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Summary of My Post-CPI Tweets

Below is a summary of my post-CPI tweets. ou 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.

  • Core CPI prints +0.145…just misses printing +0.2, which will make it seem weak. We will see the breakdown.
  • y/y core goes to 1.73% from 1.81%. A downtick there was very likely because we were dropping off +0.23%
  • This decreases odds of Sept Fed hike (I didn’t think likely anyway) but remember we have a couple more cpi prints so don’t exaggerate.
  • Core goods (-0.3% from -0.2%) and core services (2.4% from 2.5%) both declined. Again, some of that is base effects.
  • fwiw, next few months we drop off from core CPI: +0.137%, +0.098%, +0.052%, and +0.145%. So y/y core will be higher in a few months.
  • INteresting was housing declined to 1.9% from 2.2% y/y. But it was all Lodging away from home: 0.96% from 5.1% y/y!
  • Gotta tell you I am traveling now and that reminds you the difference between rate and level. Hotels are EXPENSIVE!
  • Owners’ Equiv Rent +2.79% from 2.77%. Primary Rents 3.47% unch. So the main housing action is still up. And should continue.
  • Remember the number we care about is actually Median CPI, a couple hours from now. That should stay 0.2 and around 2.2% y/y.
  • At root, this isn’t a very exciting CPI figure. It helps the doves, but that help will be short-lived. Internals didn’t move much tho.

The last remark sums it up. While the movement in Lodging Away from Home made it briefly look like there was some weakness in housing, I probably would have dismissed that anyway. There’s simply too much momentum in housing prices for there to be anything other than accelerating inflation in that sector. We have a long way to go, I think, before we have any topping in housing inflation.

But overall, this was a fairly boring figure. While the year-on-year core CPI print declined, that was due as I mentioned to base effects: dropping off a curiously strong number from last year. (That said, this month’s core CPI definitely calms things a bit after last month’s upward surprise). However, the next few base effect changes will push y/y core CPI higher. While today’s data will be welcomed by the doves, by the time of the September meeting the momentum in core inflation will be evident and median inflation is likely to be heading higher as well.

Note that I don’t think the Fed tightens in September even with a core CPI at 2% or above, but the bond market will get very scared about that between now and then. Could be some rough sledding for fixed income later in the summer. But not for now!

Summary of My Post-CPI Tweets

December 17, 2014 2 comments

Below is a summary of my post-CPI tweets. You can follow me @inflation_guy :

  • 1y inflation swaps and gasoline futures imply a 1-year core inflation rate of 0.83%. Wonder how much of that we will get today.
  • Very weak CPI on first blush: headline -0.3%, near expectations, but core 0.07%, pushing y/y core down to 1.71% from 1.81%.
  • Ignore the “BIGGEST DROP SINCE DECEMBER 2008” headlines. That’s only headline CPI, which doesn’t matter. Core still +1.7% and median ~2.3%
  • Amazing how core simply refuses to converge with median. Whopping fall in used cars and trucks and apparel – which is dollar related.
  • Core services +2.5%, unch; core goods -0.5%, lowest since 2008. But this time, we’re in a recovery.
  • Medical Care Commodities, which had been what was dragging down core, back up to 3.1% y/y. So we’re taking turns keeping core below median.
  • Core ex-housing declines to +0.800%, a new low.
  • That’s a new post-2004 low on core ex-shelter.
  • Accel major groups: Food, Med Care (22.5%) Decel: Housing, Apparel, Transp, Recreation, Educ/Comm, Other (77.5%). BUT…
  • But in housing, Primary Rents 3.482% from 3.343%, big jump. Owners’ Equiv to 2.707% from 2.723%, but will follow primaries.
  • Less-persistent stuff in housing responsible for decline: Lodging away from home, Household insurance, household energy, furnishings.
  • Real story today is probably Apparel, which is clearly a dollar story. Y/y goes to -0.4% from +0.6%. Small weight, but outlier.
  • Similarly used cars and trucks, -3.1% from -1.7% y/y (new vehicles was unch at 0.6% y/y).
  • On the other hand, every part of Medical Care increased. That drag on core is over.
  • Curious is that airfares dropped: -3.9% from -2.8%. SHOULD happen due to energy price declines, but in my own shopping I haven’t seen it.
  • I don’t see persistence in the drags on core CPI. There’s a rotation in tail-event drags, which is why median is still well above 2%.
  • We continue to focus on median as a better and more stable measure of inflation.
  • Back of the envelope calc for median CPI is +0.23% m/m, increasing y/y to 2.34%. Let’s see how close I get. Number around noon. [Ed. note: figure actually came in around 0.15%, 2.25% y/y. Not sure where I am going wrong methodologically but the general point remains: Median continues to run hotter than core, and around 2.3%.]

