Bond Vigilantes Still Slumber

I read an article recently that noted the 65-75bp rise in Treasury yields over the last year or so, and sought to explain, through a labyrinthine line of reasoning/model, that most of the rise was due to the “reflationary” trade, with the Fed hopelessly behind the curve. The model the author used depicted inflation expectations as being fairly directly tied to the rise in inflation outcomes that we’ve seen: headline inflation has risen from below 1% at the middle of last year to 2.4% year-over-year ended last month.

This approach was, at one time, fairly standard. Since there was no way to directly observe inflation expectations, people measured real rates by taking current interest rates and subtracting trailing 1-year inflation, reasoning that recent inflation is a good proxy for expectations. Indeed, you will still see some economists and bloggers referring to the “recent decline in real rates” that has happened since headline inflation has risen about 250bps since mid-2015 (see chart, source Bloomberg) while 10-year rates are approximately unchanged over the same time horizon.

With this framework, economists would say that real interest rates have fallen precipitously and are now roughly zero, whereas two years ago they were over 2%.

Of course, that old way of doing things is nonsense today. Because past inflation is highly influenced by changes in energy prices (oil prices bottomed in early 2016), trailing inflation is in fact a pretty poor measure of longer-term inflation expectations, and we no longer need to rely on this method because we can directly observe real interest rates, and to some extent market measures of inflation expectations.[1] Here are the current levels, along with 1-year and 2-year changes, in real rates and inflation over the last one and two years (source: Bloomberg; Enduring Investments calculations):

So what has really happened to longer-term real rates and inflation expectations? Over the last two years, 10-year real yields have risen about 27bps, with roughly unchanged 10-year inflation expectations, producing a 25bp rise in nominal interest rates. Over the last year, those numbers are +38bps and +27bps, leading to a 65bp rise in 10-year nominal yields.

Those figures give the central bank tremendous credit for not being behind the curve. Over the last two years, core and median inflation has risen 0.3% while 10-year expectations have been stable. Over the last year, core inflation has fallen a bit (though that has a lot to do with the quirky plunge in telecom prices last month, which should be reversed this month) while median has risen about 10bps. Still, there’s no panic at all in inflation markets. Real yields have risen only 16-65bps over the last two years, despite 75bps of rate hikes.

The Fed very probably is well behind the curve, but the market doesn’t think so. The bond vigilantes haven’t even begun to light their torches yet.

[1] Since market nominal interest rates are lower than they would be if the Fed had not bought a few trillion in securities, breakevens and inflation swaps are probably lower than true inflation expectations would be if the market was freely trading, but since at some point market rates will begin to anticipate the unwind of the Fed’s balance sheet we can’t really say for sure.

Categories: Federal Reserve, TIPS

Pre-Existing Conditions and Fire Insurance

When it comes to health care, I continue to be amazed at the utter nonsense that gets tossed about when the discussion comes to insuring pre-existing conditions. The problem seems to be that no one who understands insurance has anything to say about health care legislation, because the question of why you may not want to guarantee issuance of insurance at a given rate no matter what pre-existing conditions the patient has is really not hard to understand. Consider this little vignette:

Caller: Hi, I’d like to buy some home insurance, please.

Agent: Sure, I’d be happy to help with that.

Caller: Does the insurance cover loss from fire?

Agent: Of course. That’s just one of many coverages you get with our insurance. Can you tell me a little bit about your house?

Caller: It’s three bedrooms, two baths. Worth about $300,000. What will the insurance cost me?

Agent: It depends on a few more pieces of information I have to gather from you, but about <pause> $800 per year.

Caller: That sounds great. Sign me up. Do you need my credit card?

Agent (laughing): Just a moment, sir! I need to get more information to give you an accurate quote. Can you tell me about the condition of your home?

Caller: You mean, right now?

Agent: Um…yes.

Caller: It’s on fire.

Agent: Your house is on fire?

