeting. Certainly, for some time now that has been the case: in a week with a Fed meeting, nothing else matters. Knowing this, many investors will probably over-parse the language from the FOMC statement following the meeting, even though there is little to no chance of any policy change at this meeting nor at any of the next few meetings (it certainly would be a huge surprise if the Fed were either to tighten, or even to indicate a growing likelihood of a future tightening, after Cleveland Fed President Mester recently mused about helicopter drops).

In the meantime, though, we have some housing data that is somewhat interesting. New Home Sales were released today, showing a new seasonally-adjusted post-crisis high. To be sure, sales are still well off the bubble highs, but they are back to roughly average for the period prior to the bubble (see chart, source Bloomberg).

nhsl

New Home Sales is more regular (outside of a bubble) than Existing Home Sales, because additions to the housing stock are partly driven by household formation and that’s reasonably constant over long periods of time. The more important number (in part because it is also it is much larger) is Existing Home Sales, which was released last week and looks even stronger (see chart, source Bloomberg).

ehsl

Existing Home Sales is also affected by household formation, but the level of the aggregate stock of housing matters as well so this measure tends to rise over time. Even so, it looks to be at least back on the long-run trend.

Now, as an inflation scout I spend a lot of time looking at housing. Housing is the largest part of the consumption basket almost everywhere in the world, whether the shelter is owned or rented, and it is an even larger part of the more-stable core inflation basket. If you get housing right, in short, it is hard to be very wrong on inflation overall. This is why I’ve been persistent in saying that deflation in the US, outside of the energy price collapse, isn’t coming any time soon. The rise of home prices in the US, as measured by the S&P CoreLogic Case-Shiller index (which becomes more of a mouthful every time someone new buys the index!), has eased to around 5% per annum versus a rebound-inspired 10% in late 2013/early 2014 (see chart, source Bloomberg).

corelogic

Here is where it pays to be a bit careful. A simple-lag model would predict that rents and owners-equivalent-rents should shortly be declining from current 9-year high rates of increase. But logically, that can’t make sense – if home prices rose 5% forever, then obviously rents would eventually rise something like 5% per year as well. This is a case for a distributed-lag model (even better would be distributed lags on real prices, reflecting the fact that if overall inflation rises then the same real home price increase would reflect a higher nominal home price increase, but there isn’t enough “exciting” inflation in the last couple decades of data to calibrate that well). And one simple such model, shown below (source: Enduring Investments),[1] suggests that the current level of OER is sustainable even though it currently incorporates the lagged effects of that post-2013 deceleration.

oerfromehsl

Now, of interest is that all of our models currently predict that rents will continue to rise for a bit, but only for a bit. Shelter inflation seems baked-in-the-cake through 2017, which is as far as our models project, but doesn’t seem to have a lot of acceleration left (maybe 0.25%) before levelling off. Having said that, there is another consideration that bears comment. The chart below (source: Bloomberg) shows the S&P CoreLogic CS Index again, this time plotted against the number of “Existing Homes Available for Sale” (and a 12-month moving average of that not-seasonally-adjusted index).

homeinventory

The relationship here is a bit loose, for a bunch of reasons, but the point to be made is this: the inventory of homes for sale has returned to levels that prevailed in the late-90s and early-00s, leading to home price increases in excess of the current 5%-per-annum level. When inventories first fell to this level, there was some fear that a large “shadow inventory” of homes that would have been sold at higher prices would be released into the market, holding down prices. If that has happened, it has been gradual as the inventory of homes actually listed has not risen appreciably in the last three years; moreover, it hasn’t held down home prices very well. The upshot is, I think, that home prices are likely to continue to rise by around 5% per year, or possibly faster; this will likely keep upward pressure on rents for the next couple of years.

But, as noted above, the upward pressure on rents will probably be limited from these levels, unless and until prices ex-housing begin to rise more aggressively. We expect them to do so; in any case, current CPI swaps quotes that imply core inflation will be at or below 1.5% for the next three or four years remain egregiously mispriced.

