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 http://events.shindig.com/event/tmenduringinvestments
  • 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 http://events.shindig.com/event/tmenduringinvestments … 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!”

medins

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.

medicinaldrugs

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.

oer

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.

multicountrym2

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!

 

Even With a Crisis, No Deflation Coming

September 28, 2016 2 comments

Recently I’ve been thinking a lot about what might happen in the event of a banking crisis redux. While I’m not very concerned about US banks these days, there is a ‘developing situation’ in China that could well eventually lead to crisis (although the state might prevent outright collapses), and of course ongoing gnashing of teeth over Deutsche Bank’s capital situation if it is fined as heavily as some have suggested they will be.

I am not yet really worried about the banking side of things. But there are plenty of sovereign issuers who are clearly heading down unsustainable paths (not least of these is the US, especially if either of the leading Presidential candidates really implements the high-cost programs they are declaring they will), and when sovereigns tremble it is often banks that bear the direct brunt. After all, you can’t form a line outside of the sovereign to withdraw your money.

But, in a spirit of looking forward to anticipate potential crises, let us pretend we are confronting another banking crisis. The question I often hear next is, “how deflationary would it be to have another crisis when inflation is already low?”

Unpeeling the onion, there are several reasons this doesn’t concern me much. First, inflation is stable or rising in most developed nations. Yes, headline inflation is still sagging due to energy prices, but median inflation is 2.6% in the US and core inflation is 0.8% in Europe and 1.3% in the UK. To be sure, all of those are lower than they were in mid-2008. But remember that in 2009 and 2010, median (or core) inflation never got below 0.5% in the US, 0.8% in Europe, and 2.7% in the UK. Japan of course experienced deflation, but that wasn’t the fault of the crisis – as I’ve pointed out before, Japan has been in long-running deflation due to the BOJ’s inability or unwillingness to grow the money supply.

So, if the worst crisis in 100 years didn’t take core inflation negative – a major, major failure of Keynesian predictions – then I’m not aflutter about it happening this time. Heck, in 2009 and 2010 core inflation wouldn’t even have been as low as it was, had the cause of the crisis not been the bursting of the housing bubble. The chart below (source: Bloomberg) shows the Atlanta Fed’s “sticky” CPI (another way to measure the underlying inflation trend) ex-shelter. Note that in 2010, the low in this measure was about 1.25%…it was actually lower in 2014 and 2015.

stickyexshelter

But we can go further than that. One reason that inflation decelerated in 2009 and 2010 was because money velocity dropped sharply. As I’ve shown before, and argued in my book, the decline in money velocity was not particularly unusual given the decline in interest rates. That is, if you had known what was going to happen to interest rates, you would have had a very good forecast of money velocity and, hence, core inflation.

Back in 2008, I never dreamed that interest rates would go so low, or stay so low for so long. Few of us did! But the outcome, in the event, was consistent with the monetarist model while being completely inconsistent with the Keynesian model. And here’s the point, when thinking about the next crisis: interest rates are already at incredibly low levels, lower even than the 36-year downtrend channel would have them (see chart, source Bloomberg).

log10s

With the wisdom of experience, I would never be so cavalier as to say that interest rates cannot go lower from here! But in 2008, 10-year rates were around 3.80% and they’re 1.60% now (in the US, and lower elsewhere). Real rates were around 2% at the 10-year point; they are at 0% now. It is difficult to imagine how rates can have another dramatic move as they did in 2008-09.

It is important to understand, that is, just why inflation tends to fall in recessions. It is not, as the Keynesians would have it, that a growing “output gap” reduces the pressure on resources and relieves price increases. It is because slack demand for credit causes interest rates to decline, which leads to lower money velocity and hence, lower inflation. If the central bank responds in a timely manner to increase money supply growth by increasing reserves, then inflation doesn’t fall very far. In the last crisis, the Fed and other central banks added enough liquidity to ramp up M2 growth, and that kept the decline in money velocity from causing outright deflation (then, they kept adding reserves for a few more years, which led to the situation we are in now – too many reserves in the system, so that central banks no longer control the marginal dollar that goes into the money supply).