Caller: Yep. Can we speed this up a bit?

Agent: Sir, we can’t insure your house against fire if it’s already on fire!

Caller: Why not? Just because it’s a condition that existed prior to my call?

Agent: Well, yes.

Caller: That’s outrageous! I demand you issue me insurance!

Agent (after conferring with management): Sir, it turns out we can offer you insurance on your home…

Caller: See? I knew you could be reasonable.

Agent: …for $350,000.

See, here’s the thing. Insurance is based on the principle of distributing money in a pool of similar risks from insureds who don’t experience the insurable event to those who do experience the insurable event. If someone enters the pool who has already had the insurable event, it’s simply a transfer – there’s no insurance. Person A needs $100,000 in surgeries, and gets an insurance policy that costs $1,000. Where does the rest of the money come from? It doesn’t come from the insurance company, and I think perhaps people don’t understand that point (and Republicans are truly abysmal at explaining it). The rest of the money comes from other insureds. Consider this situation: rather than get private insurance, you and twenty of your fraternity brothers from college – all about the same age and health – decide to form your own mutual insurance network. Everyone agrees that if anyone gets sick, the whole group will pitch in equally to pay the medical bills of the sick person. Now, suppose one person says “can we take my mom in as well? She has early-onset dementia and was just diagnosed with lung cancer. She’d be glad to join the group and pay an equal share, because fair is fair!” Do you think it is fair that mom pays the same amount?

The insurance company makes money if the money they pay out is less than the money they take in, but they also stand to lose if they underwrite the risks poorly and pay out more than they take in. And insurance companies don’t systematically rip people off by underwriting policies super-conservatively. In fact, the evidence seems to be that insurance companies rather frequently fall prey to pressures to move more product, and underwrite policies too aggressively.

The social-justice question can be separated from the health care insurance question. If you feel that everyone should have their medical bills covered, no matter what, then create a federal umbrella program for high-risk insureds and pay for that program with taxpayer funds. That’s explicit: let the cost of health insurance cover the actual cost of health insurance, which involves conditions the risk pool doesn’t have yet, and represent the welfare or charity – because that’s what it is, of course, when others pick up the expense of those unable to pay – as exactly that. After all, the federal government offers flood insurance to landowners who can’t get insurance at a “reasonable price” because the land floods all the time; that is a similar welfare situation in which taxpayers have decided they are willing to foot the bill because it’s a social good that people live or build on the flood plain. (I’m not sure why, but that’s the import of the federal flood insurance program). So there’s precedent for the government taking over pools that are too risky for private markets.

Again, this isn’t rocket science and it isn’t hard to explain. Why doesn’t someone get on television and explain it? How about a commercial using my script?

Categories: ACA, Analogy, Good One, Insurance, Rant

Tariffs are Good for Inflation

The news of the day today – at least, from the standpoint of someone interested in inflation and inflation markets – was President Trump’s announcement of a new tariff on Canadian lumber. The new tariff, which is a response to Canada’s “alleged” subsidization of sales of lumber to the US (“alleged,” even though it is common knowledge that this occurs and has occurred for many years), ran from 3% to 24% on specific companies where the US had information on the precise subsidy they were receiving, and 20% on other Canadian lumber companies.

In related news, lumber is an important input to homebuilding. Several home price indicators were out today: the FHA House Price Index for new purchases was up 6.43% y/y, the highest level in a while (see chart, source Bloomberg).

The Case-Shiller home price index, which is a better index than the FHA index, showed the same thing (see chart, source Bloomberg). The first bump in home price growth, in 2012 and 2013, was due to a rebound to the sharp drop in home prices during the credit crisis. But this latest turn higher cannot be due to the same factor, since home prices have nearly regained all the ground that they lost in 2007-2012.