[1] Please contact me, or contact us through our website, if you’re interested in inflation-related products and services, including institutional consulting arrangements. Interested in investing in Enduring Investments? We are currently raising equity in the firm through a Crowdfunding campaign. See https://www.crowdfunder.com/enduring-investments-llc/ or contact me for more details as we expect to close subscriptions soon.

Categories: CPI, Housing

Summary of My Post-CPI Tweets

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.

  • Ah, CPI day!
  • Writing today from the skies above…Pennsylvania maybe? Hi Pennsylvania!
  • Not sure how well this will work…bear with me.
  • Street forecast for core is 0.182% or so m/m, rounding to 0.2% and 2.2% y/y.
  • But if core is only 0.187% m/m, y/y will rise to 2.3% after rounding. So a low hurdle for a “surprise”
  • Since this year core has averaged 0.208% (and 0.243% ex-March), I suspect a good chance of a 2.3% y/y print.
  • Over the next 2 months we have comparisons of 0.173% and 0.155% from year-ago, so core likely rises further.
  • As a reminder, median CPI is already at 2.53% and a 7-year high so such a move in core isn’t a shock.
  • But all that is in the future. We get today’s CPI in 14 minutes.
  • Note my response to tweet messages will be worse than normal today… from 35,000 feet this is a bit wonky.
  • 17% on core. y/y to 2.23% from 2.24%. Be still my heart.
  • Have to wait for the breakdown…not trusting numbers at this altitude. But looks like Medical Care jumped. Not sure what went dn then.
  • OK, Housing 2.39% from 2.38%. Apparel 0.42% from 0.53%; Medical Care – 3.65% from 3.17%! Small drips elsewhere.
  • Core services stayed 3.2% and core goods dripped to -0.6% y/y.
  • Within Housing: Primary rents 3.81% from 3.80%. Should keep rising. OER 3.25% from 3.26% ditto.
  • Big jump in Lodging Away from Home: small category and volatile but excites some people. Not me.
  • Motor vehicles -0.82% from -0.50%, still dragging on core goods.
  • In Medical Care: Drugs 3.40% from 2.34%. Yes, >1% acceleration in y/y. Volatile but…
  • Balancing that a bit was Professional Services 2.60% from 2.81%. But Hospital Services 4.12% from 3.25%.
  • And Health Insurance? +7.10% vs 6.30%. Thanks, ACA.
  • With drugs pushing core goods higher, not sure what was going the other way enough to make core goods decelerate some.
  • Good Lord they just said we’re over Wisconsin. Already?
  • Take this projection for Median CPI with a grain of salt, but looks to me like +0.19% and the annual rate stays 2.5%.
  • biggest monthly declines were toddlers’ apparel, jewelry and watches, footwear, and used cars/trucks.
  • biggest monthly gains in fuel oil, motor fuel, car and truck rental, and medical care commodities (drugs).
  • core ex-housing still fairly low at 1.37%.
  • Overall – core and median inflation still are in rising trends, but nothing particularly alarming about this month’s figure.
  • Certainly, nothing that is going to turn Pres. Mester from talking about helicopter drops to talking about tightening.
  • That’s all for now…thanks for bearing with me.
  • Be sure to look at our Crowdfunder equity raise: https://www.crowdfunder.com/enduring-investments-llc … The subscription package is up and live!

Last month’s core inflation number was not pretty. Medical care rose, rents jumped, and in general it was a sloppy mess. This month is not like that. The story is one of continuing trends: a trend to higher rents, higher medical care inflation; continued weakness in apparel and transportation and other core goods. The key point though is that there is no sign that inflation is about to fall. Whether bottom-up, aggregated from the detailed pricing data, or top-down, looking at money supply growth and possible velocity outcomes, the uptrend in prices looks steady.

While that could change, if interest rates continue to decline and depress money velocity even further, it can’t be the null hypothesis at this point. What is amazing is that the market, in its pricing of inflation, has made that the null hypothesis. Breakeven inflation is low, low, low for more than a decade in the future according to the market. Considerably lower than today’s core inflation. It is a bet that looks increasingly out-of-whack.

Categories: CPI, Tweet Summary

Summary of My Post-CPI Tweets

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.