So, in the next crisis I expect central banks will add still more reserves to the pile of excess reserves, which will be meaningless but will make them feel better. Interest rates will decline, but not by as much as they did in the last crisis, and money velocity will fall. So, in a real serious crisis, inflation will decline – however, it will not decline very much.

That is the world we are now living in: higher highs to inflation on each subsequent peak, and higher lows in each subsequent trough. The vicious cycle counterpart to the virtuous cycle we have enjoyed for 35 years. This is true, I think, whether or not we get a crisis or just a garden-variety recession.

I should be clear that I think that such a crisis would be horrible for growth. That is, our current weak growth in global GDP would turn negative again, and possibly even more painful. And times would be truly bad in the stock market. But inflation will not follow, just as it didn’t follow in 2009-2010, and turn into deflation.

Japan Is Doomed. Again.

September 21, 2016 1 comment

Japan is doomed. Again.

A couple of years ago, the Bank of Japan began to pursue QE, with the intention of doubling its money supply. While this is a bad plan for almost every country, it was exactly the right plan for Japan, whose economy had been mired in deflation from 1999 until this policy began (see chart, source Bloomberg).

japancore

To a monetarist, it was no surprise that Japan was experiencing deflation. Since the early 1990s, annual money supply growth in Japan has been below 4% (see chart, source Bloomberg). It averaged 2.4% from 1992-2012. (The new policy pushed M2 growth above 4% for the first time since the 1990s, albeit briefly as it turned out).

japanm2

Remember, the monetarist equation says MV≡PQ. With unchanged money velocity and an economy with, say, a 3% potential growth rate in GDP, a 2.4% growth in M2 should result in deflation. And, in fact, just as in the US lower interest rates in Japan produced lower monetary velocity.

Quantitative easing does nothing to help economic growth, and so QE was the wrong prescription for most of the world after 2010. But if deflation is your disease, QE is your cure and that is Japan’s situation. When the BOJ decided to start QE, money supply growth moved above 4% for the first time in years, and “miraculously” core inflation moved above zero as the first chart above illustrates. (Abstract from the spike over 2%, which was due to a one-time consumption tax effect; but core inflation in Japan was over 1% even excluding that spike). When that happened, I wrote in our Quarterly Inflation Outlook that Japan was no longer the poster child for inept central banking; that award had been moved to the European Central Bank.

Unfortunately, even though QE did exactly what it was supposed to do, to Japanese policymakers it seemed to have failed because their intention had been to raise real growth. So, since the hammer they were using did not function very well as a saw, they discarded the tool.

Japan’s problems with growth are structural. There’s not a lot that can be done, and nothing that can be done in the short run and with monetary policy, about the demographic train wreck they are experiencing. But the problem with inflation was, and is, fixable. But only if the Bank of Japan does QE, and a lot of it, and keeps doing it. As they shifted from straight QE to targeting negative interest rates, money supply growth began to ebb (now back to 3.3% y/y) and inflation began to roll over (now 0.3% ex-food-and-energy). Indeed, with lower rates the BOJ is making it worse by helping to push money velocity even lower.

There had been hope that the BOJ might abandon the NIRP experiment, which was clearly not working by every metric you can use to measure it, and go back to the policy that had been working at least with respect to the fixable problem. But instead, last night the Bank of Japan “shifted the policy framework” to targeting the yield curve. According to the Bloomberg story, the Bank is moving away from a “rigid target for expanding the money supply, while seeking to control bond yields across different maturities.”

So money? The heck with that. We just want to make sure that prices are at the “right” levels. Clearly, the BOJ thinks the market is totally failing when it comes to setting the interest rate correctly (to be fair, all central banks seem to now view interest rates as a tool rather than an indicator, as they used to), and so it is assuming control of that job. Clearly, only the wise policymakers at the BOJ can divine the right level for interest rates: the one which leads to great growth and moderate inflation for the country. Sure.

Japan had a chance. Whether by design or pure chance, they had stumbled on the policy that was able to banish the deflation that had plagued them, and perverted decision-making, for two decades. But because they are pursuing a pot of gold at the end of the rainbow – growth springing from monetary policy in the same way that you can plant olive trees and harvest carrots – they abandoned the working policy to pursue one that has no chance of success.

