Archive for the ‘Trading’ Category

TIPS Are Less Cheap – But Still Very Cheap

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Yesterday I wrote about the crowded short trade that boosted energy futures 40-50% from the lows of only a few weeks ago. A related crowded trade was the short-inflation trade, and it also was related to carry.

TIPS, as many readers will know, accumulate principal value based on realized inflation; the real coupon rate is then paid on this changing principal amount. As a rough shorthand, TIPS thus earn something like the real interest rate plus the realized inflation (which goes mainly to principal, but slowly affects the coupon over time). So, if the price level is declining, then although you will be receiving positive coupons your principal amount will be eroding (TIPS at maturity will always pay at least par, but can have a principal amount less than par on which coupons are calculated). And vice versa, of course – when the price level is increasing, so does your principal value and you still receive your positive coupons.

This means that, neglecting the price change of TIPS, the earnings that look like interest – those paid as interest, and those paid as accumulation of principal, which an owner receives when he/she sells the bond or it matures – will be lower when inflation is lower and higher when inflation is higher. It acts a little bit like a floating-rate security, which is one reason that many people believe (incorrectly) that FRNs hedge inflation almost as well as TIPS. They don’t, but that’s something I’ve addressed previously and it’s not my point today.

My point is that TIPS investors behave as if this carry is a hot potato. When carry is increasing, everyone wants to own TIPS; when carry is decreasing no one wants to own TIPS. The chart below (Source: BLS) shows the seasonal adjustment factor used by the Bureau of Labor Statistics to adjust the CPI. The figure implies that prices tend to rise into the summer and then decline into year-end, compared to the average trend of the year, so we should expect higher increases in nonseasonally-adjusted CPI in the summer and lower increases or even outright decreases late in the year.


Now, the next chart (Source: Enduring Investments) shows what 10-year breakevens have done over the last 16 years, on average, compared to the year’s average.


Do these two pictures look eerily similar?

From a capital markets theory perspective, this is nuts. It says that breakevens expand (TIPS outperform) when everyone knows carry should be increasing, and narrow (TIPS underperform) when everyone knows carry should be decreasing. And from a P&L perspective, a 30bp increase in 10-year breakevens swamps the change in accruals that happens as the result of seasonal changes in CPI. Moreover, these are known seasonal patterns; one should not be able to ‘outsmart’ the market by buying breakevens in January and shorting them in May. Theory says that while you’re owning negative carry, you should make it up in the rise of the price of the bond to meet the forward price implied by the carry. Nevertheless, for years you were able to beat the carry, at least if you were a first mover. (Incidentally, an investor doesn’t try to beat the average seasonal, but the actual carry implied by movements in energy too – which are also reasonably well-known in advance).

But as liquidity in the market has suffered (not just in TIPS, but in many non-benchmark securities, thanks to Dodd-Frank and the Volcker Rule), it has become harder for large accounts to do this. More importantly, the market has tended to drastically overshoot carry – either because less-sophisticated investors were involved, or because momentum traders (aka hedge funds) were involved, or because investor sentiment about inflation tends to overshoot actual inflation. Accordingly, as energy has fallen over the last year-and-a-half, TIPS have gotten cheaper, and cheaper, and cheaper relative to fair value. In early January 2015, I put out a trade recommendation (to select institutional clients) as breakevens were about 90bps cheap. The subsequent rally never extinguished the cheapness, but it was a profitable trade.

On February 11th of this year, TIPS reached a level of cheapness that we had only seen in the teeth of the global financial crisis (ignoring the period prior to 2002, when TIPS were not yet a widely-held asset class). The chart below shows that TIPS recently reached, by our proprietary measure, 120bps cheap.


But, as with energy, the short trade was overdone. 10-year breakevens got to 1.20% – an almost inconceivable level that would signal a massive failure not only of Fed policy, but of monetarism itself. Monetarism doesn’t make many claims, but one of these is that if you print enough money then you can create inflation. Since then, as the chart below (source: Bloomberg) shows, 10-year breakevens rallied about 35 bps before falling back over the last couple of days. And we still show breakevens as about 100bps cheap at this level of nominal yields.

10y bei

Yesterday I noted that the structural negative carry for energy markets at present was likely to limit the rally in crude oil, as short futures positions get paid to stay short. But this is a different type of carry than the carry we are talking about with TIPS. With TIPS, the carry is caused by movement in spot energy (mostly gasoline) prices; with crude oil markets, the carry is caused by rolling futures positions forward. The TIPS carry, in short, will eventually stop being so miserable – spot gasoline is unlikely to continue to decline without bound. But even if spot gasoline stabilizes, short futures positions can still be profitable if oversupply into the spot market keeps futures curves in contango. Accordingly, while I think energy futures will slip back down, I am much more confident that TIPS breakevens have seen the worst levels we are likely to see.

