Spinning Economic Stories

January 4, 2019 5 comments

As economists[1] we do two sorts of things. We do quantitative work, and we tell stories.

One of the problems with economics is that we aren’t particularly regimented about how we convert data into stories and about how we look at stories to decide how to interrogate the data. So what tends to happen is that we have a phenomenon and then we look at what story we like and decide if that’s a reasonable way to explain the data…without asking if there isn’t a more reasonable way to explain the data, or at least another way that’s equally consistent with the data. I’m not saying that everyone does this, just that it’s disturbingly common especially among people being paid to be storytellers and for whom a good story is really important.

So for example, there is a well -known phenomenon that inflation tends to accelerate after the Fed begins raising interest rates.[2] Purporting to explain this phenomenon, here is a popular story that the Fed is just really smart, so they’re ahead of inflation, and when they seeing it moving up just a little bit they can jump on it real quick and get ahead of it and so inflation goes up…but the apparent causality is there because we just knew it was going to go up and acted before the observation of the higher inflation happened. This is basically Keynesian theory combined with “brilliant person” theory.

There is another theory that is consistent with this, of course: monetarism, which explains that increasing interest rates actually causes inflation to move higher, by causing velocity to increase. But, because this isn’t the popular story, this doesn’t get matched up to the data very frequently. In my mind it’s a better theory, because it doesn’t require us to believe that the Fed is super brilliant to make it work. (And, not to get snarky, but the countervailing evidence versus Fed staff economist genius is pretty mountainous). Of course, economists – and the Fed economists in particular – like theories that make them look like geniuses, so they prefer the prior explanation.

But again, as economists we don’t have a good and rigorous way to say that one way is the ‘preferred’ story or to look at other stories that are consistent with our data. We tend to look at what part of the data supports our story – in other words, confirmation bias.

Why this is relevant now is that the Fed is in fact tightening and inflation is in fact heading higher, and the story being pushed by the Fed and some economists is “good thing the Fed is tightening, because it looks like inflation was going up!” The story on the other hand that I have been telling for quite some time (and which I write about in my book) is that it’s partly because the Fed is tightening and interest rates are going up that that inflation is rising, in a feedback loop that is missed in our popular stories. The important part is the next chapter in the story. In the “Fed is getting ahead of it” story, inflation comes down and the Fed is able to stop tightening, achieving a soft landing. In the “rate increase is causing velocity to rise and inflation to rise” story, the Fed keeps chasing the dog which is only running because the Fed is chasing it.

There is another alternative, which really excites the stock market as evidenced by today’s massive – although disturbingly low-volume – rally. That story is that the Fed is going to become more “data dependent” (Chairman Powell suggested something along these lines today), which is great because the Fed has already won on inflation and growth is still okay. So the Fed can stop the autopilot rate hikes. This story unfortunately does require a little suspension of disbelief. For one thing, today’s strong Employment report (Payrolls 370k, including revisions, compared to 184k expectations) is unfortunately a December figure which means it has huge error bars. Moreover, the Unemployment Rate rose to 3.9% from 3.7%, and while a higher Unemployment Rate doesn’t mean the economy is definitely slowing (it could just be that more people are looking for jobs because the job market is so robust – another fun story), it is certainly more consistent with the notion that the economy is slowing at the margin. The fact that the Unemployment Rate went up, while Hourly Earnings rose more than expected and Jobs rose more than expected, should make you suspect that year-end quirkiness might have something to do with the figures. For the decades I’ve watched economic data, I always advise ignoring the January and February Employment Reports since the December/January changes in payroll are so large that the noise swamps the signal. But professional storytellers aren’t really content to say “this doesn’t really mean anything,” even if that’s the quantitative reality. They get paid to spin yarns, so spin yarns they do.

Yeah, about those wages: I’m not really sure why economists were expecting hourly earnings to decelerate this month. All of the anecdotal data, along with other wage measures, are suggesting that wages are rising apace (see chart, source Bloomberg, showing the Atlanta Fed Wage Tracker vs AHE). Not really a surprise, even given its compositional challenges, that AHE is also rising.

The thing about all of these stories is that while they can’t change the actual reality, they can change how reality is priced. This is one of the reasons that we get bubbles. The stories are so powerful that trading against them, with a ‘value’ mindset for example, is quixotic. Ultimately, in the long run, the value of the equity market is limited by fundamentals. But in the short run, it is virtually unlimited because of valuation multiples (price as a speculative multiple of fundamental earnings, e.g.) and those valuation multiples are driven by stories. And that’s a big reason that bullish stories are so popular.

But consider this bearish footnote on today’s 3.4% S&P rally: volume in the S&P constituents today was lower than the volume was on December 26! To be fair, the volume yesterday, when the S&P declined 2.5%, was even a bit lower than today’s volume. It’s typical thin and whippy first-week-of-the-year trading. Let’s see what next week brings.


[1] People occasionally ask me why I didn’t go on for my MA or PhD in Economics. I reply that it’s because I learned my Intermediate Microeconomics very well: I stopped going for a higher degree when the marginal costs outweighed the marginal benefits. When you look at it that way, it makes you wonder whether the PhD economists aren’t just the bad students who didn’t absorb that lesson.