Those price increases are in the prices of existing homes, of course, but I wanted to illustrate that, even without new increases in materials costs, housing costs were continuing to rise faster than incomes and faster than prices generally. But now, the price of new homes will also rise due to this tariff (unless the market is slack and so builders have to absorb the cost increase, which seems unlikely to happen). Thus, any ebbing in core inflation that we may have been expecting as home price inflation leveled off may be delayed somewhat longer.

But the tariff hike is symptomatic of a policy that provokes deeper concern among market participants. As I’ve pointed out previously, de-globalization (aka protectionism) is a significant threat to inflation not just in the United States, but around the world. While I am not worried that most of Trump’s proposals would result in a “reflationary trade” due to strong growth – I am not convinced we have solved the demographic and productivity challenges that keep growth from being strong by prior standards, and anyway growth doesn’t cause inflation – I am very concerned that arresting globalization will. This isn’t all Trump’s fault; he is also a symptom of a sense among workers around the world that globalization may have gone too far, and with no one around who can eloquently extol the virtues of free trade, tensions were likely to rise no matter who occupied the White House. But he is certainly accelerating the process.

Not only do inflation markets understand this, it is right now one of the most-significant things affecting levels in inflation markets. Consider the chart below, which compares 10-year breakeven inflation (the difference between 10-year Treasuries and 10-year TIPS) to the frequency of “Border Adjustment Tax” as a search term in news stories on Google.

The market clearly anticipated the Trumpflation issue, but as the concern about BAT declined so did breakevens. Until today, when 10-year breakevens jumped 5-6bps on the Canadian tariff story.

At roughly 2%, breakevens appear to be discounting an expectation that the Fed will fail to achieve its price inflation target of 2% on PCE (which would be about 2.25% on CPI), and also excluding the value of any “tail outcomes” from protectionist battles. When growth flags, I expect breakevens will as well – and they are of course not as cheap as they were last year (by some 60-70bps). But from a purely clinical perspective, it is still hard to see how TIPS can be perceived as terribly rich here, at least relative to nominal Treasury bonds.

Book Review: The Mandibles (related to inflation)

April 7, 2017 1 comment

For something a little different, I wanted to write a book review today. But this is not as far removed as it seems, from my normal beat. In fact, this book could actually be a companion piece to my own book published last year, What’s Wrong with Money?: The Biggest Bubble of All. I really mean that.

The book is “The Mandibles: A Family, 2029-2047,” by Lionel Shriver. This is a terrific work of fiction, especially if you like futuristic dystopian novels. From the jacket:

In 2029, the United States is engaged in a bloodless world war that will wipe out the savings of millions of American families. Overnight, on the international currency exchange, the “almighty dollar” plummets in value, to be replaced by a new global currency, the “bancor.” In retaliation, the president declares that America will default on its loans. “Deadbeat Nation” being unable to borrow, the government prints money to cover its bills. What little remains to savers is rapidly eaten away by runaway inflation.

The Mandibles have been counting on a sizable fortune filtering down when their ninety-seven-year-old patriarch dies. Once the inheritance turns to ash, each family member must contend with disappointment, but also—as the U.S. economy spirals into dysfunction—the challenge of sheer survival.

This book was recommended to be by a friend who knows of my background in inflation – many years of study of the topic, and the fact that I founded and run a firm that’s dedicated to inflation hedging of various kinds (e.g., college tuition or healthcare, but also things like commodities and inflation-linked bond strategies). I took up the novel with some trepidation, since most treatments of inflation in fiction…heck, in non-fiction…are shallow and generally just plain obtuse. I’m including works by famous economists. So I didn’t have high hopes for this book.

I was completely wrong.

When I said that this book could be a companion book to my own (non-fiction) work, I wasn’t kidding. The author got virtually every detail right, about how the pieces fit together, about what causes inflation – including the question of how moderate and high inflation can turn into hyperinflation, a transition that has little to do with monetary policy actions and everything to do with confidence in the monetary unit. And that’s actually why my book is titled “What’s Wrong with Money…” the fact that confidence is the underlying unit (in a fiat currency) creates the potential for an outcome such as Ms. Shriver describes. It isn’t a likely outcome, but it is entirely plausible that it could work out in this way.

