Archive for the ‘Federal Reserve’ Category

Summary of My Post-CPI Tweets

October 18, 2016 Leave a comment

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

  • CPI coming up in 14 minutes. Consensus on core is for a barely 0.2% print, (more like 0.15%). That would keep the y/y barely at 2.3%.
  • Remember to join me at 9am for a (FREE) live interactive video event at
  • okay, core 0.1%, y/y to 2.2%. Yayy! And by the way it was only 0.11% so not close. y/y to 2.21%.
  • core rate is only 1.8% over last 3 months, vs 2.0% over last 6 and 2.2% over last 9. November tightening is wholly out.
  • Housing accelerated, Medical care roughly unch. Educ/Communication dropped. Getting breakdown now.
  • Headline was also soft. Market was 241.475 bid before the number and 241.428 was the print. Still rounded to 0.3% m/m though.
  • Bonds don’t love this as much as I thought they would. 10y note up about 4 ticks after the data.
  • 10y inflation swaps also didn’t do much. Close to 2% for first time in a long, long time.
  • Primary rents 3.70% from 3.78%, I was reading last month. But OER still up, 3.38% from 3.31%.
  • New and used cars -1.16% vs -0.95%, so more weakness there.
  • In Med care: Drugs 5.38% vs 4.59%, ouch. But prof svcs 3.22% vs 3.35%, and hospitals 5.64% vs 5.81%, and insurance 8.37% vs 9.10%.
  • But those are all retracements within trend.
  • Tuition ebbed to 2.32% vs 2.53%, and “information and info processing” -1.98% vs -0.90%. Those two add up to 7% of CPI.
  • I can see why bonds aren’t super excited. This isn’t a trend change. It looks like a pause.
  • ok, have to go get ready for the video event. See you at … in about 10.
  • Probably good news from Median as well. I see 0.17%, bringing y/y down to 2.54% vs 2.61%. But hsg is median category so I may be off.

I covered some stuff in the Shindig event, but it’s worth showing a couple of charts. Here is health insurance. You can see the little drop this month isn’t exactly something that would make you say “whew! Glad that’s over!”


This next chart, also in medical care, is the year/year change in the cost of medicinal drugs (prescription and non-prescription). Also, not soothing. And these are where the important things are happening in CPI right now.


Finally, the big momma: Owners’ Equivalent Rent. This is not looking like it’s rolling over! And if it’s not rolling over, it’s not likely that inflation overall is rolling over.


In short, the monthly weakness was enough to sooth the Fed and take them off the table for November. And, unless the next figure is really, really bad – like over 0.3% – then they’ll still say “two of the last four are soft.” The December Fed meeting, for what it’s worth, is the day before the CPI is released. The Fed won’t know that number in advance, although nowadays with “nowcasting” they’ll have a clue. But at this point, unless next month’s CPI is very high and/or the Payrolls number is very strong, I think a rate hike in December is also unlikely.

That’s good for markets in the short run. But inflation is rising, and that’s bad for markets in the medium-run!

Inflation Dogma Dies Hard

October 14, 2016 Leave a comment

It has been a busy week, if short. We found out this week that there is pressure on the doves at the Federal Reserve, the biggest of which is Chairman Yellen, to raise interest rates. To some extent we already knew this, based on the dissents in favor of immediate hiking at the latest FOMC meeting. But the minutes this week provided evidence that the support for such a move is broadening, and even normally-dovish Fed speakers have lately been conceding the argument that it “may” soon be time to raise rates again. Notably, and critically, the Chairman is not among those turncoats. I continue to believe that Dr. Yellen will look for any and all excuses to skip a rate hike at coming meetings. Most observers don’t expect an increase to happen immediately before the US election, but the market is putting a pretty heavy weight on December. According to Bloomberg, Fed funds futures are implying a 2/3 chance of a hike at one of the next two meetings.

But lots can change before December 14th, and it will not take much to constitute an excuse to remain sidelined. It is an absurdly high hurdle that Yellen has set. But it makes sense if you remember that Yellen believes that monetary policy is an important and useful tool for increasing employment, that inflation has been so low for so long that it can run “a bit hot” for a while and not be worrisome, and that it can be reined back in at will.