[2] It’s referred to as the “price puzzle”; see Martin Eichenbaum, “Interpreting Macroeconomic Time Series Facts: The Effects of Monetary Policy: Comments.” European Economic Review, June 1992. And Michael Hanson, “The ‘Price Puzzle’ Reconsidered,” Journal of Monetary Economics, October 2004.

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Ride ’em Cowboy

One disease that afflicts writers of financial commentary…actually, probably commentators in all fields come to think of it…is that when the landscape gets in a ‘rut’ so does our writing. Eventually, if nothing changes about the economy or the market landscape, there isn’t much left to say and thus we (and I really mean “I”) are left repeating ourselves. For those of us who – despite all efforts – aren’t paid for our work, it means that sometimes the right thing to do is to just shut up.

And so that’s what I have done over the last year. As the equity market melted up in somnambulant sameness, as the economy chugged along without major crises or roadblocks…or, anyway, no change in those roadblocks…I wrote less and less. To be sure, part of that was because business was picking up, and this remains an impediment to me writing as frequently as I used to, but much of the reason I didn’t write so much was that not much was changing. There just aren’t many ways you can keep saying “stocks are too expensive, commodities are too cheap, interest rates aren’t at neutral levels, the Fed is screwing up, inflation markets are too low and inflation is rising,” so I took the time to work on other important things.

Well, things are changing. Finally.

The stock market is going down for sensible reasons – which is a major change from when stocks were going up, for nonsensical reasons. President Trump’s trade war, which he promised would hurt China more than the US while every mainstream economist said the opposite, is in fact hurting China more than the US. But the frostiness of global trade relations is hurting growth globally, and pushing inflation higher just as we always knew it would. Domestic growth is slowing; although I’ve said for a while I thought there was a good chance that the US would be in recession sometime in 2019 – which suggestion was scoffed at roundly and regularly – it is starting to look like the US might actually be in recession sometime in 2019. In these events, there is something worth writing about! Guiding a canoe across a placid lake is boring (although lots of equity analysts make a ton of money telling you to buy stocks when they’re going up – good for them!), but guiding a boat through rapids is fun stuff. So, let’s go ride those rapids. I won’t write every day, and I might not even write every week. I’m not sure how often I’ll do my live CPI breakdown…when I asked people to pay for that analysis, the resounding answer was that it wasn’t worth a ton, so I’ll do it when I feel it!

But that brings up another important point I want to be sure to mention: I am very grateful for those of you who did support my various experiments trying to establish the monetary value of my commentary. Some of you subscribed to my private Twitter feed, or the chart package, or bought my book. I really appreciate your voting with your dollars (or yen, or euros, or rupiah, etc) on my behalf. Moreover, I really value the feedback from readers of all persuasions – agreeing, disagreeing, or just expanding on the topic. Most of all, I appreciate those of you who have visited Enduring Investments or Enduring Intellectual Properties and have become clients. You know who you are!

We live, as they say, in interesting times. They’re about to get even more interesting, I’m sorry to say. But it gives me reason to write. Stay tuned.

Categories: Announcements

Summary of My Post-CPI Tweets (December 2018)

December 12, 2018 1 comment

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

  • Been a while since I did a live CPI dive here. Thanks to all of those who voted with their dollars over the last year and supported my private CPI tweets. It wasn’t enough to make a commitment to it, so I’m back to occasionally doing it free on this channel. Hope it helps.
  • I do it anyway for myself and Enduring Investments, so it’s not THAT big a deal to put it here if I happen to be in the mood. Anyway, hope you get some value. If so, think about whether I or Enduring can help your investment processes. Now for the walk-up.
  • Consensus calls for about 0.18% on core CPI today, with the y/y rising to 2.2%. The bouncy PPI helps the mood although the PPI itself doesn’t have much forecasting power for CPI.
  • in PPI there were clear freight and other upstream pressures though. We haven’t really seen much of this in CPI – no real trade/tariff effect yet e.g. Apparel is where I’d expect to see than and in core goods generally. But they’re still slightly in deflation.
  • I think there’s some upward risk to used cars and trucks, but there was a big jump last month so we could get a retracement of that before another move higher next month, or continue the ‘catch up’ to private surveys this month. Hard to tell on a month-to-month basis.
  • Lodging Away from Home took a dip last month and might be upside risk today. Medical Care is due to start rising again too. So in a minute, we will see!
  • Slightly stronger core than expected…0.21% when they were looking for 0.18%. But pretty close.

  • 21% on NSA core y/y.
  • Let’s see. Core goods went up to 0.0% y/y from -0.1%, so that’s moving in the expected direction. Another big month from Used Cars and Trucks, +2.37% m/m after +2.62% last month. y/y now up to 2.30%. It was negative just a few months ago.

  • Lodging Away from Home rose from -2.42% y/y to -1.38% y/y, as we got a small positive this month after a big negative last month. I’m still skeptical that hotel prices are in deflation but someone will yell “AIRBNB” loud enough like that’s an argument, so I’ll leave it there.
  • Hefty lift in Primary Rents. +0.36% m/m, bringing y/y to 3.61% from 3.57%. That’s news because lots of pundits have been decrying the end of the housing market and therefore housing inflation. These aren’t necessarily the same thing.
  • Apparel actually took another large fall m/m. This continues to make little sense in a tariffy world.