Ms. Shriver skillfully works current events of today into the novel, as characters occasionally recollect some old policy from the 2000s or 2010s and explain why that policy didn’t work. I was amazed at the competence with which she tackled all of these subjects.

All in all – if you like the things I write, and especially if you read my book and liked it (or even if you didn’t read it, and probably even if you didn’t like it), you will really like The Mandibles. I highly recommend it.

Categories: Book Review

Is This Bubble Smaller Than We Thought?

I haven’t written in a few weeks. It has been, generally, a fairly boring few weeks in terms of market action, with inflation breakevens oscillating in a narrow range and equities also fairly somnolent. But I can’t blame my lack of posts on a lack of interesting things to remark upon, nor on March Madness, nor on New Jersey Transit (although each of these is a very valid excuse for the general lackadaisical nature of trading in recent weeks). In my case, I plead business exigencies as we are working on a few very exciting projects, one of which I expect to be able to announce in the next week or two.

But writing a blog post/article is never far from my mind. I’ve been doing it for far too long – since the ‘90s if you count the daily letters I wrote for client distribution when I was on Wall Street – and when I haven’t written something in a while it is a bit like an itch on the sole of my foot: I am constantly being reminded about it and the only way to make it stop is to rip the shoe off and scratch. Which tickles. But I digress. What I mean to say is that I have a long list of things I’ve written down that I could write about “if I have time this afternoon,” and it’s only the lack of time that has stopped me. (Some of these are also turning into longer, white-paper type articles such as one I am writing right now estimating the cost of the “Greenspan Put.”)

Some of these ideas are good ideas, but I can’t figure out how to address my hypothesis. For example, I suspect that inflation swaps or breakevens, now that they are near fair value for this level of interest rates, have some component in them right now that could be interpreted as the probability that the Border Adjustment Tax (BAT) eventually becomes law. If the BAT is implemented, it implies higher prices, and potentially much higher depending on the competitive response of other countries. If the BAT fails, then breakevens may not set back very much, but they should decline some; if the BAT looks like it is fait accompli, then inflation quotes could move sharply higher (at least, they should). But prediction markets aren’t making book on the BAT, so I don’t have a way to test (or even illustrate) this hypothesis.

But enough about what I can’t do or won’t be doing; today I want to revisit something I wrote back in December about the stock market. In an article entitled “Add Another Uncomfortable First for Stocks,” I noted that the expected 10-year real return premium for equities over TIPS was about to go negative, something that hadn’t happened in about a decade. In fact, it did go slightly negative at the end of February, with TIPS guaranteed real return over ten years actually slightly above the expected (risky) real return of equities over that time period. At the end of March, that risk premium was back to +3bps, but it’s still roughly the same story: stocks are priced to do about as well as TIPS over the next decade, with the not-so-minor caveat that if inflation rises TIPS will do just fine but stocks will likely do quite poorly, as they historically have done when inflation has risen.

But I got to wondering whether we can say anything about the current market on the basis of how far stocks have outperformed the a priori expectations. That is, if we made a forecast and a decade goes by and stocks have shattered those expectations, does that mean that the forecast was bad or that stocks just became overvalued during that period so that some future period of underperformance of the forecast is to be expected? And, vice-versa, does an underperformance presage a future outperformance?

The first thing that we have to confess is that the way we project expected real returns will not produce something that we expect to hit the target every decade. Indeed, the misses can be huge in real dollar terms – so this is not a short-term or even a medium-term trading system. Consider the following chart (Source: Enduring Investments), which shows the difference of the actual 10-year return compared with the a priori forecast return from 10 years prior. A positive number means that stocks over the period ending on that date outperformed the a priori forecast; a negative number means they underperformed the forecast. In context: a 5% per year miss in the real return means a 63% miss on the 10-year real return. That’s huge.