Some of her insouciance is shared by many at the Fed (and described in this Bloomberg article from August). The article is delicious, because some of the quotes suggest confusion about certain notions that have been long held at the Fed but don’t seem to be working any more. They’re not working because they never did, but there was correlation without causation that confused them, and an embraced dogma about inflation that was simply wrong and ignored everything we had learned about inflation in the 1970s and early 1980s. For example, the Fed has long believed that inflation expectations play an important role in anchoring inflation. They have believed this since the 1990s, when a role for expectations was inserted in economists’ models to explain the break to low inflation around 1993. Now, however, “movements in inflation expectations now appear inconsequential since they no longer have any predictive content for subsequent inflation realizations.”

It isn’t clear why anyone ever believed that the shopkeeper will set his prices based on what his customers expect to pay, rather than on what his input costs are, but there was a lot of math and some spurious correlations and poof! let there be dogma.

So here’s a thought: maybe inflation is caused by changes in money float and money velocity? And maybe…just maybe…changing the amount of the measurement stick (money) in circulation doesn’t change the amount of stuff (real GDP) being measured? Call me crazy, but these ideas have worked for decades, and they might be useful even if there isn’t as much math.


For fun, I did the chart above with both US and Eurozone money supply growth, versus US inflation. Even though I am ignoring the things the orthodoxy considers causal, like unemployment rates and inflation expectations, the fit is pretty good. MV=PQ still outperforms the output-gap based models easily. Of course, now that the unemployment rate is back to being low, the rising inflation that we are seeing will be attributed by the economic high priests to the closing of the output gap, despite the fact that inflation started accelerating in earnest long before that gap closed. Dogma dies hard.

Ironically, Yellen has the right stance but for the wrong reason: higher rates will cause higher money velocity, which will cause higher inflation; without any attempt to restrain reserves money supply growth will not roll over and squelch that inflation. So, if rates start to rise – Fed induced, or not – in earnest, the vicious cycle (higher rates cause higher velocity, which causes higher inflation, which causes higher rates, etc…) is going to kick into gear and it could be a long decade ahead. Go to our website and play with the MVPQ calculator. Starting velocity is 1.45. Remember that is an all-time low, and that the average velocity for 1960-1990 was 1.72 (and the average for 1980-2010 was 1.94). Current M2 growth is about 7.5%. It’s October. Go scare yourself.

On Tuesday, we will get another CPI and another chance to turn up the heat on the doves. In three of the last eight months, core CPI has been above 0.25%. If that happens again, then the year-over-year figure will rise to 2.4%. The Cleveland Fed’s Median CPI is already at 2.6%; the Atlanta Fed’s “Sticky” CPI is 2.72%. After the report, at 9am ET I will be doing a (free) live interactive virtual video event; you can sign up at this link. I will summarize what the inflation report said and what effect it should have on Fed and markets, and I will take audience questions. You need to RSVP, so get in there while you can!

Why Does the Fed Focus on a Flawed PCE?

On Friday, I was on Bloomberg TV’s “What’d You Miss?” program to talk about the PCE inflation report from Friday morning. You can see most of the interview here.

I like the segment – Scarlet Fu, Oliver Renick, and Julie Hyman asked good questions – but we had to compress a fairly technical discussion into only 5 or 6 minutes. As a result, the segment might be a little “wonky” for some people, and I thought it might be helpful to present and expand the discussion here.

The PCE report itself was not surprising. Core PCE came in as-expected, at 1.7%. This is rising, but remains below the Fed’s 2% target for that index. I think it is interesting to look at how PCE differs from CPI to see why PCE remains below 2%. After all, core PCE is the only inflation index that is still below 2% (see chart, source Bloomberg). And, as we will see, this raises other questions about whether PCE is a reasonable target for Fed policy.

fourmeasuresThere are several differences between CPI and PCE, but the main reasons they differ can be summarized simply: the CPI measures what the consumer buys, out-of-pocket; the PCE measures not only household expenditures but also spending on behalf of consumers, including such things as employer-purchased insurance and some important government expenditures. As pointed out by the BEA on this helpful page, “the CPI is based on a survey of what households are buying; the PCE is based on surveys of what businesses are selling.”

This leads to two major types of differences: weight effects and scope effects.

Weight effects occur because the PCE is a broader index covering more economic activity. Consider housing, which is one of the more steady components of CPI. Primary rents and owners’-equivalent rent constitute together some 32% of the CPI and those two components have been rising at a blended rate of about 3.4% recently. However, the weight of rent-of-shelter in PCE is only 15.5%. This difference accounts for roughly half of the difference between core CPI and core PCE, and is persistent at the moment because of the strength in housing inflation.