  • Some of that is dollar strength, sure. But I’m still surprised.
  • Medical was +0.37% m/m after -0.07%, so that came through as I expected/hoped. Y/y rose to 2.03% vs 1.71%. Both Pharma and Doctor’s Services rose nearly 0.5% m/m after declines last month. Interesting that despite this, and housing, core services were unch at 2.9% y/y.
  • Core inflation, ex-shelter rose to 1.53%, almost at the 2016 highs (1.61%). The disinflationary impulses are deep in the rear-view mirror now.

  • The Apparel breakdown is always so weird. Y/Y, “Boys’ apparel” is +11.9% while “Girls’ apparel” is -0.7%. Hokay.
  • Brace yourself for a big jump in Median. Looks like the median category is a housing subindex so my estimate won’t necessarily be accurate but it won’t be LOWER than 0.28% m/m and my best guess is 0.33% m/m pushing y/y median CPI to 2.83%. Won’t know for a few hours yet.
  • 83% if it happened would be basically back to the highs. So the question is, what’s keep Core Services from a bigger bounce if housing and medical care are both looking strong?
  • Motor Vehicle Insurance? This is 2.4% of CPI.

  • Health insurance rising again…we knew this was true on the wholesale level but seems to be coming thru retail as well. But CPI measures health insurance inflation in an odd way, too much to get into here.

  • Oh no. Are you kidding me? Wireless telephone services -3% y/y down from -0.5%y/y last month. *smh* Here we go again?

  • Currently triumph of hope over experience in stocks. This figure clearly puts the Fed squarely still in tightening mode. And I don’t expect any major easing of inflationary pressures soon.
  • Kind of a good reminder of how out over their skis the inflation shorts are here. With Median at 2.7% or 2.8% after today, here’s the core cpi curve from inflation swaps (calculated by Enduring Investments). X-axis is years. Tremendous confidence that the Fed will win.

  • Now, to be sure the hurdles for y/y core get higher over the next few months, with Dec ’17 at +0.24% m/m and Jan ’18 at +0.35% (remember that??), so core will probably not reach new highs until Q2. But there’s nothing here to give confidence that inflation is about to fall.
  • Let’s do the four pieces. For new followers, these four pieces are each roughly a quarter (0.2%-0.3%) of CPI. The first and most volatile is Food & Energy. We don’t spend a lot of time on this. No forecasting power.

  • Piece 2 is core goods, the smallest of these 4 pieces but the main thing that has kept inflation sedated over last half decade. Now out of deflation even with a strong dollar. Sustainable? In a de-coupling world, maybe.

  • Core services, less rent of shelter. long downtrend still in place. This includes stuff like medical care, but also wireless services. Which really ought to have its own category I’m starting to think!

  • Steadiest piece is Rent of Shelter. This is just coming back to model. No real upstream signs that this is about to roll over – it was just ahead of itself. Latest point is actually an up-wiggle.

  • One more chart. The weight of the distribution of y/y changes. You can see the big bars for housing but the long tail. The bar at left is mostly food, energy, tech, and apparel at the moment. Without those categories, CPI is around 2.8%, right around median.

No real reason to wrap this one up – the numbers speak for themselves. Despite the weakness in energy, which is killing the inflation markets (since energy is most of the volatility in headline inflation, to which TIPS and inflation swaps are tied), prices in general continue to rise and if anything seem to be gaining a little steam even outside of housing. Housing inflation isn’t likely to move very far in either direction for a while from the current level, so the next movement in core or median CPI is going to come from core-ex-shelter categories like Medical Care (possibly looking up), Apparel (quite heavy), and other core goods like autos.

But there’s no reason whatsoever in these numbers to indicate to the Federal Reserve that it’s time to stop raising rates. To the extent that they begin to chirp about a pause, it’s because they want stock prices to go up (or, I guess, more accurately they just don’t want to be blamed for the bear market). Yes, growth is slowing but no formulation of the Taylor Rule is going to give a lot of cover to a decision to ease off of rate hikes when the policy rate is below the current rate of inflation.

Summary of My Post-CPI Tweets (October 2018)