Unfortunately, for the non-institutional investor it is hard to be long breakevens. The CME has never re-launched CPI futures, despite my many pleadings, and most ETF products related to breakevens have been dissolved – with the notable, if marginal, exception of RINF, which tracks 30-year breakevens but has a very small float. It appears to be approximately fair, however. Other than that – your options are to be long a TIPS product and long an inverse-Treasury product, but the hedge ratios are not simple, not static, and the fees would make this unpleasant.

However, as I wrote recently what this means for the individual investor is that there is no strategic reason to own nominal bonds now. If I own nominal Treasury bonds, I would be moving into TIPS in preference to such a low-coupon, naked-short-inflation-risk position.

Categories: Investing, Theory, TIPS, Trading

Crowded Shorts and Stupid Math

March 7, 2016 3 comments

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With today’s trade, WTI Crude oil is now up 45% from the lows set last month! That’s great news for the people who had endured a 75% fall from the 2014 highs to last month’s low. More than half of the selloff has been recouped, right?

Well…not exactly.


Stupid math.

In a nutshell, a 45% rally from $110 would be a bit more impressive than 45% from $26.05, which was the low print for front Crude. And energy markets, in both technical and fundamental terms, have a lot of wood to chop before prices return to the former highs, or even the $40-60 range on crude that many people think reflects fundamental value.

So why the dramatic rally? Oil bulls will say it is because rig counts are down, so that supply destruction is happening and helping to balance the market. Perhaps, although rig counts have been falling for some time. Also, some producers have been talking about reining in production…again, perhaps this is important although since the US is the world’s largest producer of oil and neither Saudi Arabia (#2) nor Russia (#3) are in a good economic position to reduce revenues further than they already have been reduced by falling prices this would seem to be a marginal effect. And I might also add the point that thanks to the very long fall in prices, energy commodities are much cheaper than other commodities – which have also fallen, but far less – on a value metric. But no one trades commodities on value.

The real reason is that being short energy has become a very crowded trade. This is partly because of the large overhang of crude and other products in storage, but also partly because the energy futures curves are enormously in contango, which means there are large roll returns to be earned on the short side by being short – because, when the delivery month approaches, the short position buys back the front month and sells the next, higher-priced, contract. In this way, the seller is continuously selling higher prices and rolling down into a well-supplied spot market. See the chart below (source: Enduring Investments), which shows the return you would earn if you shorted the one-year-out Crude contract and rolled it in to the current spot price.


Obviously, the main risk is if spot prices suddenly rally, say, 45%, leaving you with a heavy mark-to-market loss and the prospect of only making some of it back through carry. That is what has started to happen over the last couple of weeks in crude (and some other contracts). It was a crowded carry trade that is now somewhat less crowded.

What happens over time, though, is that it is hard to sustain these flushes unless the carry situation changes markedly. Once oil prices rise enough that the short on fundamentals is at least a not-horrible bet, the carry trade re-asserts. It is, simply put, much easier to be short this contract than long it. What changes the picture eventually is that the fundamental picture changes, either lowering future expected prices (flattening the energy curve relative to spot, and reducing the contango) or raising spot prices as the supply overhang is actually absorbed (raising the front end, and reducing the contango). In the meantime, this is just a crowded-trade rally and likely limited in scope.

Tomorrow, I will mention another crowded-short trade that has recently rebounded, but which is less likely to re-assert itself aggressively going forward.

Swimming Naked

December 3, 2015 2 comments

I almost never do this, but I am posting here some remarks from another writer. My friend Andy Fately writes a daily commentary on the FX markets as part of his role at RBC as head of US corporate FX sales. In his remarks this morning, he summed up Yellen’s speech from yesterday more adroitly than I ever could. I am including a couple of his paragraphs here, with his permission.

Yesterday, Janet Yellen helped cement the view that the Fed is going to raise rates at the next FOMC meeting with her speech to the Washington Economic Club.  Here was the key paragraph:

“However, we must also take into account the well-documented lags in the effects of monetary policy. Were the FOMC to delay the start of policy normalization for too long, we would likely end up having to tighten policy relatively abruptly to keep the economy from significantly overshooting both of our goals. Such an abrupt tightening would risk disrupting financial markets and perhaps even inadvertently push the economy into recession. Moreover, holding the federal funds rate at its current level for too long could also encourage excessive risk-taking and thus undermine financial stability.” (Emphasis added).