However, more intriguing are the “scope” differences. These arise because certain products and services aren’t only bought in different quantities compared to what businesses sell (like in the case of housing), but because the two surveys include and exclude different items in the same categories. So, certain items are said to be “in scope” for CPI but “out of scope” for PCE, and vice-versa. One of the places this is most important is in the category of health care.

Most medical care is not paid for out-of-pocket by the consumer, and therefore is excluded from the CPI. For most people, medical care is paid for by insurance, which insurance is usually at least partly paid for by their employer. Also, the Federal government through Medicare and Medicaid provides a large quantity of medical care goods and services that are different from what consumers buy directly – at least, purchased at different prices than those available to consumers!).

This scope difference is enormously important, and over time accounts for much of the systematic difference between core CPI and core PCE. The chart below (source: BEA, BLS) illustrates that Health Care inflation in the PCE essentially always is lower than Medical Care inflation in the CPI.

pceandcpiMoreover, thanks in part to Obamacare the divergence between the medical care that the government buys and the medical care consumers buy directly has been widening. The following chart shows the spread between the two lines above:

pceandcpispreadIt is important to realize that this is not coincidental, but likely causal. It is because Medicare and other ACA control structures are restraining prices in certain areas (and paid by certain parties) that prices to the consumer are rising more rapidly. Thus, while all of these inflation measures are likely to continue higher, the spread between core CPI and core PCE is probably going to stay wider than normal for a while.

Now we get to the most interesting question of all. Why do we care about PCE in the first place? We care because the Fed uses core PCE as a policy target, rather than the CPI (despite the fact that it has ways to measure market CPI expectations, but no way to measure PCE expectations). They do so because the PCE covers a wider swath of the economy. To the Fed, this means the PCE is more useful as a broader measure.

But hang on! The extra parts that PCE covers are, substantially, in parts of the economy which are not competitive. Medicare-bought prices are determined, at least in the medium-term, by government fiat. The free market does not operate where the government treads in this way. The more-poignant implication is that there is no reason to suspect that these prices would respond to monetary policy! Ergo, it seems crazy to focus on PCE, rather than CPI (or one of the many more-useful flavors of CPI), when setting monetary policy. This is one case where I think the Fed isn’t being malicious; they’re just not being thoughtful enough.

Every “core” inflation indicator, including the ones above (and you can throw in wages and the Employment Cost Index as well!), is at or above the Fed’s target even accounting for the typical spread between the CPI and PCE. Not only that, they are above the target and rising. The Fed is most definitely “behind the curve.” Now, as I have noted before in this space I don’t think there’s anything the Fed can do about it, as raising rates without restraining reserves will only serve to accelerate inflation further since it will not entail a slowing of money supply growth. But it seems to me that, for starters, monetary policymakers should focus on indices that are at least in principle (and in normal times) more responsive to monetary policy!


Summary of My Post-CPI Tweets

September 16, 2016 7 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! 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.


  • 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.


  • CPI Medical – professional services highest since 2008.


  • 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.


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.


Reforming Priors and Re-Forming Europe

September 7, 2016 1 comment

By now, you have probably heard that the sun did not set on the British Empire as a result of BrExit. Here is one chart from Tuesday’s Daily Shot letter – and see that letter for others.


This is not at all shocking. While in the long-term it is possible (though I think unlikely) that Germany and other major European trading partners may choose to reduce the business they do with the UK – business which is bilateral, by the way – the immediate short-term impact of a lower pound sterling was much easier to read. In the immediate aftermath of the vote, I made the bold prediction that “Britain Survived the Blitz and Will Survive Brexit,” and then later that week in a post called “Twits and Brits” I made the fairly out-of-consensus prediction that “For what it’s worth, I think that thanks to the weakening of sterling Brexit is likely to be mildly stimulative to the UK economy, as well as somewhat inflationary, and slightly contractionary and disinflationary to the rest of the world.”

Oh, I should also point out that in early July I asked the question whether UK property price declines were rational, or overdone and concluded that “I don’t believe the current drop in listed UK property funds is a rational response to correcting bubble pricing, and it’s probably a good opportunity for cool-headed investors…and, more to the point, cool-headed investors who aren’t expecting to liquidate investments overnight.” What has happened since? See the chart below (Source: Daily Shot).