October 11, 2018 Leave a comment

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

  • Only 20 minutes to CPI!
  • This month, we are looking for something of a correction to last month’s terribly weak and surprising core CPI (0.08% m/m).
  • Recall that last month, Apparel plunged -1.6% m/m – which seems at odds with a world of higher landed costs due to tariffs.
  • The only way that would make sense is if BLS were backing out the tariffs from the retail prices, but this isn’t like sales tax – no good way to disentangle tariffs since some products have ’em and some don’t.
  • So Apparel prices are due for a bounce. That’s well-understood out there in inflation land I think.
  • The apparel plunge was the driving force pushing core goods to -0.2% y/y when it had gotten all the way up to 0.0% y/y the prior month. It’s hard to get a lot of inflation without core goods being positive!
  • Other parts of core goods remain perky, such as Used Cars and Trucks. Probably some further gains due there.
  • The core services component was also soft last month, as OER softened slightly (but it has a big weight) and medical care declined.
  • I’m starting to get less confident that Medical Care will have a big upswing because of work I’m doing in pharma inflation. But at the same time, the y/y looks like it may have fallen too far too fast. And I don’t think doctors’ services +0.8% y/y makes a lot of sense.
  • All in all, the odds I think favor a solid 0.2% or above. This would cause y/y core to reaccelerate from 2.19% back to the 2.3% range b/c we’re dropping off an 0.13% from last Sept. To get a 2.4% print on core, we’d need 0.29% or better m/m, which is a stretch.
  • …but not out of the question if last month’s surprises are totally reversed.
  • The bottom line I am really watching is core-ex-shelter, which has been rising and is the key to the next leg higher in inflation. Housing won’t carry the water.
  • We’re down to about 12 minutes here before the number and one thing I want to add: more than recent CPIs this is likely a pretty important number for the stock market. Climbing CPI –> higher rates;stocks aren’t handling that well right now. A soft CPI is really good for stocks.
  • Ordinarily equities ignore CPI, but maybe not today.
  • One last point to make is that even with the weak month last month, core CPI is up at a 2% annualized pace over the last quarter. Median is at 2.5% annualized over the last 3 months. So we’re not talking deflation here.
  • Another very soft CPI. 0.116% on core. As that is roughly in line with what’s dropping off from a year ago, y/y core stays about the same at 2.2%.
  • First glance is that Apparel bounced but OER was weaker. If that’s true then this isn’t as weak as it looks.
  • 2.17% y/y on core, down from 2.18%, so as I said basically unch.
  • No doubt however that this is a huge relief to stocks. Even if it is stronger than it looks on the surface, it’ll help take the Fed off the relative boil (not like they’ve been crazy hawkish, just by recent standards)!
  • Incredibly, the subcomponents are AGAIN being slow-rolled by Bloomberg and this time looks like that’s because the BLS is being slow releasing the data. Crazy. Someone get them a new laptop.
  • Yayy! Finally getting data. So Apparel was +0.93% m/m, which raised y/y from -1.41% to -0.55%. Partial retracement and makes more sense. Only 3% of the CPI basket but a big move makes some difference.
  • Ah, here’s the thing. There was a MASSIVE decline in CPI-Used Cars of -2.99% m/m. That’s completely absurd. It puts y/y to -1.47% from +1.25% in that category, pushes core goods from -0.2% to -0.3%, and dampened overall CPI.
  • But it makes NO SENSE. Private surveys of used vehicle prices are still rising at around 4% per year. This is complete nonsense.
  • Here’s the chart. Used cars had been closing the gap. Again, this is nonsense. And it’s a big enough category to matter some.

  • Moving on…OER was only 0.18% m/m, pushing the y/y to 3.27% from 3.33%. Primary Rents were 0.24% m/m, 3.63% y/y up from 3.61%.
  • The OER modest deceleration isn’t terribly problematic although home prices are still rising quickly enough that I wouldn’t expect it to get much slower than it currently is. Primary Rents still rising, which puts the cherry on that point.
  • Lodging Away from Home plunged -1.01% m/mm, so the y/y dropped to 0.57% from 2.34%. Large moves in that index aren’t terribly unusual, so this isn’t an “AirBnB effect.” Will probably be reversed next month.
  • Back of the envelope by the way (and I know I’m refusing to let cars go again) is that Used Cars cost about 0.075% on core CPI. Put that back and your 0.116% becomes 0.191% m/m…right on expectations.
  • Medical Care remains weak. Pharma -0.19% m/m, but rises to 1.17% y/y from 0.77% because of base effects. Doctors’ Services 0.26% m/m, with y/y up to 0.46%..not exactly running away. And Hospital Services softened to 3.79% y/y from 4.17%.
  • BUT, because of those base effects, Medical Care overall rose to 1.73% y/y vs 1.54%.
  • doctors’ services:

  • Forgot to update this chart, last 12 core CPI prints. Although, as I said, this one is bogus.

  • Core ex-housing, even with the cars nonsense (he really just won’t let it go, will he??), accelerated to 1.38% from 1.34%. That’s still below the 1.5% hit in July, but we’d be just about there without those cars you know.
  • Here’s core ex-shelter. If you think the Fed is “going crazy” tightening, it’s because of this. Right about in the middle of the last two decades’ range. But I think it’s heading up.

  • All this talk about used vehicles…I should note that New Vehicles rose to 0.47% from 0.30% y/y. Placidly approaching the upper end of the range.

  • For something completely different, there was a rise in Cable & Satellite television service this month after a long slide. That’s 1.5% of the overall CPI…about 3/4 the weight of used cars!

  • So let’s see…m/m largest declines were …hey! Used Cars and Trucks #1, Footwear #2, and Lodging Away from Home #3. We’ve discussed two of those. Biggest gainers were Mens/Boys Apparel (retracement), Car & Truck Rental (splutter), and another couple of apparel categories.
  • Now, here’s why I prefer Median CPI. It’s totally for months like this. Median this month ought to be around 0.22%, meaning y/y should be almost exactly unch at 2.77%. As always, my Median is an estimate, but it should be pretty good this month.
  • And that’s the REAL story – inflation continues to motor along at about 2.8%, when measured using an index that isn’t perverted by inaccurate surveys of cars.
  • So here’s the summary. Great number for stocks, because they don’t care about the details. It’s not really a soft number, though – all one category. Core goods at -0.3% really ought to be at 0.3% or 0.4% (see chart), and assuming it does converge there we’ll see core CPI resume.