Quite a few tweets this morning! The number was clearly roughly in-line on a headline basis: gasoline prices have dropped sharply, in line with crude oil prices. How much? Motor Fuel dropped from -5.0% y/y to -10.5% y/y. The monthly decline was over 6%, and so a decline in headline inflation on a month/month basis was all but certain. Had core inflation been as low now as it was in 2010, we would have seen a year-on-year headline price decline (as it is, headline CPI is +1.3% y/y).

However, core inflation is not as low as it was in 2010. It continues to surprise us by failing to converge upwards to median CPI. Last year, the reason core CPI was inordinately low compared to the better measure of central tendency (median) was that Medical Care inflation was weak thanks to the effects of the sequester. But that effect is now gone. Medical Care inflation is back to 2.5% on a year-on-year basis; this month’s print was the highest in over a year. The chart below (Source: Bloomberg) shows the y/y change in Medical Care Commodities (e.g. pharmaceuticals) – back to normal.

medcarecommod

The 2013 dip is very clear there, and the return to form is what we expected, and the reason we expected core inflation to return to median CPI. But it hasn’t yet; indeed, core is below median by around 0.6%, the biggest spread since 2009. Now, it may be that core is simply going to stay below median for an extended period of time as one category after another takes turns dragging core lower. From 1994-2009, core was almost always lower than median. That was a period of disinflationary tendencies, and the fact that different categories kept trading off to drag core CPI lower was one sign of these tendencies.

I do not think we are in the same circumstances today. Although private debt levels remain very high (weren’t we supposed to have had deleveraging over the past six years? Hasn’t happened!), public debt levels have risen dramatically and the latter tends to be associated with inflation, not deflation. Money supply, especially here in the US, has also been growing at a pace that is unsustainable in the long run and it seems unlikely that the Fed can really restrain it until they drain all of the excess reserves from the system. These are inflationary tendencies. The risk, though, is that the feeble money growth in Europe could suck much of this liquidity away and move global inflation lower. This is an especially acute risk if Japan’s monetary authorities lose their nerve or if other central banks rein in money growth. In such a case, global inflation would decline so that, while US inflation rises relatively, it falls absolutely. I don’t consider this a major risk, but it is a risk which is growing in significance.

Of course, all of that and more is priced into inflation-linked bond and derivative markets, as well as in commodities. Only a massive and inexplicable plunge in core inflation could render the market-based forecasts correct – and there is no sign of that. Housing inflation continues to rise, and the soonest we can see that peaking is late next year. Getting core inflation to decline appreciably while housing inflation is 2.6% and rising is very unlikely! Accordingly, we see inflation-linked assets as extremely cheap currently.

Is This the “Real” Selloff?

June 5, 2013 3 comments

Let the wailing and gnashing of teeth begin: the stock market is down almost 5% from the highs!

It was once the case that investors viewed equity market volatility with aplomb. When you could only check your stock prices daily in the paper, and when people were cautious and unlevered because they recognized that crazy things sometimes happened and they couldn’t count on the central bank to bail them out, a 5% setback was just part of the normal zigs and zags. But now we see the VIX rising into the high teens, and a bid developing in Treasuries.

The bid, however, is not as apparent in TIPS. Investors irrationally consider TIPS a “risk-on” asset, even though they are safer than Treasuries since they pay in real dollars. It’s a wonderful thing, because every time there is a market upset “risk-off” trade, TIPS and/or breakevens start to offer terrific value and instead of losing when the panic passes, as with normal Treasuries that slide back down when the flight-to-quality passes, TIPS valuations will snap back. In the meantime, they offer hard-to-miss entry points. For example, right now the 10-year breakeven is at 2.19%, which means expectations are that the Fed will miss its 2% target on PCE on the low side over the next ten years (since PCE is regularly around 0.25%-0.5% below CPI).

Even if that happens, the Fed surely will not miss it by very much (in that direction) – in the worst recession of our lifetimes, core CPI printed 1.8% for 2009, 0.8% for 2010, 2.2% for 2011, and 1.9% for 2012. Headline CPI was 2.7%, 1.5%, 3.0%, and 1.7%, so the average for core over the last four years of epic financial disaster has been 1.7% and for headline, 2.2%. So why in the world would someone buy a 10-year Treasury note at 2.09% when they can own 10-year TIPS for -0.10% + inflation? There seems to me to be mostly downside to holding nominal bonds relative to TIPS…but investors will consistently make this error, and it may get worse, if stocks continue to correct.

However, that error will not last for long, I suspect. CPI will be released on June 18th, and I expect everyone will expect a very soft core inflation number. I believe the housing part of inflation will start to heat up as soon as this month, and I would be very surprised to see inflation print below what will surely be very soft expectations. If core inflation prints 0.3%, rather than last month’s 0.1%, the market will be completely the other way.