So after nearly seven years of zero interest rates and massive inflation in the size of the Fed balance sheet, the last five of which were in place after the end of the Financial Crisis induced recession, the Fed is now concerned about encouraging excessive risk-taking?  Really?  REALLY?  That may be the most disingenuous statement ever made by a Fed Chair.  Remember, the entire thesis of QE was that it would help encourage economic growth through the ‘portfolio rebalancing channel’, which was a fancy way of saying that if the Fed bought up all the available Treasuries and drove yields to historic lows, then other investors would be forced to buy either equities or lower rated debt thus enhancing capital flow toward business, and theoretically impelling growth higher.  Of course, what we observed was a massive rally in the equity market that was based largely, if not entirely, on the financial engineering by companies issuing cheap debt and buying back their own shares.  Capex and R&D spending have both lagged, and top-line growth at many companies remains hugely constrained.  And the Fed has been the driver of this entire outcome.  And now, suddenly, Yellen is concerned that there might be excessive risk-taking.  Sheesh!

Like Andy, I have been skeptical that uber-dove Yellen would be willing to raise rates unless dragged kicking and screaming to that action. And, like Andy, I think the Chairman has let the market assume for too long that rates will rise this month to be able to postpone the action further. Unless something dramatic happens between now and the FOMC meeting this month, we should assume the Fed will raise rates. And then the dramatic stuff will happen afterwards. Actually I wouldn’t normally expect much drama from a well-telegraphed move, but in an illiquid market made more illiquid by the calendar in the latter half of December, I would be cutting risk no matter which direction I was trading the market. I expect others will too, which itself might lead to some volatility.

There is also the problem of an initial move of any kind after a long period of monetary policy quiescence. In February 1994, the Fed tightened to 3.25% after what was to that point a record period of inaction: nearly one and a half years of rates at 3%. In April 1994, Procter & Gamble reported a $102 million charge on a swap done with Bankers Trust – what some at the time said “may be the largest ever” swaps charge at a US industrial company. And later in 1994, in the largest municipal bankruptcy to that point, Orange County reported large losses on reverse repurchase agreements done with the Street. Robert Citron had seen easy money betting that rates wouldn’t rise, and for a while they did not. Until they did. (It is sweetly sentimental to think of how the media called reverse repos “derivatives” and were up in arms about the leverage that this manager was allowed to deploy. Cute.)

The point of that trip down memory lane is just this: telegraphed or not (it wasn’t like the tightening in 1994 was a complete shocker), there will be some firms that are over-levered to the wrong outcome, or are betting on the tightening path being more gradual or less gradual than it will actually turn out to be. Once the Fed starts to raise rates, the tide will be going out and we will find out who has been swimming naked.

And the lesson of history is that some risk-taker is always swimming naked.

Swiss Jeez

January 21, 2015 2 comments

The focus over the last few days has clearly been central bank follies. In just the last week:

  1. The Swiss National Bank (SNB) abruptly stopped trying to hold down the Swiss Franc from rising against the Euro; the currency immediately rose 20% against the continental currency (see chart, source Bloomberg). More on this below.


  1. The ECB, widely expected to announce the beginnings of QE tomorrow (Jan 22nd), have quietly mooted about the notion of buying approximately €600bln per year, focused on sovereign bonds, and lasting for a minimum of one year. This is greater than most analysts had been expecting, and somewhat open-ended to boot.
  2. The Bank of Canada announced today a surprise cut in interest rates, because of the decline in oil prices. Unlike the U.S., which would see an oil decline as stimulative and therefore something the central bank would be more inclined to lean against, Canada’s exports are significantly more concentrated in oil so they will tend to respond more directly to disinflation caused by oil prices. This explains the very high correlation between oil prices and the Canadian Dollar (see chart below, source Bloomberg).


Back to the SNB: the 20% spike in the currency provoked an immediate 14% plunge in the Swiss Market Index, and after a few days of volatility the market there is still flirting with those spike lows. The Swiss economy will shortly be back in deflation; the SNB’s addition of vast amounts of Swiss Francs to the monetary system had in recent months caused core inflation in Switzerland to reach the highest levels since 2011: 0.3% (see chart, source Bloomberg).


The good news for Europe, of course, is that the reversal will cause a small amount of inflation in the Eurozone – although probably not enough to notice, at least the sign is right.