What you can really see here is that stocks have – no surprise – very long ‘seasons’ of bear and bull markets where investors en masse are disappointed with their returns, or excited about their returns. But let me update this chart with an additional observation about real yields. During the period covered by this chart, there have been three distinct real yield regimes. In the 1960s and 1970s, real yields generally rose. In the late 1970s, 10-year real yields rose to around 4.25%-4.50%, and they didn’t begin falling again in earnest until the late 1980s. (This is in contrast to nominal yields, which started to fall in the early 1980s, but that was almost entirely because the premium for expected inflation was eroding). Between the late 1970s and the late 1980s, real yields were more or less stable at a high level; since the late 1980s they have been declining. In the following chart (Source: Enduring Investments), I’ve annotated these periods and you may reasonably draw the conclusion that in periods of rising interest rates, stocks underperform a priori expectations in real terms while in periods of falling real interest rates, stocks outperform those expectations.

These rolling 10-year rate-of-change figures are interesting but it is hard to see whether periods of outperformance are followed by underperformance etc. It doesn’t look like it, except in the really big macro picture where a decade of outperformance might set the stage for a decade of underperformance. I like the following look at the same data. I took the a priori 10-year real return forecast and applied it to the then-current real price level of the S&P 500 (deflated by the CPI). That produces the red line in the chart below (Source: Enduring Investments). The real price level of the S&P is in black. So the red line is the price level forecast and the black line shows where it ended up.

As I said, this is not a short-term trading model! It is interesting to me how the forecast real level of equities didn’t change much for a couple of decades – essentially, the declining market (and rising price level) saw the underperformance impounded in a higher forecast of future returns. So the “negative bubble” of the 1970s is readily visible, and the incredible cheapness of stocks in 1981 is completely apparent. But stocks were also cheap in real terms in 1976…it was a long wait if you were buying then because they were cheap. Value investing requires a lot of patience. Epic patience.

However, once equity returns finally started to outpace the a priori forecast, and the actual line caught up with the forecast line, the market leapt higher and the twin bubbles of 1999 and 2006 are also apparent here (as well as, dare I say it, the current bubble). But since the forecast line is climbing too, how bad is the current bubble? By some measures, it’s as large or nearly as large as the 1999 bubble. But if we take the difference between the black line and the red line from the prior chart, then we find that it’s possible to argue that stocks are only, perhaps, 30% overvalued and not as mispriced even as they were in 2006.

This may sound like slim solace, but if the worst we have to expect is a 30% retracement, that’s not really so terrible – especially when you realize that that’s in real terms, so if inflation is 3% per year then you’re looking at a loss of 10-15% per year for two years. That’s almost a yawner.

On the other hand, if we are entering an up cycle for real interest rates, then the downside is harder to figure. In the last bear market for real yields, stocks got 60% cheap to fair!

None of this is meant to indicate that you should make major changes in your portfolio now. If all of the evidence that stocks are rich hasn’t caused you to make alterations before now, then I wouldn’t expect this argument to do it! Rather, this is just a different rationality-check on the idea that stocks are overvalued, and my words could actually be taken as soothing by bulls. The chart shows that stocks can be overvalued, and outperform a priori expectations that incorporate valuation measures, for years, even decades. Maybe we’re back in one of those periods?

But we have to go back to the very first point I made, and that’s that if you don’t feel like betting the 30% overvaluation is going to get worse, you can lock in current real return expectations with zero risk and give up nothing but the tails – in both direction – of the equity bet. The equity premium, that is, is currently zero and stocks are additionally exposed to rising inflation. I see nothing tantalizing about stocks, other than the possibility that the downside is perhaps not as bad as I have been fearing.