  • But you don’t really need Core CPI because Median is already telling you what you need to know: inflation is in the high 2s. The rebound from last year is over, and last few numbers have been basically flat around 2.8%.
  • Same story in this chart, showing the weight of categories inflating faster than 3%. It’s pretty steady and has been for a while. This is why we were able to ‘look through’ the 2017 slowdown in core CPI. The middle of the distribution was stable/rising slightly.

  • The key question for the next leg, up or down, is what happens to core goods. Housing, as I wrote recently, is not about to accelerate or decelerate in a MAJOR way. The next leg will have to come from other categories catching up.
  • With a following wind from clearly-rising wages and “protection” from offshore price competition, this seems very probable. Ergo, I expect Median to be over 3% in the next quarter or two. We’re not talking hyperinflation, but it’s going to keep creeping higher.
  • People sometimes ask me, “don’t you think the Fed knows how to look through the CPI to see what’s really going on?” The answer is no, I do not. I’ve yet to find a Fed person who gets very down and dirty with the data in a way that’s illuminating (as opposed to a wonky model).
  • OK, to wrap this up let’s look at the four pieces charts and tell the story (for new followers: these four pieces are each around 1/4…actually 0.2-0.33…of overall CPI). First, Food & Energy.

  • Next, Core Goods. Already discussed. This should be, and will be, higher.

  • Core Services less Rent of Shelter. A lot of this is Medical Care Services and I’m less bullish on that than I have been. It would help the bull-inflation story to see this above 3%, but I’m just not sure it can get there in short order.

  • Finally, Rent of Shelter. It’s probably a bit below where it should be, but as I recently wrote it’s not going to be doing anything dramatic here for a while.

  • That’s all for today. I just want to conclude by saying that it is a NATIONAL EMBARRASSMENT that we can’t accurately measure the behavior of used car prices. Not to put too fine a point on it.
Categories: CPI, Tweet Summary

Update and Summary on Housing Inflation

It’s inflation week, and so an excellent time to sign up to follow my live CPI tweets on my “premium” channel by signing up at PremoSocial. Membership also gets you access to my daily and weekly chart packages, to which I tweet a link daily on that channel. (Consider it – for only $10/month!)

It’s worth turning for a bit to look at the housing market. Shelter is a large part of what consumers spend money on, and therefore a large part of the CPI. It also happens that primary rents (if you rent your dwelling) and “Owners’ Equivalent Rent” or OER tend to be some of the slowest-moving pieces of the CPI. I’ve said many times that if you can get the direction of OER right, it’s very hard to be extremely wrong on the direction of core inflation.

Recently, there’s been some softening in home sales, and so in some quarters there has been an alarm raised that OER is about to start softening and therefore core inflation has peaked. My purpose in this article is to examine that evidence with an eye that is a bit more studied on these matters.

I think that often, economists tend to see patterns in the data when those patterns are congruent with what their models suggest should be happening. For example, it is reasonable to think that high home prices, coupled with rising mortgage rates, ought to slow home sales. There’s certainly evidence that changes in yields affects refinancing activity, as the chart below (source: Bloomberg) relating the Mortgage Bankers’ Association refi index to 10-year yields shows. The recent rise in yields (I’ve shown Treasuries, but mortgage rates move similarly) has depressed refinancing activity – and this makes sense, since fewer mortgages are profitable to refinance at these rates.

Alas, this relationship doesn’t hold very well when it comes to purchase data. Far more important to a home purchaser are current incomes and job prospects, both of which remain relatively strong for now. This next chart shows 10 year yields against the MBA “Purchase” index. At best, interest rates are a secondary or tertiary effect. This makes sense because the decision to refinance a house is a financing decision; the decision to buy a house in the first place is an investing decision.

Nevertheless, there has recently been some softening in purchasing activity of new homes. This next chart shows the seasonally-adjusted rate of existing home sales. I can see the softening, but I’m not sure it looks like it’s a very big deal yet. This is where, though, economists’ models might cause one to say that this looks like it’s rolling over because higher interest rates and lower affordability are dampening demand. Maybe. But this might also be noise especially considering we don’t see any softening in the purchase data. It might be that there’s less home-hopping (maybe because more people have secure jobs, there’s less migration?) or perhaps there’s less activity from the pure financial buyer (pension fund, e.g.) who is paying cash. Or, it could be noise.

Now, one of the reasons that people are sounding an alarm about housing might be that equities of home builders have recently swooned. The chart below shows the S&P Homebuilders SPDR ETF (Ticker: XHB), which has been declining rather sharply of late. Weak homebuilders, weak homebuilding, right? Perhaps. But lumber prices also recently doubled and then halved so there could be some volatility on costs as well. In any event, I’m extremely reluctant to attribute dramatic economic significance, not to mention prescience, to a collection of stocks run by equity monkeys.

I think the picture of home sales and home building is a typical late-cycle picture. That shouldn’t be surprising – we’re late in the cycle, even if there are some people who believe that the expansion will still be going strong in 2020. I’m not one of those people, although I hope I’m wrong. There is definitely some softening in activity indicators. But we’re talking here about pricing indicators. How do those look in housing and rents?

The chart below is the Case-Shiller 20-city composite, y/y. I’ve definitely read commentaries recently saying that this is a sign that housing inflation is rolling over.