Clearly the SNB had identified that trying to keep the Swissy weak while the ECB was about to add hundreds of billions of Euro to the system was a losing battle. In the long history of central bank FX price controls, we see failures more often than successes, especially when the exchange-rate control is trying to repress a natural trend.

But the point of my article today is not to discuss the SNB move nor the effect of it on local or global inflation. The point of my article is to highlight the fact that the sudden movement in the market has caused several currency brokers (including FXCM, Alpari Ltd., and Global Brokers NZ Ltd.)  to declare insolvency and at least two hedge funds, COMAC Global Macro Fund and Everest Capital’s Global Fund, to close. More to the point, I want to highlight that fact and ask: what in God’s name were they doing?

Let’s review. In order to lose a lot of money in this trade, you need to be short the Swiss Franc against the Euro. Let’s analyze the potential risks and rewards of this trade. The good news is that the SNB is going your way, adding billions of Swissy to the market. The bad news is that if they win, it is likely to be a begrudging movement in the market – the underlying fundamentals, after all, were heavily the other direction which is why the SNB was forced to intervene – and if they lose, as they ultimately did, it is almost certainly going to be a sudden snap in the other direction since the only major seller of Swiss was exiting. Folks, this is like when a commodity market goes limit-bid, because everyone wants to buy at the market’s maximum allowable move and no one wants to sell. When that market is opened for trading again, it is very likely to continue to move in that direction hard. See the chart below (source: Bloomberg) of one of my favorite examples, the early-1993 rally in Lumber futures after a very strong housing number. The market was limit-up for weeks, most of the time without trading. If you were short, you were carried out.


Of course, there was at least a rationale for being short lumber in early 1993. No one knew that there was about to be a huge housing number. There’s very little rationale to being short Swiss Francs here that I can fathom. This is a classic short-options trade. If you win, you make a tiny amount. If you lose, then you blow up. If you do that with a tiny amount of money, and make lots of small bets that are not only uncorrelated but will be uncorrelated in a crisis (it is unclear how one does this), then it can be a reasonable strategy. But how this is a smart strategy in this case escapes me. And as a broker, I would not allow my margining system to take the incredibly low volatility in the Euro/Swiss cross as a sign that even lower margins are appropriate. VaR here is obviously useless because the distribution of possible returns is not even remotely normal. Again, as a broker I am short options: I might make a tiny amount from customer trading or carry on their cash positions; or I might be left holding the bag when the margin balances held by customers prove to be too little and they walk away.

And I suppose the bottom line is this: you cannot know for certain that your broker or hedge fund manager is being wise about this sort of thing. But you sure as heck need to ask.

What Risk-Parity Paring Could Mean for Equities

October 9, 2014 14 comments

The stock market, the bond market, the commodities markets (to a lesser extent), FX markets – they are all experiencing a marked increase in volatility.

Some observers want to call this bearish for equities, mainly because they already are bearish. This is a very bad reason. While really bad equity returns almost always occur coincident with a rise in volatility – the old maxim is that stocks go ‘up on the staircase and down on the escalator’ – that does not mean that volatility causes bad returns. Or, put another way, there are also periods of increased volatility that do not precede and are not coincident with bad returns.

However, there actually is a reason that increased volatility might lead to poor short- to medium-term returns, that isn’t based on technical analysis or spurious correlations. Moreover, a relatively new phenomenon (the rise of so-called ‘risk-parity’ strategies) is starting to institutionalize what was already a somewhat natural response to volatility.

In ‘risk-parity’ strategies, the weight of an asset class (or a security within an asset class, sometimes) is inversely proportional to the risk it adds to the portfolio. Generally speaking, “risk” here is defined as variance, because it is easy to estimate and there are markets where symmetrical variance trades – i.e., options markets. But what this means is that when volatility (sometimes realized volatility, and sometimes option “implied” volatility) rises in stocks, then risk parity strategies tend to be shedding equities because they look riskier, and vice-versa. Right now, risk parity strategies are likely to be overweight equities because of the long period of low realized and implied volatility (even though the valuation measures imply quite high risk in the sense most of us mean it, in terms of the probability of return shortfall). Risk parity strategies are probably superior to ‘return-chasing’ methodologies, but by being ‘risk-chasing’ they end up doing something fairly similar when they are all operating together.

