Summary Of My Post-CPI Thoughts

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Includes: DIA, IWM, QQQ, SPY
by: Michael Ashton

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

  • whoopsie daisy! core CPI +0.3%.
  • …actually +0.29%, so not just a barely-round-up thing. Y/Y t0 2.22%. Both comfortably above consensus.
  • Next month, we drop off a +0.16% from last year so even a +0.20% print on core would push us to 2.3% in Feb.
  • Core converging with median, as expected. Look at chart. What impression will it give FOMC?

core

  • core services +3% from +2.9% y/y; core goods to -0.1% from -0.4%. least-negative in two years.
  • I am not sure the core goods improvement can be sustained, yet, given lagged effects of dollar. Will eventually, though.
  • dealers holding all those 30y TIPS from y’day auction feel better today.
  • Cpi breakdown shortly. Taking unusually long to parse the data. Really need to optimize my database.
  • OK! Housing 2.10% from 2.07%. Primary rents 3.71% from 3.68% and OER 3.16% from 3.14%. So housing isn’t the big story.
  • Medical care: 3.0% from 2.58% y/y. As the mythbusters would say, “there’s yer problem.”
  • Medicinal drugs 2.21% from 1.66%; Professional svcs to 2.08% from 1.92%, Hospital 4.32% from 3.96%.
  • Medicinal drugs is what to watch going fwd. That’s in core goods & in 2015 fell from 5% to 1.7%
  • motor vehicles +0.51% from +0.14% y/y. Also in core goods.
  • Of interest – the fall in energy prices has reduced “food and energy” to 21% from 22.3%. So core is bigger.
  • Core ex-shelter 1.47% from 1.29%…highest since 3/2013. I think @TheStalwart showed a picture of that earlier.
  • This is less and less just a housing phenomenon.
  • OK, good news is that it looks like median CPI ought to be about 0.18%ish, so y/y will inch back up to 2.5% but not jump to 2.6%.
  • Also interesting is that the diffusion indices didn’t go wacky. So this number is not QUITE as bad as it seems at first blush.
  • Still the overall trend is clear: housing and now core ex-housing inflation are headed higher.
  • Still very hard for the Fed to ignore the core CPI chart. And PCE will be worse, because it is heavier in medical care.
  • I think March just went back on the table for the FOMC.

So, here are the main takeaways from this month’s report:

First, inflation in medical care is coming back, and that is starting to blunt the deflation in other core goods. At this point, the question is whether medical care inflation goes back to what it was prior to the Affordable Care Act, or goes higher. Although I am a staunch opponent of Obamacare, and I believe it will drive costs higher overall, I think anecdotally there are some signs that the free market is working to correct some of the most egregious failings of the Act. So it may not be quite as bad as it otherwise would be. Still, it appears the temporary lull in medical care inflation is past us.

Second, the fact that medical care was a big driver in this month’s CPI report means the core PCE report will likely be worse, since medical care carries a much larger weight in core PCE. This is why core PCE has been weaker than core CPI for some time, but that will correct.

Third, and a related point: the lagging measures of inflation are catching up with median CPI. The chart below, which is really just an expanded version of the chart above, doesn’t have the updated median CPI, which will be released later today, but that line won’t look much different. And it doesn’t have the updated core PCE, which will be released next week. But you can see what is happening to core CPI, which is the middle line.

cpis

Fourth, core goods prices are not likely to suddenly explode higher. The delayed impact of dollar strength, while it will not drive deflation broadly, will keep a lid on core goods inflation for a while longer. However, the core goods part of CPI is the less important and persistent part, and services (driven by housing, but no longer just by housing) continues to accelerate.

Fifth, the Federal Reserve had been inching away from the expectation that they would tighten in March, due to weak global growth and domestic equity markets. I think that possibility just landed back squarely on the table. If folks don’t realize it today, they will realize it when core PCE “surprises” higher next week.

And all of this means that higher inflation remains in our future. The notion that deflation is some kind of existential threat makes as much sense as the notion that alien invasion represents an existential threat: possible, but not something that ought to keep us awake at night worrying. Inflation expectations do not drive inflation – it is the other way around. Inflation is headed higher, whether people – and the FOMC – expect it, or not.