By: Michael Ashton | Thu, Jan 19, 2012
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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).

Initial Jobless Claims

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.



Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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