Note that while risk-parity strategies are comparatively new – well, not exactly because it is an oldish idea, but they have only recently become a big fad – this general phenomenon is not. The natural response to greater equity market volatility is to pare back exposure; when your broker statement starts to swing around wildly it makes you nervous and so you may start to take some profits. This is also true of other asset classes but it seems to me to be especially true in equities. Nobody who gets involved in commodities is surprised at volatility: the asset class suffers from a midguided belief that it is terribly volatile even though commodity indices are just about exactly as volatile as equity indices over time. But equity investors, contrariwise, seem perennially surprised at 2% moves.

So, while the recent volatility doesn’t mean that a move lower in equities is assured, it increases the probability of such because risk-parity strategies (and other investors reacting nervously to overweights in their equity exposure) will begin to scale back positions in the asset class in favor of positions in other asset classes, probably mostly bonds and commodities. At this point it would be good for me to point out that only the very short-term volatility measures have moved up dramatically; the VIX is well off its bottom but only up to 18.8 and it has been there numerous times in the last few years (see chart, source Bloomberg). But the longer the volatility continues like we have seen it for the last week or two, the bigger the chances that the asset-allocation boxes start to make important shifts (and the quant hedge fund boxes will probably move a bit before those asset allocation boxes do).


As an aside, the tendency for asset allocation shifts to follow volatility shifts is not the reason that the VIX displays a strong inverse directionality. Neither is the main reason for this inverse directionality because the VIX is a “fear gauge.” The main reason is that the VIX weights near-the-money options more heavily than out-of-the-money options. Because options skews almost always imply more downside volatility for stocks than upside volatility[1], when the market declines it tends to bring more “high volatility” strikes into play and so part of the VIX increase in a down market is simply mechanical.

I am not calling for a sharp decline in stocks, nor for an extended decline in stocks. My position and view is as it has long been, that the prospect for attractive real returns from equities over the next 5-10 years is quite small and beaten handily by commodities’ prospective returns at that end of the risk spectrum. I don’t think that most investors (me included!) should swing asset allocations around frequently in response to technical indicators or such things as “momentum”, but rather should focus on evaluating expected long-term returns (which are somewhat predictable) and invest for value. And I must admit I also think that “risk-parity” is a clever marketing gimmick but a pretty absurd way to assemble a portfolio for almost everyone. My point here is to highlight one little-considered aspect of herd behavior, and how that herd behavior may have become more institutionalized as late, and to consider the risks that herd behavior may create.

[1] This in turn is not due so much from the tendency of markets to have more downside volatility than upside volatility, but from the fact that buying protective puts and selling “covered” calls are both considered “conservative” options strategies. So, out-of-the-money puts tend to be too expensive and out-of-the-money calls too rich.

Why So Many Inflation Market Haters All of a Sudden?

September 25, 2014 6 comments

The inflation market offers such wonderful opportunities for profit since so few people understand the dynamics of inflation, much less of the inflation market.

One of the things which continually fascinates me is how the inflation trade has become sort of a “risk on” kind of trade, in that when the market is pricing in better growth expectations, reflected in rising equity prices, inflation expectations move with the same rhythm.[1] The chart below (source: Bloomberg) shows the 10-year inflation breakeven rate versus the S&P 500 index. Note how closely they ebb and flow together, at least until the latest swoon in inflation expectations.


Your knee-jerk reaction might be that this is a spurious correlation caused by the fact that (a) bond yields tend to rise when growth expectations rise and (b) when bond yields rise, the components of bond yields – including both real rates and expected inflation – tend to rise. But look at the chart below (source: Bloomberg), covering the same period but this time charting stocks versus real yields.


If anything, real yields ought to be more correlated to movements in equities than inflation expectations, since presumably real economic growth is directly related to the real growth rates embedded in equity prices. But to my eyes at least, the correlation between real interest rates and equity prices, for which there is a plausible causal explanation, doesn’t look nearly as good as the relationship between stocks and inflation expectations.

It doesn’t make any sense that long-term inflation expectations should be so closely related to equity prices. I know I have mentioned before – in fact, regular readers are probably sick of me pointing it out – that there is no causal relationship between growth and inflation. Really, it is worse than that: one really needs to torture the data to find any connection at all, causal or not. The chart below (source: Bloomberg) shows quarterly real GDP in yellow against core inflation in white.


I’ve pointed out before that the big recession in ’08-09 saw almost no deceleration in core inflation (and none at all if you remove housing from core inflation), but it’s hard to find a connection anywhere. The next chart (source: Bloomberg) makes the point a different way, simply plotting core inflation (y-axis) against real GDP (x-axis) quarterly back to 1980.