The problem is that the Case-Shiller survey is smoothed, lagged, and revised. Moreover, it typically has much more volatility than we have seen in the last few years. The chart below is longer-term. I don’t know that I’d read a great deal into the recent weakening. Even if it is a true reading of a slowdown in pricing, it’s a pretty small effect. My own study suggests about a 10% pass-through to rents, with an 18-month lag. So, even if you want to get alarmed, you have a year and a half to do it.

I’m not really convinced, in case you couldn’t tell, that home prices are about to plunge even though I think they’re high. For one thing, the inventory of homes available for sale remains very low (a regression of properly lagged-and-seasonally-adjusted home inventories against the change in CPI shelter suggests that the current level of inventories is consistent with a 3.6% rise in Shelter CPI between August 2019 and August 2020. Currently, Shelter CPI is at 3.39%).

A more direct effect on Primary Rents and OER is from actual rental inflation, rather than indirectly through home prices. And here the information is again pretty ho-hum. The chart below is of CBRE apartment rents, y/y percentage change. Rents have slowed from 2015-16, but they’re still well above core inflation.

There have been some anecdotal reports of cooling rentals in hot or dense markets, but so far these are mostly anecdotes. Rental prices bear some watching, of course – especially since they pass through into CPI much more quickly than changes in home prices do.

Now, here’s a cautionary note about housing in general. I am most assuredly not a bull on real home prices and I think that they’ll probably underperform CPI going forward. And here’s the reason why. For many years, the relationship between home prices and incomes was very stable. Starting in 2000, home prices began to rise sharply faster than incomes, culminating in what we now know was a pretty ugly bubble. The chart below shows that bubble, and the return to the traditional relationship between home prices and incomes…and a renewed rise in that ratio. I am not saying that home prices are as bubbly now as they were in 2005. Indeed, the easy availability of credit these days makes it plausible that the equilibrium ratio is higher than the 3.4x of the 1970s, 80s, and 90s. The caveat, of course, is that this is true only if there has been a permanent easing in the availability of credit…and as the Fed is currently starting to slowly drain excess reserves, this is less clear. So, this is the warning sign and one good reason to keep a careful eye on home prices going forward.

Adding it all up, I don’t think there’s very persuasive evidence that we are about to see a meaningful deceleration in rental inflation. But just as I’m not persuaded that rents are about to decelerate markedly, I don’t see a great chance of a strong further acceleration (and our model is strikingly boring at present, as the chart below – source Enduring Intellectual Properties – illustrates).

Ergo, core inflation (and more importantly, median), to accelerate much further, needs to see a broadening of pressures from beyond merely rent.  And we’re starting to see some signs of that in core goods, and a faint whisper in other quarters. Rents are not likely to be the driving force for the next leg higher in inflation. But at the same time, we haven’t yet seen very much evidence that rents are about to collapse. Home prices are too high, relative to incomes. They’re probably higher partly because of optimism about incomes, though, and if wages validate that optimism then home prices may not be due for as bruising a correction this time. Wages are clearly accelerating, so the jury is out on that point.

I think the overall conclusion therefore is that a fair forecast for rents and OER in the CPI still calls for stability for a while. If you’re hoping for inflation to decelerate soon, you ought look elsewhere.

Again, don’t forget to sign up at PremoSocial to get access to my CPI-day updates!

Categories: Housing

The Neatest Idea Ever for Reducing the Fed’s Balance Sheet

September 19, 2018 14 comments

I mentioned a week and a half ago that I’d had a “really cool” idea that I had mentioned to a member of the Fed’s Open Market Desk, and I promised to write about it soon. “It’s an idea that would simultaneously be really helpful for investors and help the Fed reduce a balance sheet that they claim to be happy with but we all really know they wish they could reduce.” First, some background.

It is currently not possible to directly access any inflation index other than headline inflation (in any country that has inflation-linked bonds, aka ILBs). Yet, many of the concerns that people have do not involve general inflation, of the sort that describes increases in the cost of living and erodes real investment returns (hint – people should care, more than they do, about inflation), but about more precise exposures. For examples, many parents care greatly about the inflation in the price of college tuition, which is why we developed a college tuition inflation proxy hedge which S&P launched last year as the “S&P Target Tuition Inflation Index.” But so far, that’s really the only subcomponent you can easily access (or will, once someone launches an investment product tied to the index), and it is only an approximate hedge.

This lack has been apparent since literally the beginning. CPI inflation derivatives started trading in 2003 (I traded the first USCPI swap in the interbank broker market), and in February 2004 I gave a speech at a Barclays inflation conference promising that inflation components would be tradeable in five years.

I just didn’t say five years from when.

We’ve made little progress since then, although not for lack of trying. Wall Street can’t handle the “basis risks,” management of which are a bad use of capital for banks. Another possible approach involves mimicking the way that TIGRs (and CATS and LIONs), the precursors to the Treasury’s STRIPS program, allowed investors to access Treasury bonds in a zero coupon form even though the Treasury didn’t issue zero coupon bonds. With the TIGR program, Merrill Lynch would put normal Treasury bonds into a trust and then issue receipts that entitled the buyer to particular cash flows of that bond. The sum of all of the receipts equaled the bond, and the trust simply allowed Merrill to disperse the ownership of particular cash flows. In 1986, the Treasury wised up and realized that they could issue separate CUSIPs for each cash flow and make them naturally strippable, and TIGRs were no longer necessary.

