It’s CPI day again. I know we all get excited about inflation day. Or maybe it’s just me.
Going into last month, we’d seen a dramatic collapse of breakevens: -210bps on the 1y, -70bps on the 5y, -50bps on the 10y. Some of this was the decline in energy, but not all. Implied core inflation also fell.
This month has seen a bit of a rationalization, and stability returning. Short breakevens still contracted because of gasoline, but longer inflation swaps/breakevens actually rose a smidge.
Since gasoline caught up in a way, core inflation implied by swaps increased a bit. Right now, the curve implies 3.7% core CPI over the next year, 3.2% the year after that, then 2.95%, and so on. Actually, not pricing in that core will get back to the Fed’s target.
As an aside, to me this still looks low. There should be asymmetry to outcomes (5% higher inflation is more likely than 5% lower inflation) that implies these should have some option value and trade above our raw expectations for inflation’s path. Still, it’s not horrible.
Although I think the 3.7% for the next 1y does look quite low. We’re at 6%-ish right now on both core and median. It isn’t just one thing that needs to revert to some mythical mean. It’s the whole dang distribution. That seems challenging.
Especially since rents, both primary and OER, continue to surge. I’ll be honest: when I first sat down to think about this month’s CPI, I thought there was a chance for a small deceleration in rents, which jumped from 0.6% to 0.7% m/m on OER and slightly more on Primary Rents.
That was a big part of the upside surprise in core last month. But when I look at it…I’m not convinced that was necessarily an outlier. Yes, rents will eventually decelerate. But not yet I think. The chart here is census for asking rents and Reis for effective.
The gap between them came about during the eviction moratorium. I thought it would close. But asking rents are moving higher, not converging back. (Some other private surveys suggest asking rents may sag, but it seems speculative at the moment).
There’s another reason I’m concerned about rents, and I’ll talk about it on Zoom after the number when I’m working through the charts.
For this number today, the consensus is for 0.5% on core and 0.2% on headline because of the decline in gasoline. The OTC market has core around 0.54% and economists are at 0.49%, basically; they both round to 0.5% but the market is more bullish.
I’ve mentioned why I don’t think the downside risks from rents will necessarily materialize. But there are a couple of other downside risks.
Airfares, which is essentially energy services because it tracks jet fuel (see chart), will very likely decline this month. Some of this is seasonal, though – I adjust for that in the chart – which means that raw airfares could fall and not bring down airfare CPI.
Used cars seems overextended too and I’ve been expecting a correction there. The Black Book index Jan-June was -2% vs CPI for Used Cars +3%. FWIW, the Black Book index was down this month. So that’s another potential drag.
But, all of that sort of seems to be ‘in the price’ as they say. The last 3 core CPIs were 0.57%, 0.63%, and 0.71%, and the consensus this month is around 0.5%. So some of that is in the pudding already. I don’t know that I’m short at 0.5%.
Reaction function? Well, a strong core…I think even an 0.6% may qualify…is going to be rough on stocks and bonds. Another 0.7% and you’ll hear talk about an intermeeting move (I don’t think that’s likely).
Softer core, 0.4% print, will be initially taken well by the market. But be careful about jumping in. If we get an 0.3% or lower and the market rallies, sell into it because most likely there is a one-off that is pushing it lower. Watch the real-time Median I produce, to tell.
The market’s currently pricing in lots of good news, which is why I’d be leery about riding a pop higher. After all, the next 2 core readings to roll out of the y/y will be 0.18% & 0.26%…core will keep rising, so Fed heads are safe to react hawkishly to a modest core surprise.
Last 12 core CPI figures:
M/M, Y/Y, and prior Y/Y for 8 major subgroups:
- Core Goods: 6.98% y/y Core Services: 5.54% y/y
Primary Rents: 6.31% y/y OER: 5.83% y/y:
Primary rents were 0.78% m/m last month, so the 0.7% was a modest deceleration but not exciting. OER was 0.70% last month so also a deceleration.
Some ‘COVID’ Categories:
- Airfares -7.83% M/M (-1.82% Last)
- Lodging Away from Home -2.74% M/M (-2.82% Last)
- Used Cars/Trucks -0.41% M/M (1.61% Last)
- New Cars/Trucks 0.62% M/M (0.65% Last)
The big story for ‘why the tail’ in core comes mostly from here, and maybe a bit in apparel (down on the month). An 8% drop in airfares is a big deal. Lodging Away from Home. And Used Cars wasn’t really a surprise, as I mentioned in my walkup.
Used cars could have been down more. I expected a decline, but there was room for more underperformance than that.
Piece 1: Food & Energy: 18.5% y/y:
Piece 2: Core Commodities: 6.98% y/y:
Core commodities is where we find Used Cars and Apparel. New cars was still strong. We knew that as supply chain constraints cleared, this would moderate.
Piece 3: Core Services less Rent of Shelter: 5.26% y/y:
Medical care was +0.44% m/m after 0.95% last month. Pharma +0.58% (0.38% last month). Doctors’ Services +0.27%, hospital services +0.49%.