Administrative Note: Our website at EnduringInvestments.com is about five years overdue for a facelift. We are currently considering how we want to change it, the look & feel we want, and the functionality we desire and require. If you have a suggestion for something you think would be helpful for us to include, please let me know. (Note that this is not a solicitation for web design services so please do not ask! We have picked a firm to do that. I’m just curious what customers and potential customers might want.)

Categories: Investing, Stock Market

Profits and Health Care: A Beneficial Connection

March 17, 2017 4 comments

I usually try to avoid political commentary in this space, because it has become so personal to so many people. If I point out that a particular program of the “left” is smart, or cleverly put together, then half of my readership is annoyed; if I point out the same about the right, then half of my readership is angry. It doesn’t really make sense to waste article space except on those occasions when a policy has a clear effect on inflation over time, such as when the structure of the ACA made it clear that it would put upward pressure on inflation (as I pointed out in 2013) or in response to someone else’s flawed analysis of a policy, as I did last year when I tackled the San Francisco Fed for their weak argument about how the ACA would hold down inflation because the government would demand lower prices. Actually, there is no policy I have written about more than the ACA over the years – but again, this was economic commentary and not political commentary.

This article will be short, but different in that I am writing it to express frustration with the absolute lack of intellectual clarity on the part of the Republicans in making a particular argument that immediately impacts the debate over health care but also extends far into other policies. And, because the argument is simple, direct, and has tremendous empirical support, I couldn’t restrain myself. I expect this article will not be picked up and syndicated in its usual channels since it isn’t directly about economics or markets, but it needed to be said.

I’ve been stewing about this topic since Tuesday (March 14th), when I happened to catch part of the daily White House press briefing. Press Secretary Sean Spicer was asked a question about the President’s health care proposal, and tap danced away from the question:

Q    Thanks, Sean.  You mentioned the call with the CEO of Anthem Health.  Can you tell me what this proposal of the President means for health insurance companies?  Will their profits go up or down under the President’s proposal?

SPICER:  Well, I don’t think that’s been the focus of the President’s proposal.  It’s not about them, it’s about patients.  But I think what it means for them is that they finally get to create more choice and more plans and allow people to choose a plan that fits them.  Right now, they don’t have that choice.  And, frankly, in more and more markets, companies like Anthem, UnitedHealth, Signa are pulling out — Aetna — because they don’t have the choice and because of the government mandate.  I think what we want to do is allow competition and choice to exist so that they can offer more options for the American people.

Q    But will those companies make more money under the President’s plan or less?

SPICER:  I don’t know the answer to that.  That’s not been the focus of what we’re doing now.  And at the end of the day, right now they’re pulling out of market after market, leaving the American people with fewer and fewer choices.  So right now it’s not a question of — from the last I checked, I think many of them were doing pretty well, but it’s the American people and its patients that are losing under the current system.  So I think that there’s a way you can do a little of both.

Spicer’s response was the usual drivel that the Republicans have adopted when they run in fear from any question that includes the word “profits.” To summarize, the question was basically, “you’re doing this to throw a sop to fat-cat insurance companies, aren’t you?” and the answer was “we don’t think about that. No idea. Profits? Who said anything about profits? It’s about patients and choice. And, if anyone gets more profits, it wasn’t on purpose and we didn’t have anything to do with it.”

But this was actually a softball question, and the answer ought to have been something like this:

Q    But will those companies make more money under the President’s plan or less?

BIZARRO SPICER: Well, I hope so. After all, the insurance companies want every person in America to have health care – which is the same thing that we want – because the more people they sell their product to, the more money they can make. The insurance companies want to sell insurance to every person in the U.S. The insurance companies also want costs to be lower, and constantly strive to lower the cost of care, because the lower that costs are, the more profit they can make in the short run. But they don’t want lower costs at the expense of health – clearly, the best outcome for their profits is that most people covered by insurance are healthy and so don’t require the insurance they’ve paid for. So, if we just get out of the way and let companies strive for better profits, we are likely to get more coverage, lower costs, and a healthier population, and that is the goal of the President’s plan.

