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Don’t Look Now, But

July 16, 2013 2 comments

In our business, one must be very careful of confirmation bias of course (as well as all of the other assorted biases that can adversely affect one’s decision-making processes). And so I want to be very careful about reading too much into today’s CPI report. That being said, there were some hints and glimmers that the main components of inflation are starting to look more perky.

Headline (“all items”) inflation rose in June to 1.75% y/y, with core inflation 1.64%. About 20% of the weights in the major groups accelerated on a year-on-year basis; about 20% declined, and 60% were roughly flat. However, two thirds of the “unchanged” weight was in Housing, which moved from 2.219% to 2.249% y/y…but the devil is in the details. Owner’s Equivalent Rent, which is fully 24% of the overall CPI and about one-third of core CPI, rose from 2.13% to 2.21%, reaching its highest rate of change since November 2008. Primary Rents (that is, if you are a renter rather than a homeowner) rose from 2.83% to 2.89%, which is also a post-crisis high. Since much of my near-term expectations for an acceleration in inflation in the 2nd half of the year relies on the pass-through of home price dynamics into rentals, this is something I am paying attention to.

This is what I expected. But can I reject a null hypothesis that core inflation is, in fact, in an extended downtrend – that perhaps housing prices are artificially inflated by investor demand and will not pass through to rents, and the deflation in core goods (led by Medicare-induced declines in Medical Care) will continue? I cannot reject that null hypothesis, despite the fact that the NAHB index today surprised with a leap to 57, its highest since 2006 (see chart, source Bloomberg, below). It may be, although I don’t think it is, that the demand is for houses, rather than housing and thus the price spike might not pass into rents. So, while my thesis remains consistent with the data, the real test will be over the next several months. The disinflationists fear a further deceleration in year-on-year inflation, while I maintain that it will begin to rise from here. I still think core inflation will be 2.5%-2.8% by year-end 2013.nahbboom

In fact, I think there is roughly an even chance that core inflation will round to 1.8% next month (versus 1.6% this month), although the 0.2% jump will be more dramatic than the underlying unrounded figures. The following month, it will hit 1.9%. That is still not the “danger zone” for the Fed, but it will quiet the doves somewhat.

Meanwhile, the Cleveland Fed’s Median CPI remained at 2.1%, the lowest level since 2011. The Median CPI continues to raise its hand and say “hello? Don’t forget about me!” If anyone is terribly concerned about imminent deflation, they should reflect on the fact that the Median CPI is telling us the low core readings are happening because a few categories have been very weak, but that there is no general weakness in prices.

Although I maintain that the process of inflation will not be particular impacted by what the Fed does from here – and, if what they do causes interest rates to rise, then they could unintentionally accelerate the process – the direction of the markets will be. And not, I think, in a good way. We saw today what happens when an inflation number came in fairly close to expectations: stocks down, bonds flat, inflation-linked bonds up, and commodities up. Now, imagine that CPI surprises on the high side next month?

Speaking of the fact that commodities have had (so far at least) their best month in a while, there was a very interesting blog entry posted today at the “macroblog” of the Atlanta Fed. The authors of the post examined whether commodity price increases and decreases affect core inflation in a meaningful way. Of course, the simple answer is that it’s not supposed to, because after all that’s what the BLS is trying to do by extracting food and energy (and doing that across all categories where explicit or implicit food and energy costs are found, such as in things like primary rents). But, of course, it’s not that simple, and what these authors found is that when commodity prices are increasing, then businesses tend to try and pass on these cost increases – and they respond positively to a survey question asking them about that – and it tends to show up in core inflation. But, if commodity prices are decreasing, then businesses tend to try and hold the line on prices, and take bigger profit margins. And that, also, shows up in the data.

To the extent this is true, it means that commodity volatility itself has inflationary implications even if there is no net movement in commodity prices over some period. That is because it acts like a ratchet: when commodity prices go up, core inflation tends to edge up, but when commodity prices go down, core inflation tends not to edge down. Higher volatility, by itself, implies higher inflation (as well, as I have pointed out, as increasing the perception of higher volatility: see my article in Business Economics here and my quick explanation of the main points here). It’s a very interesting observation these authors make, and one I have not heard before.