Piece 4: Rent of Shelter: 5.76% y/y:
Core ex-housing 6.04%, which is down from 7.6% in Feb, and dragged down by the same stuff the overall core was. But still pretty high.
a little surprised stocks holding as much onto their gains…this was soft for some really obvious reasons. It’s good news for the Fed but not GREAT. I guess it does take 75bps off the table probably.
It’s not time for a victory lap but I guess it does help to remove the sense of panic.
We’re still going to get higher core over the next couple of comps are easy and since the central tendency of this distribution is still strong, there’s no reason to think we’re going to keep getting 0s on core.
Checking my Median CPI. The median category as I said was Midwest OER, and since I manually seasonally adjust the OERs I could be a bit off. But looks like it will still be somewhere between 0.52 and 0.57 m/m…so again, no crash in the broad distribution.
Car and truck rental was also really weak, although a very small weight. Public Transportation, Lodging AFH, Misc Personal Goods, and on the Apparel side Infants/Toddlers and Men’s/Boys were all negative m/m.
Communication was also -0.33% m/m. Internet Services and electronic information providers was -0.81% m/m. That’s 1% of CPI, so that’s about 1bp of the core miss right there.
Also weak were various furnishings categories. Major appliances were -1.8% NSA m/m. Indoor plants and flowers…which has about the same weight as major appliances – check your understanding by answering why…were -1.2% NSA m/m.
“Other Furniture” was -4.3%! Other linens -1.8%. These are all NSA m/m figures. And this is where the supply chain squeeze lessening is going to show.
Here is major appliances price level. Yes, they’re down, but they’re not going all the way back. The price level is permanently higher. What remains to be seen is how much of this is permanent and how much is ‘transitory’ due to supply constraints.
Same message from apparel—seasonally we tend to get a decline in July but this was larger than the normal seasonal which is why apparel was down m/m. And we import almost all apparel.
The message from the people who say inflation will go back down with recession is that unintended inventory accumulation is going to cause retailers to cut prices. Apparel is where you expect to see that first, because the seasons change quickly.
Here is the distribution of the CPI weights. There is more weight in the left tail, and that’s why core declined. But it’s REALLY in many cases that the weight in the left tail moved further left.
And here’s why I make that statement: the weight of categories inflating above 5% y/y went down only a tiny bit. So this is a left-tail event…which again is what median inflation is telling us.
The ongoing question is, “have inflation pressures peaked?” and “are we now in a disinflationary mode?” On the former, it’s too early to say but median at 0.53% rather than 0.7% is at least hopeful.
On the latter question, also too early BUT one small positive sign is that core inflation moved below median. It’s just one month, but remember: inflationary environments tend to have long upper tails (core>median), and v.v.. So watch this.
Median is going to get to about 6.27% y/y this month. And when the Quarterly Inflation Outlook comes out in a couple of days, you’ll see (if you are a client, or subscribe to it) that the midpoint of our 2022 median CPI forecasts have been moved WAY up to 6.3%. And 5.2% for 2023.
I think this is the last chart. The Enduring Investments Inflation Diffusion Index remains very high, no real sign of retracement yet.
So wrapping up. Stocks at this hour remain ebullient, while bonds have retraced some of the initial spike. It makes sense to reduce the probability of 75bps at the next FOMC meeting, even though this was mostly a left-tail event.
To be sure, I think the Fed still needs to reduce its balance sheet an awful lot, but if it just levels off then the price level will eventually converge to the rise in money growth. There’s a lot more to go there, though, which is why we’re not going back to 2% core soon.
So, I understand why stocks are excited. But I would be loathe to jump aboard unless the S&P 500 can get above 4200 decisively and/or stay there for a few days. There’s a lot of optimism priced in. And CPI was nice…but the IMPORTANT parts aren’t yet “good news.”
Stocks at this hour continue to celebrate, and not entirely without reason. The Fed is much less likely to tighten by 75bps this month than they were before the number. However, we have some doves scheduled to speak today (Evans and Kashkari) so be attentive and if they’re still talking about 75bps, and keeping in mind there’s one more CPI print before the next FOMC meeting – it’s a sign that they really are focused on the bigger picture.
And the bigger picture is this: the economy is headed into a recession, but the signs on that will be unclear and/or people will be able to explain the signs away for a while. Meanwhile, inflation remains high and sticky, despite today’s number. I’m pleased that median CPI, which exploded to 0.7% m/m in June, was back down to “only” 0.53% or so in July. But that’s still a 6.4% rate, and looking over the last several months you certainly can’t say there are any signs that inflation pressure is lessening or narrowing. At best, leveling off…and it’s even too early to be sure about that, given the continued acceleration in rents.
A year ago, I would have said that the Fed will take advantage of the weaker inflation data to back off of tightening some. But the Fed has been far more hawkish than I expected, and if they really do want to “get ahead” of inflation then they need to do it sooner rather than later since once core inflation starts to drop because of base effects, and the employment situation starts to weaken, there will be much more resistance to 75bp hikes. If Unemployment is at 5% and rising, they will not be hiking 75bps per meeting, no matter where inflation is.
So I’d repeat my admonition above – be careful jumping on board this equity rally. If stocks can sustain above 4200, then I have to reluctantly go along with the momentum. But I’d be careful about being too excited about inflation just because airfares dropped 8% this month.