Japan is back in its comfort zone: the developed world’s basket case. Congratulations to the Bank of Japan.

Do Shortages Cause Lower Prices?

September 19, 2016 3 comments

This is a quick post this morning because it is rainy and I am grumpy and feel like complaining.

Over the weekend I saw a post from a major market news website. I don’t want to name the website, because what they wrote was embarrassingly obtuse. I wouldn’t like it if someone cited my blog when I write something obtuse, so I won’t link to theirs. Consider it professional courtesy.

Here is what they wrote: “The global bond selloff was blamed largely on fears the European Central Bank and the Bank of Japan will eventually run out of bonds to buy.”

At this point, time yourself to see how long it takes you to figure out what’s wrong with that sentence. Score yourself with this table:

1 second or less: Congratulations! You have excellent common sense.

2-30 seconds: You have good common sense but maybe spend too much time around markets.

31-2 minutes: You are smart enough to figure this out, but you watch too much financial TV.

Over 2 minutes: You can be a Wall Street economist!

“I don’t see anything wrong” : You can write for the blog in question.

I could give an answer key, but in the interest of ranting let me present instead an analogy:

In a certain town there is a grocery store, whose proprietor sells apples for 50 cents. One day, a man walks in, flags down the proprietor, and says, “Hello kind sir. I see you have apples for sale. I would like to buy your apples. You see, I have bought all of the apples in this state, and in the surrounding state. I have bought every apple in this town. In fact, I have bought almost all of this year’s harvest. So, I’d like to buy your apples because I have money to buy apples and you have the only apples left.”

The proprietor responds, “Great! I will sell them to you for a nickel each!”

Because, you see, since the apple buyer has just about run out of apples to buy, the price of apples should fall. Right? Well, that’s exactly the point the blog made about bonds: because investors fear the ECB and BOJ will eventually run out of bonds to buy, bond prices fell. If there are really investors out there who think that when the supply of something declines, its price will fall…please introduce me to them, because I’d like to trade with them.

The fact that global central banks continue to buy bonds is the single, best reason to think that yields may not rise. In normal times, bond yields would be rising right now to reflect the fact that inflation is rising, just about everywhere we measure inflation (maybe not in Japan – core inflation in Japan was rising thanks to more-rapid money growth, but when the BOJ lowered rates into negative territory it lowered money velocity and may have squashed the recent rise). But if central banks are buying every bond they can, then prices are more likely to stay high and yields low – even in places like the US where the central bank is not currently buying bonds, because a paucity of Japanese and European bonds tends to increase the demand for US bonds. The risk to the bulls is actually that central banks stop buying bonds.

Maybe that is the weird reasoning that the blog in question was employing: once there are no bonds, central banks will have to stop buying them. And when the central banks stop buying bonds, their prices should fall. Ergo, when there are no bonds to buy the prices should fall. Sure, that makes sense!

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 https://mikeashton.wordpress.com! And #3: my book!
  • Fed’s job just got a lot harder, with weaker growth but a messy inflation print. 0.25% on core, y/y rises to 2.30%.
  • And looking forward BTW, for the balance of the year we’re rolling off 0.19, 0.20, 0.18, and 0.15 from last year.
  • …so it wouldn’t be hard to get a 2.4% or even 2.5% out of core by year-end.
  • Housing rose to 2.58% y/y from 2.45%. Medical Care to 4.92% from 3.99%. Yipe. The big stories get bigger.
  • checking the markets…whaddya know?! they don’t like it.
  • starting to drill down now. Core services 3.2% from 3.1%; core goods -0.5% from -0.6%.
  • Core goods should start to gradually rise here because the dollar has remained flat for a while.
  • also worth pointing out, reflecting on presidential race: protectionism is inflationary. Unwinding the globalization dividend=bad.
  • Take apparel. Globalizing production lowered prices for 15 years 1994-2009.

apparel

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

medcare

  • CPI Medical – professional services highest since 2008.

prof

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

coreexshelter

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

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

Now, about the Fed.

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

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

allup

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