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Summary of My Post-CPI Tweets

June 18, 2013 3 comments

The following is a summary and further explanation of my tweets following today’s CPI release:

  • core #inflation +0.167, a smidge higher than expected but basically in line. Dragged down by medical care (-0.13%).
  • Housing #inflation a solid 0.3%…this part is, as we expected, accelerating.
  • Core commodities still dragging down overall core, now -0.2% y/y while core services still 2.3%.
  • I still think Owners’ Equiv Rent will get to our year-end target but core goods not behaving. Have to lower our core CPI range to 2.5%-2.8%
  • That 2.5%-2.8% still much higher than Street. Still assumes OER continues to accelerate, and core goods drag fades. Fcast WAS 2.6-3.0.
  • Note that CPI-Housing rose at a 2.22% y/y rate, up from 1.94% last month. Highest since late ’08 early ’09. Acceleration there is happening.
  • Major #CPI groups accel: Housing, Trans, Recreation (63.9%), Decel: Food/Bev, Apparel, Med Care, Educ/Comm (32.7%)
  • Overall, IMO this CPI report is much more buoyant than expected. Core goods is flattering some ugly trends.

The important part of this CPI report is that CPI-Housing is finally turning up again, as I have been expecting it would “over the next 1-3 months.” Hands down, the rise in housing inflation (41% of overall consumption) is the greatest threat to effective price stability in the short run. Home prices are rising aggressively in many places around the country, and it is passing through to rents. Primary rents (where you rent an apartment or a home, rather than “imputed” rents) are up at 2.8% year/year, the highest level since early 2009, but not yet showing signs that it is about to go seriously vertical. Some economists are still around who will tell you that rapidly rising home prices are going to cause a decline in rents, as more rental supply comes on the market. That would be a very bizarre outcome, economically, but it is absolutely necessary that this happen if core inflation isn’t going to rise from here.

The last 7 months of this year see very easy comparisons versus last year, when CPI rose at only a 1.6% annualized pace for the May-December period. Only last June saw an increase of at least 0.20%. So, even with a fairly weak trend from here, core CPI will rise from 1.7% year/year. If each of the last 7 months of this year produces only 0.2% from core CPI, the figure will be at 2.2% by year-end. At 0.25% monthly, we’ll be over 2.5%; at 0.3% per month core CPI will be at 2.9% by year-end. So our core inflation forecast, at 2.5%-2.8%, is not terribly aggressive (and if we are right on housing inflation, it may be fairly conservative).

We have not changed our 2014 expectation that core CPI will be at least 3.0%.

Honest, Abe?

November 15, 2012 4 comments

Today was CPI day, which after Christmas and Thanksgiving is one of my most favorite of days. Here is what I tweeted earlier today (and there’s lots more commentary below):

  • unrounded core CPI at +0.18%, a bit higher than what dropped off. Not exactly alarming, but higher than Street expectations.
  • y/y core to almost exactly +2.000%. Apparel rose again after the recent rise had slowed in the last couple of months.
  • Subindices: ACCEL: Housing, Apparel, Transp, Food/Bev (75.2% of basket). DECEL: Med Care (6.9% of basket). UNCH: Recreation, Comm/Ed, Other
  • OER was unch…rise in Housing came from primary rents (that is, you actually pay rent) and lodging away from home.
  • Core goods inflation stayed stable at +0.7% y/y; core services stable at +2.5%. I think the former number is going to rise.

This was actually something less than the most exciting CPI report in history. It was better than the Street expected, and although the year/year figure barely nudged higher the components of the number were strong. The rise came from Housing, which ought to continue to accelerate for a while given rental tightness and other forward-looking indicators, and Apparel resumed its rise as well. See the chart below (source: Bloomberg) for the update to what is rapidly becoming one of my favorite inflation-related charts.

The Cleveland Fed’s Median CPI dropped just enough to round down to +2.2% on a y/y basis, and the Atlanta Fed’s “Sticky” CPI is also at 2.2%. These measures are other ways to look at the central tendency of the inflation figures, and suggest that the current 2.0% from the traditional Core CPI is likely to converge higher rather than vice-versa.

But today didn’t change any inflation paradigms.

There was other news, however, that struck me as inflation-related and worth commenting on.

One was a story in the UK Daily Mail citing the case of a Denny’s franchisee (he owns a few dozen Denny’s restaurants) who is planning to add a 5% “Obamacare surcharge” to customer dining checks.

Now, the sum of all of the sales of this man’s Denny’s restaurants is a tiny part of the CPI category “Food away from home,” which is itself a small part of CPI, so it won’t have any impact on the numbers. Even if lots of restaurants followed suit, it wouldn’t have much of an impact since “Food away from home” is only 5.6% of the consumption basket (so a 5% surcharge on all checks would cause a rise in CPI of 0.28%), but it serves as a good reminder of one important point.