The reason we don’t already have these things is that laws we have previously passed don’t allow insurance companies to offer certain plans, to certain people, which both sides want but which politicians think are “unfair” for one reason or another. Trying to create a certain preconceived Utopian outcome while limiting profits of insurance companies is what caused this mess in the first place.

If you want to beautify gardens in this city, does it make sense to limit the amount of money that gardeners can make? If you did, you would find fewer gardens got tended, and gardeners would not strive to make improvements that they didn’t get paid for. We can see this clearly with gardeners. Why is it so hard to understand with the companies that tend to the nation’s health? Next question.

For some reason, Republicans think that saying “profits are good” is the same thing as saying “greed is good” and leads to caricatures of conservatives as cigar-smoking industrialists. But while at some level it is the desire for a better material outcome – which I suppose is greed, but aren’t there degrees of greed? – that drives the desire for profit, we cannot dismiss the power of self-interest as a motive force that has the effect of improving societal outcomes. “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest,” after all.

Of course, Republicans must also remember that profit without competition is a different animal. If an insurance company creates an innovation that lowers medical care costs, but does not face competitive pressure, then the benefit of the innovation accrues to the company alone. There is no pressure in such circumstances for the company to lower the price to the customer. But consider what happened to air fares after the deregulation of 1978, or to the cost of telephone service when the AT&T monopoly was broken up in 1984, as competition was allowed and even encouraged. Competition, and the more brutal the better, is what causes companies to strive for an edge through innovation, and it’s also what causes the benefit of that edge to eventually be accrued by the end customer. The government didn’t invent cell phones. Motorola did, in order to try and gain an edge against AT&T,[1] but until the telephone monopoly was broken up there were no commercial versions of the cell phone. The first cell phones cost $10,000 in 1983, about $25,000 in today’s dollars, but now they are ubiquitous and cost about 2% as much in real terms. But this didn’t happen because of a government program to drive down the cost of cell phones. It was the profit motive, combined with competition. All that government did was create the conditions that allowed innovation and competition to happen. And wouldn’t we like health care to be as ubiquitous and cheap as cell phones are?

This is not a hard thing to get right. It isn’t hard for people to understand. But for some reason, it seems incredibly hard for politicians to believe.

Note that nothing I have written here should be construed as an opinion about the President’s health care plan, which I have not read. My remarks are only meant to reflect on the utter inability of Republicans to properly convey the reasons that a different approach – one where the government’s involvement is lessened, rather than increased – would make more sense.

[1] The first cell phone call was made by the inventor, Martin Cooper at Motorola, who called his competition with it: the head of the cellular program at AT&T. According to him, he said “Joel, I’m calling you from a cellular phone, a real cellular phone, a handheld, portable, real cellular phone” and he said it got really quiet on the other end of the line.

Summary of My Post-CPI Tweets

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

  • Pretty big market day! Importantly, CPI: remember last month was big upside surprise, and driven by unusual suspects – core goods.
  • There’s a decent base effect hurdle today, as last Feb was 0.25% on core CPI. Consensus today is for a very weak 0.2% (almost 0.1%).
  • The consensus forecast clearly says that most economists see last month’s shocking 0.31% on core as one-offs.
  • Consensus expectation is for core to slip back to 2.2% from 2.3%. But then, last month they thought we’d fall to 2.1%.
  • Hurdles get easier next month: March ’16 saw 0.09% core CPI, and then a series of low 0.2s & 0.1s. So core is going up this summer.
  • Here is what I said about last month’s figures: https://mikeashton.wordpress.com/2017/02/15/summary-of-my-post-cpi-tweets-36/
  • 5 mins to CPI. Sources say the headline number is trading 243.34 (which would be -0.04% on headline) in the CPI derivs mkt.
  • core at 0.21%, higher than consensus expectations of 0.15% or so. Keeps y/y at 2.22%, down from 2.26%. But next month is an easy comp.
  • Monthly core CPI prints.