In case anyone out there is protesting that there should be a lagged relationship between growth and inflation, I am happy to report that I was able to get an r-squared as higher as 0.257 with a lag of 12 quarters. Unfortunately, the lag goes the wrong way: high inflation precedes high growth, not vice-versa. And I don’t know anyone who proffers a reasonable explanation of a causality running in that direction. Lags the other way fail to produce any r-squared over 0.1.

So, how to explain the fact that since the end of August we have seen 10-year real rates rise 29 basis points while 10-year breakevens were falling 12bps (producing a net rise in nominal rates of only 17bps)? The explanation is simple: the market is wrong to treat breakevens as a “risk on/risk off” sort of trade. Breakevens have cheapened far too much. I don’t know if that means that TIPS yields have risen too much, or nominal yields have risen too little (I rather expect the former), but the difference is too narrow. The short end of the US curve (1 year inflation swaps are at 1.44%) implies either that core inflation will decline markedly from its already-depressed level well below median inflation, or that energy prices will decline sharply and much further than implied by gasoline futures.

I think that one of the reasons US inflation has been under pressure is that it is currently at a very large spread versus European inflation, and earlier this month it was at the highest level in at least a decade (see chart, source Enduring Investments).


This may look like an appealing short, perhaps, but based on our internal analysis and some historical relationships we track we actually believe the spread is too low by about 50bps. And think about it this way: if Europe really is in the process of inheriting Japan’s lost decade, then 10-year expectations for the US ought to be much, much higher than in Europe. I don’t really think Europe will end up there, because the ECB seems to be trying to do the right thing, but it is not unreasonable to think that there should be a hefty premium to US inflation over Europe.

[1] Of course, the correlation of levels won’t be very good because stocks have an upward bias over time while inflation expectations do not. To run the correlation, you’d have to de-trend stocks but I’m trying to make a visceral point here rather than a quantitative one.

Setting Up For a CPI Surprise?

Heading into the CPI print tomorrow, the market is firmly in “we don’t believe it” mode. Since the CPI report last month – which showed a third straight month of a surprising and surprisingly-broad uptick in prices – commodity prices are actually down 4% (basis the Bloomberg Commodity Index, formerly known as the DJ-UBS Commodity Index). Ten-year breakeven inflation is up 1-2bps since then, but there is still scant sign of alarm in global markets about the chances that the inflation upswing has arrived.

Essentially, no one believes that inflation is about to take root. Few people believe that inflation can take root. Indeed, our measure of inflation angst is near all-time lows (see chart, source Enduring Investments).


…which, of course, is exactly the reason you ought to be worried: because no one else is, and that’s precisely the time that often offers the most risk to being with the crowd, and the most reward from bucking it. And, with 10-year breakevens around 2.22%, the cost of protecting against that risk is quite low.

I suspect that one reason some investors are less concerned about this month’s CPI is that some short-term indicators are indicating that a correction in prices may be due. For example, the Billion Prices Project (which is now Price Stats, but still makes a daily series available at monthly inflation chart (shown below) suggests that inflation should retreat this month.


However, hold your horses: the BPP is forecasting non-seasonally-adjusted headline CPI. The June seasonals do have the tendency to subtract a bit less than 0.1% from the seasonally-adjusted number, which means that it’s not a bad bet that the non-seasonally-adjusted figure will show a smaller rise from May to June than we saw April to May, or March to April. Moreover, the BPP and other short-term ‘nowcasts’ of headline inflation are partly ebbing due to the recent sogginess in gasoline prices, which are 10 cents lower (and unseasonally so) than they were a month ago.

But that does not inform on core inflation. The last three months’ prints of seasonally-adjusted core CPI have been 0.204%, 0.236%, and 0.258%, which is a 2.8% annualized pace for the last quarter…and accelerating. Moreover, as I have previously documented the breadth of the inflation uptick is something that is different from the last few times we have seen mild acceleration of inflation.

None of that means that monthly core CPI will continue to accelerate this month. The consensus forecast of 0.19% implies year/year core CPI will accelerate, but will still round to 2.0%. But remember that the Cleveland Fed’s Median CPI, to which core CPI should be converging as the sequester/Medical Care effect fades, is at 2.3% and rising. We should not be at all surprised with a second 0.3% increase tomorrow.

But, judging from markets, we would be.

This is not to say I am forecasting it, because forecasting one month’s CPI is like forecasting a random number generator, but I think the odds of 0.3% are considerably higher than 0.1%. I am on record as saying that core or median inflation will get to nearly 3% by year-end, and I remain in that camp.


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