The higher taxes and other costs of doing business that are going to be targeted at business is going to show itself to individuals one way or the other. The higher cost of Obamacare compliance, and any other increased business taxes, will not be paid by businesses for the simple reason that businesses are pass-through entities. That is, businesses don’t make money; people who own businesses (partners or shareholders) make money. So whether the higher costs show up as higher prices to the consumer (in which case the government’s attempt to raise revenue from business will result in higher inflation prints, as the transition takes place) or as lower profits to the businesses themselves, the cost will end up being borne by real humans.

At the end of the day, how much of these costs is absorbed by the owners and how much is paid by the consumers is determined by the elasticity of supply and demand for the product. For example, if the elasticity of demand is infinite, then the owners will bear the entire cost; if the elasticity is zero, then consumers will pay it all. My personal guess is that given the current level of gross margins, more of these taxes and higher costs will be paid by owners – implying lower equity earnings – than by consumers, but we will see. But notice that either way, you get lower real earnings. Either nominal earnings fall, or prices rise. Not good for stocks in either case; bad for bonds in the latter case, too.

Then there are the actions of several central banks in the other hemisphere. A story in the Wall Street Journal,  and echoed elsewhere such as in this Australian news outlet, suggests that the Reserve Bank of Australia has adopted a form of QE by allowing its foreign currency reserves to rise in order to push down the currency. The RBA has been one of the bastions, at least relatively, of ‘hard money’ in a world of central banks that have gone wild, so this isn’t a positive development unless you’re long inflation-related assets.

And also hard to miss were the comments by the leader of Japan’s main opposition party, Shinzo Abe, who may become the next prime minister quite soon. Abe suggested that the Bank of Japan should target 3% inflation, rather than 1% inflation, and threatened to revise the law that (supposedly) insulates the BOJ from politics.  Note that 5-year Japanese inflation swaps are near all-time highs, but still only at 0.77%, and 10-year inflation swaps are at only 0.48%. Under Abe’s pressure, we would likely see a substantial acceleration in QE by the BOJ, which has already succeeded in pushing core inflation in Japan from -1.6% to -0.6% over the last two years (see chart, source Bloomberg).

We are increasingly moving into a one-way street for central bank policy. Central bankers are essentially engaging in a sophisticated version of competitive devaluations. The Fed does QE, the BOE does QE, the ECB does QE (but claims it doesn’t), the SNB and BOJ and now the RBA does QE. It is a one-way street because whoever stops printing first will see his currency shoot higher as investors flock to the harder currency. The chart below shows what has happened to the Aussie dollar over the last decade versus the USD. While the strengthening trend was interrupted by the 2008 flight-to-quality, it quickly resumed. Since that time, it has risen roughly 50% (and 100% overall since 2001).

Now, a strong currency is good. It makes foreign goods cheaper and raises the standard of living overall. However, it also hurts exports, which slows the economy and results in visible layoffs while the economy adjusts. There’s only so much of this a country’s politicians are willing to take, and it seems Australia may have reached its limit.

If everyone is printing, exchange rates may not move at all. It has frustrated many dollar bears that the greenback hasn’t declined under the profligate printer Bernanke; printing money is supposed to destroy a currency. It has done so repeatedly over the course of history, and it happens for obvious reasons: when you get a bumper crop of something, its price tends to fall. More supply induces lower prices. In this case, it induces a lower price of a currency unit in terms of other currency units.

But that only happens if the relative supply of a currency is changing. If everyone is printing at roughly the same pace, there is no reason that currencies should move at all relative to each other. They should all fall relative to non-printers, or to hard assets. And that’s why it’s even more incredible that commodities are not shooting higher. Yet.

Those effects, in my view, absolutely swamp in importance the weak growth news we’re getting these days. Today, the Philly Fed report and Initial Claims were both quite weak, but the data is going to be polluted by hurricane Sandy for a while and hard to interpret. I don’t think the hurricane had anything to do with this story, or its timing for that matter:

FHA Needs Bailout From Treasury to Plug Budget, Bachus Says

“Nov. 15 (Bloomberg) — The Federal Housing Administration will need billions of dollars in aid from the U.S. Treasury before the end of the year to fill a financial hole caused by defaults on mortgages it insures, House Financial Services Committee Chairman Spencer Bachus said today.