That’s not the near-term concern, though. Near-term, investors are concerned that the weak economic growth we have seen for the last several years rolls over rather than continuing to accelerate. The weak ISM print on Monday (the first below 50 since 2009) and today’s modest downward surprise in the ADP employment number (135k new jobs, the weakest since September) has increased nervousness that a stock market which is currently trading at nearly 23 times 10-year earnings, in an environment of record gross margins, might not be able to handle an environment that is less than perfect. I don’t blame investors for that concern.

Another concern, which oddly seems to be vying for equal time, is that the Fed “sounds serious” about ceasing its program of securities purchases. I am highly doubtful that both the weak growth and the end-of-QE concerns can both come to fruition, but even if growth continued to bump along at soft, but not recession levels I doubt the Fed would be cutting QE very soon. The Fed speakers who “sound serious” about reining in QE are mostly established hawks like Dallas Fed President Fisher, who said on Tuesday that “we cannot live in fear that gee whiz, the market is going to be unhappy that we are not giving them more monetary cocaine.” Against that, set the people whose votes actually matter: Bernanke, who evinces few concerns that there’s anything negative about QE and so isn’t in any particular hurry to stop it, and Dudley, who said recently that it will be a few months before the Fed can even decide on a tapering strategy (which would presumably have to precede an actual taper). I side with Fisher on this one, but my vote counts just about as much as Mr. Fisher’s.

(However, I can’t wait to see what my friend Andy at fxpoetry.com does with the cocaine comment tomorrow).

My view has not changed much: I think growth is going to be slow, but we’re probably not going to slip back into recession although we are technically due for one by the calendar. I think inflation is going to rise, and keep rising, and I think the Fed will be very slow to stop QE. Even once it stops QE, it will be slow to remove the accommodation, and inflation will continue to accelerate while it does so. I think stocks are overvalued and offer very poor real returns going forward. I do think that TIPS are now a much better deal than Treasuries, and not a bad deal on an outright basis relative to equities – the first time in a while I could have said that. In fact, the expected 10-year real return on equities is less than 2% more than the expected 10-year real return on TIPS (the latter of which has no risk), which is the worst valuation for stocks relative to TIPS since August of 2011.

In fact, here’s a fact which is worth dwelling on for any investor who says that stocks are a good deal because nominal interest rates are low. Stocks, of course, are real assets (although they tend to do poorly in inflationary periods, as I have said), and if you want to compare them to an interest rate you ought to be comparing them to a real interest rate rather than a nominal interest rate. So, let’s do that. The chart below (Source: Bloomberg) shows the 10-year TIPS yield (in yellow, inverted) plotted against the S&P 500 for the period I just mentioned.

tipsandstocksI think the conclusions are likely obvious. The last time real yields were at these levels, the S&P was between 1200 and 1400 (if you want to be generous about the early-2012 example). It’s over 1600 now.

Price-A-Palooza

January 19, 2012 6 comments

The monthly price-a-palooza from the Bureau of Labor Statistics, coinciding with the auction of $15bln in new 10-year TIPS, also shared the day with Housing Starts and Initial Claims. Dispensing with those two details first: Housing Starts was 657k, which was a disappointing shortfall after the strong NAHB number on Wednesday. Initial Claims looked strong, at 352k, but this comes with two caveats that are really the same caveat. The first is that the prior week’s claims were over 400k; the second is that year-end seasonal adjustment to these figures makes them nearly useless. It is probably most-useful (which is to say, only barely useful at all) to think of the last two weeks together and figure that the current pace of Claims is “about” 375k, right in the middle. This would coincidentally be consistent with the level of claims prior to the year-end volatility (see Chart, Source Bloomberg).

Also out was CPI, of course. Headline CPI was unchanged on a seasonally-adjusted basis, but Core CPI came in as-expected at +0.1% keeping the year-on-year rate at 2.2%. “Stabilization!” screamed the pundits, but it isn’t yet so. Core CPI was actually up 0.145% before rounding, which means we were a mere 0.005% from what would have been considered a surprise for the cheerleaders on CNBC. The year-on-year figure, too, rose nearly a tenth, from 2.153% for the year ended in November to 2.230% for the year ended in December. Rounding giveth and rounding taketh away! Yes, a rise in the year/year pace of only 0.08% represents a modest slowing, but that would still add a full percent to core CPI over the next year were it to persist.

It probably will not persist, because housing is going to begin to act like ballast on the number over the next few weeks, but core ex-housing is already at 2.46% and I see few reasons to expect it to not continue its rise.

In any event, we should remember that the 1.6% rise in core inflation over the last 14 months is the fastest such rise since 1984. A little respect, please, for the inflation process. I know it doesn’t always act like an instant-gratification video game, but looking at the chart of 14-month changes, below, can you tell me that this advance is so shaky that stabilization is automatic from here? I didn’t think so.