A similar approach was used with CDOs (Collateralized Debt Obligations). A collection of corporate bonds was put into a trust[1], and certificates issued that entitled the buyer to the first X% of the cash flows, the next Y%, and so on until 100% of the cash flows were accounted for. Since the security at the top of the ‘waterfall’ got paid off first, it had a very good rating since even if some of the securities in the trust went bust, that wouldn’t affect the top tranche. The next tranche was lower-rated and higher-yielding, and so on. It turns out that with some (as it happens, somewhat heroic) assumptions about the lack of correlation of credit defaults, such a CDO would produce a very large AAA-rated piece, a somewhat smaller AA-rated piece, and only a small amount of sludge at the bottom.

So, in 2004 I thought “why don’t we do this for TIPS? Only the coupons would be tied to particular subcomponents. If I have 100% CPI, that’s really 42% housing, 3% Apparel, 9% Medical, and so on, adding up to 100%. We will call them ‘Barclays Real Accreting-Inflation Notes,’ or ‘BRAINs’, so that I can hear salespeople tell their clients that they need to get some BRAINs.” A chart of what that would look like appears below. Before reading onward, see if you can figure out why we never had BRAINs.

When I was discussing CDOs above, you may notice that the largest piece was the AAA piece, which was a really popular piece, and the sludge was a really small piece at the bottom. So the bank would find someone who would buy the sludge, and once they found someone who wanted that risk they could quickly put the rest of the structure together and sell the pieces that were in high-demand. But with BRAINs, the most valuable pieces were things like Education, and Medical Care…pretty small pieces, and the sludge was “Food and Beverages” or “Transportation” or, heaven forbid, “Other goods and services.” When you create this structure, you first need to find someone who wants to buy a bunch of big boring pieces so you can sell the small exciting pieces. That’s a lot harder. And if you don’t do that, the bank ends up holding Recreation inflation, and they don’t really enjoy eating BRAINs. Even the zombie banks.

Now we get to the really cool part.

So the Fed holds about $115.6 billion TIPS, along with trillions of other Treasury securities. And they really can’t sell these securities to reduce their balance sheet, because it would completely crater the market. Although the Fed makes brave noises about how they know they can sell these securities and it really wouldn’t hurt the market, they just have decided they don’t want to…we all know that’s baloney. The whole reason that no one really objected to QE2 and QE3 was that the Fed said it was only temporary, after all…

So here’s the idea. The Fed can’t sell $115bln of TIPS because it would crush the market. But they could easily sell $115bln of BRAINs (I guess Barclays wouldn’t be involved, which is sad, because the Fed as issuer makes this FRAINs, which makes no sense), and if they ended up holding “Other Goods and Services” would they really care? The basis risk that a bank hates is nothing to the Fed, and the Fed need hold no capital against the tracking error. But if they were able to distribute, say, 60% of these securities they would have shrunk the balance sheet by about $70 billion…and not only would this probably not affect the TIPS market – Apparel inflation isn’t really a good substitute for headline CPI – it would likely have the large positive effect of jump-starting a really important market: the market for inflation subcomponents.

And all I ask is a single basis point for the idea!


[1] This was eventually done through derivatives with no explicit trust needed…and I mean that in the totally ironic way that you could read it.

Summary of My Post-CPI Tweets (September 2018)

September 13, 2018 4 comments

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

  • Half hour to CPI. Early thoughts:
  • This is one of those months where, because they have different survey respondents, the consensus core CPI index number does not match up with the consensus core y/y number.
  • the index number implies 0.19% m/m rise in core. But we are rolling off 0.21% or so, and only barely ticked to a rounded 2.4% core CPI last month. Ergo, if we get that index number we’ll see a rounded 2.3% on core.
  • BUT the consensus core y/y is (according to Bloomberg) 2.4%. These can’t both be true except for different survey populations.
  • The weak PPI doesn’t really concern me. The components we care about, mainly health care, were not particularly weak. PPI is one of those numbers that’s all over the place. I showed this chart yesterday. Not a lot of signal through the noise.

  • But since we’re fighting over the Maginot line of 0.2%, it could well make a difference and cause a “surprise” downtick to 2.3% on core CPI this month. I think that is the whisper consensus, is an 0.1% or low 0.2% and a core number that drops slightly.
  • That would be another excuse for an equity rally although not sure whether bond guys would buy it.
  • If there’s an UPSIDE surprise, likely will come from core goods. Got all the way to flat last month, first time in a dog’s age. And this with the dollar generally strong.
  • Some are concerned about the jump in housing last mo, but that jump merely reversed the prior drop. Don’t expect re-deceleration. Home prices remain sturdy, and wage increases are starting to provide better support to household formation and therefore, housing demand.
  • As usual keep an eye on cars as an element of core goods. Last month the y/y rose to 0.84%, finally starting to reflect some of the strength of private surveys. Will it continue?
  • Pharma is also in core goods, and it dropped precipitously last month & probably will bounce. But it has been weakening generally for a while now. Even if that trend is valid, it got ahead of itself I think.
  • So, there ARE some upside risks too. Trying to see through all of that, I will be looking at core-ex-housing, which got to 1.5% last month – hasn’t been a lot higher than that in a long time.
  • But the real bottom line is this: inflation is accelerating globally and we’re seeing lots of signs of that. Core might tick down on a y/y basis today – if it doesn’t, that’s pretty bullish. But it’s going to be going higher.
  • That’s all for now…more in about 22 minutes!
  • Ouch! Soft number. 0.1% m/m on core, 2.2% on y/y.
  • 08% m/m on core.