“… The agency is “burning through” its last $600 million and FHA officials have briefed him that they will need a financial backstop within a month, the Alabama Republican said during a press conference in Washington.”

So, we are trying to figure out how to raise a trillion dollars over ten years to start closing the budget gap, but it helps to remember that there are other groups who are going to be bellying up to the bar for a hit of government help. The FHA, the postal service (-$15.9bln this year, although they expect to lose only $7bln next year), probably California before long. We’d better get our act together quickly…but as yet, there is no sign of it. Nice of Bachus to wait until less than a month before the FHA runs out of money to mention this, by the way.

And I haven’t even mentioned the sudden explosion of violence in Israel, which doesn’t give the impression of a fire that will quickly burn out. It may not spin out of control, either, but it bears watching very closely since our influence in the region has significantly ebbed since the change of control in Egypt, our exit from Iraq, and our distancing from Israel.

I don’t think 2013 is shaping up to be a very fun year. But we’re not there yet!

The Good News On Inflation Seems Likely to End

October 15, 2012 4 comments

In case you haven’t yet heard, congratulations are due to the EU – the recipient of this year’s Nobel Peace Prize. Hey, don’t laugh; they need the money. And don’t click over to the news, where you may find pictures of riots in various places as the peace and prosperity (which, as we now know, was purchased on credit that can never be repaid) is taken away. That’s an inconvenient truth…which, ironically, won the price in 2007. I think I see a pattern.

Back in the real world, American-style capitalism (such as it is) showed some temporary vigor today with Retail Sales announced stronger than expected (+1.1% ex-autos, with a +0.2% revision, versus +0.7% expected). That’s not a huge beat, but the three-month change of 3.04% is the highest rate since late 2005. To be fair, some of that is a payback from a weak Q2, and the year-on-year number is still well below the pace of 2011 and parts of 2010. Optimists, however, will see a glimmer of hope in this number, even if kick-starting the economy through the channel of retail sales isn’t exactly the “high-quality” growth we would like to see.

Speaking of high-quality growth, the bad news today was that the Empire Manufacturing figure was weaker-than-expected, bouncing only feebly from last month’s figure (which was itself the weakest since early 2009).

The equity market responded to the data (or, more likely, to the notion that last week’s mild selloff makes stocks “cheap”) with a healthy +0.8% rally albeit on weak volume. Commodities were smashed for the second day in a row, somewhat inexplicably since the dollar didn’t strengthen and there wasn’t a lot of economic news out today.

Indeed, Monday was pre-climactic, as Mondays often are but this week in particular. For tomorrow is the monthly CPI report.

Last month, recall, core inflation printed +0.052%, a very weak surprise that pulled the year-on-year figure to 1.9%. It was especially surprising since Housing, the heaviest-weighted index, accelerated. The number was dragged down by Apparel, and the quirky drags from August did not all get reversed.

The consensus Street estimate for September CPI is +0.5% headline, +0.2% core. The consensus for the year/year changes is +1.9% for the headline, and an uptick to +2.0%.

An uptick on core is all but assured, because last September’s change in core was only +0.08%. The year-on-year number will print +2.0% if the month-on-month change is only +0.11% tomorrow. In fact, if the monthly figure for core is +0.21% (the monthly changes for March through June of this year averaged +0.22%), year-on-year core inflation will spring all the way back up to +2.1%. That would, incidentally, really help the Treasury sell the $7bln in 30-year TIPS they have to sell this week.

There is some reason to expect these upticks. As I’ve mentioned, the weak inflation data from a year ago is one reason, but even the nature of the last few months’ changes suggest that we are not likely to be in the midst of a broad slowdown in inflation. Median inflation is as high above core inflation as it has been for several years. Housing appears to be accelerating, not decelerating. And, needless to say, global central banks continue to ease aggressively. M2 has begun to re-accelerate and is back to +7% y/y (+8.2% annualized over the last 13 weeks, which is the highest rate since January).

If core comes in weak again tomorrow, it will create a difficult analytical dilemma. A string of unusually weak numbers at the same point of the year in consecutive years could point to faulty seasonal adjustment. Since other economic data have been having difficulty with seasonal adjustment, we would have to consider that possibility. But the more likely interpretation would be that something about the underlying dynamic of inflation has changed, and price increases are decelerating again. I don’t think this is going to happen, but if it does I will have to address that possibility.

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