  • I don’t pay much attention to headline but it was a little high, y/y up to 2.74%. Only matters if it affects tenor of Fed discussion.
  • In major subgroups: Housing rose to 3.18% vs 3.12%. Need to see if that’s energy. Apparel fell back, as did health care.
  • w/in housing, Primary Rents slipped to 3.91% from 3.93%, Owner’s Equiv to 3.53% from 3.54%. So the housing bump was elsewhere.
  • Looks like the housing increase was mostly household energy, 4.46% from 3.51%. So no biggie as the kids say.
  • Apparel 0.42% vs 0.99%. The big jump last month was mostly reversed. Overall core services 3.1% and core goods dropped back to -0.5%
  • Last month the big story was that core goods had caused the jump in core CPI. Looks like these were mostly seasonal issues after all.
  • Transportation 6.3% vs 4.8%. That’s mostly gasoline. New & used cars slipped. But rising: parts, maintenance, insurance, airfares.
  • In Medical Care, big drop in medicinal drugs 4.19% vs 4.85%. Also drop in prof svcs (2.68% v 2.94%). THOSE are the one-offs this month.
  • Here are y/y med care & housing, source of the big upward pressure recently. But remember this month the housing is mostly energy.

  • Four more major subcategories. Recreation is the only one moving higher, but it’s a heterogeneous group & hard to decipher.

  • Quick estimate of Median is 0.21% m/m, 2.52% y/y, not quite a new high. Official figure will be out later.
  • Next month we should have core back over 2.3% and a shot at 2.4%, thanks to easy comp in March.
  • 10y inflation swaps still below current median inflation.

  • Mkt pretty confident in Fed: CPI mkt pricing: 2017 2.0%;2018 2.2%;then 2.2%, 2.1%, 2.2%, 2.2%, 2.3%, 2.4%, 2.5%, 2.7%, & 2027:2.5%.
  • This CPI report takes inflation off the boil, but not off the burner.
  • One more chart: weight of CPI categories over 3% inflation y/y.

Let’s face it. While this month’s CPI held some intrigue because of last month’s surprising spike, nothing about the figure was likely to change the outcome of today’s FOMC meeting and probably not the tenor of the statement or post-meeting presser. So, in that sense, this was a much less-significant report than last month’s release.

At the same time…let’s not lose sight of the fact that this was still an above-consensus CPI report. While the consensus was broadly correct that some of the jumps in core goods categories from last month were one-offs, and at least partially retraced this month, it’s still the case that y/y core inflation is going to keep rising through the summer merely on base effects. If the Fed wants to be hawkish and tighten more than the market currently expects (I think that nothing could be further from the truth, with Yellen at the helm, but she seems to dislike President Trump enough that she might forget some of her dovish leanings), then they will continue to have cover from inflation reports for a while.

Going forward from that, there are two inflation questions that will be resolved: (1) Will core goods recover and rise, indicating a broadening of inflation impulses that could produce a longer-tail upside? And (2) will housing inflation flatten out or decline since rent inflation is currently rising faster than even our most-generous models? If it does, then core inflation might stabilize near the current level, or even decline.

I have trouble figuring out what the mechanism would be for inflation to flatten out at these levels, from the macro-monetary perspective. Money growth remains brisk and higher interest rates should eventually goose velocity. I don’t see much prospect of money growth rolling over while banks are neither capital- nor reserve- constrained. And it’s hard to see interest rates heading back down while central banks shift into less-accommodative stances. I have more confidence in the macro-monetary (“top down”) model at longer time frames, and more confidence in the bottom-up analysis at shorter time frames. And for years they’ve told the same story: inflation should be rising, and it has. But there is a conflict between these perspectives that is coming later this year. How it resolves will be the story of the next 3-6 months.

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