Post-CPI Tweets (And Further Thoughts On CPI)

By: Michael Ashton | Wed, Aug 15, 2012
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Here is a collection of my post-CPI tweets (follow @inflation_guy) and some additional thoughts:

I don't think my view of the likely trajectory of core CPI has changed much. Housing remains buoyant, and certainly there are no signs that housing inflation is going to decelerate going forward, since surveys of primary rents are rising comparatively briskly. If housing isn't going to slow down, then it's hard to get a meaningful deceleration of core CPI going.

The base effects at work here shouldn't be underestimated. Apparel prices rose, and rose on a seasonally-adjusted basis, but year-on-year apparel inflation declined. As the chart below shows, however, this doesn't mean that apparel prices are falling and in fact the character of apparel price inflation still appears to have undergone a tectonic shift.

US CPI Chart

August 2011 core CPI, which will fall out of the year/year calculation next month, was +0.24% and will create a decent chance of another slip lower in core CPI. But the four months following that were all +0.17% or less, which means that the local low for y/y core CPI is almost surely in August. If traders perceive a bigger swing in the CPI than is actually happening, it will represent an opportunity to get long breakevens or inflation swaps at lower-than-current levels.

Outside of core inflation, there are relevant trends building in food and energy. Although retail gasoline prices are only up about $0.12/gallon from a year ago, they're also up $0.40 in the last six weeks at a time when most observers were expecting continued low prices. Some of this is Middle East tension, but a fair amount of it is related to domestic refinery issues and, of course, the increase in money. Energy prices will continue to ebb and flow, but gasoline prices within $0.40/gallon of an all-time high at a time when the global economy is sputtering at best should not be discounted. "Slack demand" isn't working. Since 2004, retail gasoline prices are up at around a 9% per annum pace (and much faster if you measure from the 2008 lows, which erased 2004-2008 gains), while M2 is up at a 6% per annum pace over the same period. This just in: more money in the system means that money depreciates relative to hard commodities.

While the current cycle in grain prices, to be followed soon by livestock prices, is likely amplified by the domestic drought and other food crop problems worldwide, I think it is unlikely that we will see prices back to the lows of a few years ago. As I pointed out here, real grain prices are not particularly high at all, and arguably are low considering the current crop condition.

These are not in core inflation, and there is nothing that Fed officials can do to restrain these prices separately from their efforts to restrain all prices; accordingly, it is still reasonable for policymakers to focus on the more-stable core CPI and median CPI in setting policy. It doesn't mean they don't care about food prices going up. It doesn't mean they want everyone to live without energy. It is just that they need to focus on a less-noisy series. At the same time, though, a rise in food and energy prices narrows the window during which the Federal Reserve can point optimistically at headline inflation being below core inflation. If the Fed is going to ease, I think it is going to be in September or it's not going to happen. And if that's going to happen, then I think we'll hear Chairman Bernanke speak generously about the capabilities of monetary policy at the Jackson Hole conference, which begins August 30th.

Astonishingly, despite weak inflation data and a very weak Empire Manufacturing report (consensus was +7.00 and the print was -5.85, bonds sold off anyway with the 10-year yield up 5bps at 2:40pm (when I am writing this) and real yield actually up more (10y TIPS +7bps to -0.46%). Equities traded listlessly, and commodities rallied. So, even though I was completely wrong yesterday about what was going to happen with core CPI, I was fortunately also wrong about the market reaction. In this case, two wrongs make a right, although I don't recommend pursuing this method of prognostication on a regular basis.



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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