I only mention these items in back-patting fashion because (a) I am proud that I responded thoughtfully, rather than hysterically like many analysts, to the Brexit surprise, and (b) I want to promote my credibility when I make the following observation:

Good news for the UK is bad news for the Eurozone. Not for growth or inflation in the Eurozone, but for its very survival.

The audacity of Britain in leaving the EU was shocking to the establishment, but everyone carefully predicted disaster for the ancient empire. They did this not because the economics said it would be that way – as I pointed out, the economics pointed the other way – but because it was in the interest of the common-currency project that there be huge costs to breaking the covenant. The “marriage” of the countries in the Eurozone was difficult and painful, and the ongoing relationship has been difficult on some of the members. If “divorce” is easy – and even worse, if it is beneficial, then the marriage will not last. The experience of the UK so far – not only doing okay, but actually doing well – cannot be escaping notice in Athens or Rome (or Madrid or Lisbon…or Paris).

Now, that doesn’t mean the Euro is doomed to fail next week. But it means that in the next crisis, whether that is Greece redux or Italy or some other ground zero, the Eurozone bosses in Brussels will be lacking a major threat to use to force the recalcitrant nation to accept painful austerity. Remember that it was the threat of a generational depression that helped get Greece into line. How is Greece doing? The chart below (source: Bloomberg) shows that nation’s unemployment rate.


Admittedly it is not a statistically-valid sample, although to be sure it is a sample that matches the a priori arguments of those who suggested that Greece should leave the Euro: the country that exited the EU is doing fine, and better-than-expected, while the country that remained in the Eurozone is actually mired in a depression. Hmmm. So tell me again why my poor country needs to accept austerity to remain in the Eurozone?

So much about policy depends on one’s priors. If your prior expectation is that leaving the Eurozone is likely to be a disaster, then both sides in the negotiation are likely to reach agreement on a relatively smaller inducement to stay than if the prior expectation is that leaving the Eurozone might be a positive event for the leaver. The events to date should cause these priors to shift when the next crisis happens.

Speaking of priors, and changing countries: Friday’s employment report did not seem, to me, to be outside of the range of outcomes that would cause policymaker priors to change. That is, if the Fed Chairman was planning to raise rates later this month, prior to seeing the Employment report, then I wouldn’t expect the report was weak enough to change that course of action. Conversely, if the Chairman (as I believe) was not planning to hike rates, then it doesn’t seem to me that the report was strong enough to change that course of action.

Markets have decreased the implied probability of such a rate hike, compared to what it was before the report. That’s just Mr. Market’s bipolar nature. The 6-month moving average of payrolls was 189k last month; it is 175k now. The 12-month average is exactly unchanged at 204k. There’s nothing here that is out of the ordinary. But if your attitude was that rates should rise because they need to be returned to neutral, then a 151k monthly Non-Farm Payrolls shouldn’t affect that decision. And if your attitude was that the economy might be weakening, and can’t sustain a rate hike, the number doesn’t change your attitude either. So, while Mr. Market has changed the implied probability, I seriously doubt Dr. Yellen wavered at all.

The problem is that we don’t know what Dr. Yellen (and let’s be clear, hers is the only vote which matters) was thinking prior to the number. We don’t know her priors. But, unless the data appreciably strengthens or weakens between now and September 21st, we will know her priors after we see the results from the meeting. My guess continues to be that the Chairman’s operating assumption is that low rates do more good than harm, and that therefore a hike in rates is unlikely until inflation (already above the Fed’s target, and rising) gets quite a bit more above the Fed’s target, or market interest rates signal restlessness with the Fed’s course.

Categories: Euro, Europe, Federal Reserve, UK

Need a Jedi to Blow Up the R-Star

September 6, 2016 Leave a comment

I haven’t written an article for a couple of weeks. This is not entirely unusual: I have written this commentary, in some form, since about 1996 and there are occasional breaks in the series. It happens for several reasons. Sometimes it is simple ennui, as writing an analysis/opinion article for twenty years can occasionally get boring especially when markets are listless as they frequently are in August. Other times, it is because work – the real work, the stuff we get paid for – is too consuming and I have not time or energy left to write  a few hundred words of readable prose. Maybe that’s part of the reason here, since the number of inflation-investing-related inquiries has definitely increased recently, along with some new client flows (and not to mention that we are raising capital for Enduring Investments through a 506(c) offering – you can find details on Crowdfunder or contact me through our website). Finally, in recent years as the ability to track the number of clicks/eyeballs on my writing has improved, I’ve simply written less during those times…such as August…when I know that not many people will read the writing.