  • 19% on core y/y. Wasn’t even a round-down. Waiting on components.
  • I gotta say, the slow-rolling of the components is starting to get ridiculous. It used to be they came out at 8:30 like everything else. It’s 8:35 and the BLS still hasn’t posted the files. Which means Bloomberg also doesn’t have them.
  • Well, they still don’t have all the data on Bloomberg but I’m pulling the BLS figures. There was a sharp drop in Apparel, -1.6% m/m, which makes little sense in a world of tariffs.
  • The big effect was a large decline in owners’ equivalent rent to 3.33% from 3.39%, which is questionable. Primary rents down slightly.
  • Also decelerations in doctors’ services and hospital services, to 0.31% from 0.64% and to 4.17% from 4.59%, respectively. Pharma didn’t bounce; it fell further to 0.77% from 0.92%.
  • Consequence of OER, doctors/hospital services is that core services inflation dropped from 3.1% to 3.0% y/y. Core goods, thanks to Apparel, fell to -0.2% from 0.0%.
  • Core goods declined even though Used Cars rose to 1.25% y/y vs 0.84% last month. Well, that’s something.
  • Boys’ apparel y/y went to -3.43% from +4.11%. All apparel decelerated (not boys & girls or men’s footwear, but everything else), but boys’ fell the most. That’s likely a seasonal effect due to placement of Labor Day and hence start of school.
  • Yeah, so here’s apparel. Evidently plunging! As a reminder we import virtually all apparel. Looking at this it’s less obviously “transitory”, but also not obvious what’s going on. With trade wars it’s simply the wrong direction.

  • Core ex-housing decelerated to 1.34% vs 1.50% last month. Not a huge move, actually, and tells you how much of this was the deceleration in OER.
  • In the grand scheme of things, OER is just hugging the model. I don’t see any reason to expect it to suddenly drop but leveling off was in the cards.

  • I mentioned the rise in used cars. New cars didn’t do much, 0.30% from 0.23%.
  • Here’s the drop in professional services (doctors). No trade effect here.

  • Tuition and fees is starting to re-accelerate…2.77% vs 2.15% y/y
  • FWIW, Median will be soft too but not THAT soft. 0.14%-0.17% depending on where OER-South Urban falls on a seasonally-adjusted basis.
  • I’m a little torn on what to think of this report. Obviously some parts are just nonsense, like the apparel bit. The OER was large for one month but not wholly unexpected. Medical Care continues to be a conundrum. Autos are finally doing what they’re supposed to do.
  • I guess my gut feeling is that aside from apparel, this is a fairly normal report and shouldn’t really change your opinion one way or the other. The 0.2% drop in the rounded core CPI was big, but it was a tougher comp.
  • Annualized 3-month core CPI is at 2% – kinda where it has been.

  • Let’s look at the four-pieces charts and see if that sways me. Food & Energy:

  • Piece 2, core goods. I don’t think this setback is serious. A lot of it is apparel and, outside of apparel, this is doing well. Pharmaceuticals are a little weak. But cars are strong. I suspect this reverses next month.

  • Piece 3, core services less shelter. Again, a little dip here on softness in medical care services, but nothing alarming to the bullish case yet.

  • Piece 4, rent of shelter. Down this month, and clearly flattening out, but that’s what we expected.

  • In sum, I think those pictures say that this was a widespread, but fairly shallow dip. It was a tough comp versus year ago. The left tail is getting heavy again, but the median isn’t moving much.

  • weight above 3%

  • Next month, the m/m dropping off is only 0.13%, so core will pop back up again especially if any of these factors reverse. Could easily get back to 2.4% although 2.3% should be the expectation. Month after that the comp is 0.21%, and then 0.12%, and then it gets tougher.
  • So this month was the lowest m/m core in a long time, but no sign of any sea change – unless Apparel is telling us that trade wars lower prices for consumers, in which case let’s do more of that!
  • It is somewhat soothing after signs last month that the trend was not only rising (higher inflation) but accelerating (rising at an increasing rate) past the prior trend.
  • But the signs from wages (which admittedly lag), the UIG, and the underlying components is that we’re not out of the woods yet. But have a relaxed month chasing stocks higher on more-dovish fed talk! This also fits into the positive bond market seasonal from Sept-Nov.
  • That’s all for today. Thanks for tuning in.

To bottom-line it: this was a soft number with some one-offs but, with the exception of the Apparel miss – and that’s just highly unlikely to be real – it seems to be broad and slightly soft, rather than narrower with things that look like potential changes in macro trends. Housing does not look poised to collapse while unemployment and wages are pointing in the right direction, and medical care isn’t going to (probably) move into outright deflation. It’s already the slowest in a couple of generations (see chart, source Bloomberg).

I think this number will make the Fed feel better, and make investors feel better, and people who don’t take the time to peel the onion might think that the Fed has won, can stop tightening, and we can just expand the economy without price pressures or any price implications from trade. That’s almost certainly wrong, but this is a good number for the market and I totally expect talking Fed heads to be sounding even more dovish than they were.

Categories: Tweet Summary
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