Rolling 14-mo absolute change in core CPI

.

A chart of the current y/y changes and the previous y/y changes is shown below.

Weights y/y change prev y/y change
 All items

100.0%

2.962%

3.394%

  Food and beverages

14.8%

4.452%

4.373%

  Housing

41.5%

1.874%

1.918%

  Apparel

3.6%

4.573%

4.763%

  Transportation

17.3%

5.197%

8.024%

  Medical care

6.6%

3.491%

3.370%

  Recreation

6.3%

1.027%

0.348%

  Educ & Communication

6.4%

1.670%

1.418%

  Other goods and services

3.5%

1.701%

1.858%

As you can see, Food & Beverages, Medical Care, Recreation, and Education & Communication, which collectively represent 34.1% of the basket, are still accelerating. Transportation (mostly because of energy), Apparel, and Other (24.4%) are decelerating. Housing looks like it is a wash, but it isn’t really, yet:

Weights y/y change prev y/y change
  Housing

41.5%

1.874%

1.918%

   Shelter

31.96%

1.905%

1.839%

   Fuels and utilities

5.10%

2.432%

3.423%

   Household furnishings & operations

4.41%

1.000%

0.767%

As you can see, most of the apparent slowdown in Housing is also in the energy sector, while Shelter is still rising. If we put 32.4% as “accelerating” and 5.1% as “decelerating”, then we still have 2/3rds of the basket accelerating. Again, that won’t be the case for long, but it is early to call the end of the inflation rise. Note also that the Median CPI put out by the Cleveland Fed actually ticked up to 2.3%, so it is above core CPI (although for all intents and purposes, tied).

There is a reason that many models are calling for a flattening out of core “soon.” The most-honest reason is that some models establish an important role for “anchored” inflation expectations. I am familiar with the literature on inflation anchoring, and I find it completely unpersuasive. I also do not believe in poltergeists. Both theories seem to explain certain phenomena, but neither has compelling empirical data to back them up. While it does seem that poll respondents “anchor” their responses (and it seems they anchor them to the most-recently-released figure that all media trumpet), there is not any evidence that consumers and producers actually change their behavior at all because of that “anchoring.” However, if it’s in your model, it’s one reason you might think that core inflation above 2% ought to begin reining itself in.

The sneakier reason that some economists are calling for a flattening out of core inflation is that we all can see the conditions in the rental markets, and that follows the recent renewed downturn in housing prices which is due to the inventory overhang. So it’s easy to say “Core won’t reach 3% soon.” It would be remarkable if it did. Indeed, it’s remarkable it’s already this high given that it has the unwind of an epic bubble to deal with. The current 2.23% core rate is above what our models expected to see realized for 2011, because shelter inflation rose more than we expected. What’s more interesting is to forecast what is going to happen to core ex-shelter, which is already above the Fed’s target and rising.

Our models take note of the fact that 52-week M2 money growth is now at 10.71%, just slightly high of a one week peak above that level in January 2009. Before that, and a dramatic one-week spike in September 2001 (wonder what that could have been?), you have to go back all the way to 1982 to find faster year/year money growth. Unlike last year, too, it’s not all going into the vault – corporate credit growth over the last year is now up over 3% and still rising. So in my opinion, is probably too early to send the hawks back to the eyrie.

Remarkably, my measure of the spread of perceived inflation over actual measured inflation – I think of it as sort of an ‘angst’ index – reached an all-time low (going back 12 years) this month. The index is driven by, among other things, the volatility of price changes and the dispersion of price changes. In other words, inflation has been rising in a comparatively stealthy, orderly way, which tends to diminish our sensitivity to it. Not unlike a frog being cooked in water that is being brought slowly to boil, come to think of it.

And yet, with everyone telling us not to worry about inflation, with 10-year real yields negative, with dealer risk-appetites still low, and with headline inflation tumbling back down to only 3%, the Treasury today sold $15bln 10-year TIPS 3bps better through the screens at the bidding deadline. Dealer demand was strong, as was the overall bid:cover. Someone wants inflation protection here!

On Friday, Existing Home Sales (Consensus: 4.65mm vs 4.42mm last) is the only data. I think we are also supposed to hear about the private-sector cram-down from Greece. The word was that there was supposed to be an agreement “by the end of the week,” but come to think of it I guess maybe they didn’t say which week! In any event, conditions look good for a return of the 10-year yield above 2% (closed today at 1.97%). While calamity can strike at any time, a fair amount of calamity is already priced into Treasuries. Moreover, it’s only calamity of a deflationary kind, not a calamity of an inflationary kind…and it isn’t at all clear that that is the most likely kind of calamity here.

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