But this time is a little different. While some of those excuses apply in some measure, I’ve actually skipped writing over the last two weeks because there is too much to say. (Fortunately, I said some of it on two Bloomberg TV appearances, which you can see here and here.)

Well, my list of notes is not going to go away on its own so I am going to have to tackle some of them or throw them away. Unfortunately, a lot of them have to do with the inane nattering coming out of Federal Reserve mouthpieces. Let’s start today with the publication that gathered a lot of ink a couple of weeks ago: San Francisco Fed President John Williams’ FRBSF Economic Letter called “Monetary Policy in a Low R-star World.”

The conclusion that Williams reached was sensational, especially since it resonates with the “low return world” meme. Williams concluded that “The time has come to critically reassess prevailing policy frameworks and consider adjustments to handle new challenges, specifically those related to a low natural real rate of interest.” This article was grating from the first paragraph, where Williams casts the Federal Reserve as the explorer/hero:

“As nature abhors a vacuum, so monetary policy abhors stasis. Instead of being a rigid set of precepts, it follows the adage, that which survives is that which is most adaptive to change… In the wake of the global financial crisis, monetary policy has continued to evolve… As we move forward, economic conditions require that central banks and governments throughout the world carefully reexamine their policy frameworks and consider further adjustments in terms of monetary policy strategy—both in its own right and as it relates to other policy arenas—to successfully navigate these new seas.”

One might give the Federal Reserve more credit if subsequent evolutions of policy prescriptions were not getting progressively worse rather than better. Constructive change first requires critical evaluation of the shortcomings of current policy, doesn’t it?

Williams carries on to argue that the natural rate of interest (R-star) is lower now than it has been in the past. Now, Fed watchers should note that if true, this implies that current monetary policy is not as loose as has been believed. This is a useful conclusion for the Fed, since it would explain – within their existing model framework – why exceptionally low rates have not triggered better growth; it also would allow the Fed to raise rates more slowly than otherwise. I’ve pointed out before the frustrating tendency of groupthinking economists to attribute persistent poor model predictions to calibration issues rather than specification issues. This is exactly what Williams is doing. He’s saying “there’s nothing wrong with our model! If we had simply known that the natural rate was lower, we would have understood that we weren’t as stimulative as we thought.” Possible, but it might also be that the whole model sucks, and that the monetarists are right when they say that monetary policy doesn’t move real variables very well. That’s a hypothesis that at least bears examining, but I haven’t seen any fancy Fed papers on it.

What is really remarkable is that the rest of the paper is largely circular, and yet no one seems to mind. Williams attributes the current low r-star to several factors, including “a more general global savings glut.” Note that his estimates of r-star take a sharp turn lower in 2008-9 (see chart below, source FRBSF Economic Letter, figure 1).


Wow, I wonder what could have caused an increase in the global savings glut starting in 2008? Could it be because the world’s central banks persistently added far more liquidity than was needed for the proper functioning of the economy, leading to huge excess reserves – aka a savings glut?

So, according to Williams, the neutral interest rate is lower at least in part because…central banks added a lot of liquidity. Kind of circular, ain’t it?

Since according to Williams this fact explains “uncomfortably low inflation and growth despite very low interest rates,” it must mean he is bravely taking responsibility – since, after all, quantitative easing caused the global savings glut which, in his construct, caused low growth and inflation. Except that I don’t think that’s what he wants us to conclude.

This isn’t research – it’s a recognition that what they did didn’t work, so they are backfilling to try and find an excuse for why their theories are still good. To the Fed, it is just that something happened they didn’t realize and take account of. Williams wants to be able to claim “see, we didn’t get growth because we weren’t as stimulative as we thought we were,” because then they can use their old theories to explain how moving rates around is really important…even though it didn’t work this time. But the problem is that low rates don’t cause growth. The model is wrong. And no amount of calibration can fix a mis-specified model.

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.
  • 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


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


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


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


  • 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:

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…


To the same distribution from last October.


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.

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