  • CPI coming up in 15 mins. Consensus is +0.3% headline +0.2% core, putting y/y core up to 2.2% again.
  • Base effects for core suggest better chance for y/y rise for next 4mo or so.
  • Stay tuned, 10mins to CPI. In the meantime why not check out our Crowdfunding campaign? https://www.crowdfunder.com/enduring-investments-llc … (Accredited inv only)
  • Core CPI +0.203% m/m; y/y rises to 2.235%.
  • Core goods remains at -0.5% y/y; core services rises to 3.2%, highest since 2008.
  • Housing jumped to 2.37% y/y from 2.11%. Looking at breakdown to see if that’s in rents or elsewhere in housing.
  • Medical Care had fallen from 3.29% y/y to 2.98% last month. Back up to 3.17%, which is the general trend: higher.
  • Apparel flipped to +0.58% y/y vs -0.57% y/y. Only about 5% of core CPI, but a bellwether we’ve been watching (with little result so far).
  • tweeted this earlier…note that strong base effects lifted y/y CPI but next 3 months comparison also easy.

last12

  • Within Housing, Primary rents rise to 3.80% from 3.73%. OER jumps HUGE, to 3.264% from 3.147%. Big jump for a big part of basket.
  • …and that’s not a misprint. All pressures on rents are higher, and remain higher.
  • Lodging away from home is small, but was a drag last mo. Not this mo: rises to 3.83% y/y from 1.32%
  • In Medical Care, drugs actually fell to 2.34% y/y from 2.84%. But professional svcs 2.81% from 2.26%; Hospital svcs 3.25% v 3.15%
  • Health insurance 6.30% y/y from 5.80%.
  • y/y change in Health Insurance CPI

bfmE9AC

  • y/y in med care services – resuming uptrend

medcaresvcs

  • optimists can look at core ex-housing and see a rise to only 1.42%. But that’s b/c goods carry much more weight in that look.
  • W/in transportation, new and used vehicles was actually a drag, -0.50% y/y from -0.27%. That’s in core goods.
  • y/y core hasn’t been above 3% for 20 years. But will be in 2017.
  • y/y core hasn’t been above 3% for 20 years. But will be in 2017.
  • Early estimate of Median CPI…+0.26% m/m with y/y going to 2.53%, a new cycle high.
  • Probably a good time to mention the crowdfunding for Enduring Investments again: https://www.crowdfunder.com/enduring-investments-llc… Own an inflation manager!
  • Bottom line for today: nothing at all soothing in this report. Upward inflation trend continues.

Nothing at all soothing, indeed. A day after the FOMC chose to stand pat on interest rates, core inflation pushed back higher and median inflation is about to push above 2.5% for the first time since 2009 (when it was on the way down). Of course, nothing about this inflation picture, and the rotten internals that suggest higher figures are in store, would have changed the Fed’s decision yesterday. As noted previously in this space, the Yellen Fed fundamentally does not believe that inflation is a threat; if it is a threat, they believe a little inflation is okay if allowing inflation to run hot helps the overall economy and the little guy; and if they later decide inflation does need to be addressed, it can be easily reined in.

They are wrong on all three counts, and we may well be seeing the beginnings of a colossal error. Honestly, the question here is between whether it is only a bad error that is fixable or a colossal error that isn’t fixable without much pain. Inflation is headed higher.

And yet, ironically, standing pat on interest rates will slow down the near-term rise in inflation since it will keep money velocity from rising as rapidly as it would if interest rates were rising. The best way to keep cash inert is for alternative investment opportunities to remain poor! But money growth around 7% is too fast, even if velocity merely flatlines. Inflation will continue to rise for the balance of this year and into 2017 (at least).

Categories: CPI, Tweet Summary

Summary of My Post-CPI Tweets

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]

medcarecpi

  • 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.

threecat

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).

coregoodsvsusd

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).

coreCPIunder3

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.

Irrational Lugubriousness on Inflation

Today the 1-year CPI swap rate closed at 1.77%, the highest rate since 2014 (see chart, source Bloomberg).

1ycpiswap

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).

volcompar

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):

crudeccrv

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).

ImpliedCore

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.)

Categories: Commodities, CPI, Good One, Theory
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