Below is a summary of my post-CPI tweets.
- #CPI +0.0%/+0.2%. Y/y on headline goes to +0.5%, highest since December. Welcome to base effects!
- Core was actually +0.18% m/m, a bit higher than expected. y/y on core goes to 2.02% from 1.91% as we dropped off a weak mo.
- Next month, core #CPI will go to 2.1% or 2.2% y/y, simply because we drop off last December's +0.06% aberration.
- The rise in core seems dramatic (highest since 2012 now), but it's just catching up with Median. Expected.
- Primary Rents actually decelerated to 3.64% from 3.74%, and OER roughly unch at 3.08% from 3.09%. So core was held DOWN somewhat.
- Even with that, overall Housing subindex was 2.14% y/y from 2.12% y/y. Big jump in Lodging Away from Home helped that.
- Medical Care 2.95% from 2.98%. Boost to core came from "Other" (2.08% from 1.86%) and Education/Communication (1.32% from 0.97%).
- Core #CPI, ex-housing, 1.18% from 1.00%. That's the story here. Highest since mid-2014.
- Core services 2.9%, highest since Nov 2008; core goods -0.6%, partial retrace from last month but still very weak.
- The internals here not pleasant. We know housing will continue to accelerate. Core goods will not deflate forever.
- Love this picture of core goods and core services. Note services is usually the stickier piece.
- Early guess at Median CPI: 0.18%, keeping y/y at 2.47%. But median component looks like South Urban housing; hard to seasonally adj.
- The categories that are mainly non-core: Food & Beverages 1.2% from 1.6% y/y; Transportation -6% from -7.9%.
- Transport improvement not just fuel (-24.2% from -27.9%), but also insurance (5.5% vs. 4.7%) and new/used vehicles (-0.1% vs. -0.4%)
- … and airline fares (-3.8% vs. -5.2%), which is astonishing given the decline in jet fuel prices: down 67% vs. mid-2014.
- Nothing in the #CPI today is soothing. But nothing here could change the Fed outcome tomorrow anyway.
- FOMC has done nothing to dissuade the market from assuming a tightening. But important to remember the surprise risk is asymmetrical.
- That is, the FOMC is much more likely to be willing to surprise the market dovishly than hawkishly. I do think they will tighten though.
- Last fun chart of the day. Weight of #CPI components rising faster than 3% per annum.
The CPI report today was mainly interesting because while core rose as expected - actually, a little bit more than expected - that was not due to primary rents and Owners' Equivalent Rent, which have been the driving force for some time. Indeed, Primary Rents actually decelerated, so the rise in core CPI came despite sluggishness in one of the formerly-leading components.
So what happened? Well, other elements of core services took the reins. Un-sexy elements like Information and Information Processing (-0.8% from -1.5%, and compared to a 2-year compounded rate of -1.3%), Personal Care Services (3.1% vs. 2.7%), Medical Care - Professional Services (2.0% vs. 1.8%), and Health Insurance (3.6% vs. 3.0% - see chart below, source Bloomberg).
It is worth pointing out that health insurance is only 0.75% of the CPI because the BLS measures the costs of medical provision more directly. This is a residual. But still very interesting given what we know anecdotally is happening in the ACA marketplace.
Here is the chart of core inflation, ex-shelter (Source: Enduring Investments).
This doesn't look alarming, but the story of the low core inflation over the last few years can be thought of this way: shelter prices going up; core services ex-shelter decelerating somewhat; core goods deflating. We can't count on core goods deflating forever (although our models have them deflating at roughly this pace for a little while yet), and they tend to move around more than core goods. But the core services ex-shelter piece, filled with things like medical care, has played a major role. Those pieces are now re-accelerating.
Nothing that happened today, as I note in the tweet-feed, will change what the Fed does tomorrow. While I was long skeptical that the Committee would tighten in December, the market priced it in and no Fed speaker (with any weight) tried to signal otherwise. That tacit agreement with market pricing has historically meant that the FOMC was prepared to do what the market had priced in. But there are four caveats worth noting.
First, as I said in the tweet-stream, the Fed is always more likely to surprise on the dovish side than on the hawkish side. Thus, if the market was pricing in no action but the Committee wanted to tighten, they would be much more aggressive about speaking out so as not to surprise the markets. They never seem to care about surprising them in the dovish direction. So there's that.
Second, this would be the first tightening of the Yellen regime. We don't know that she operates in the same way that prior Fed Chairmen have operated; perhaps she is less worried (or aware) about surprising the markets. It is worth keeping in mind although I doubt very much she wants to be a rebel in this way, especially with high yield markets in what can generously be called "disarray."
Third, whatever happens tomorrow, the second tightening is very much up in the air. We are starting to see failures of high yield funds and we will see failures of high yield companies. If this gets particularly ugly, it is possible the Fed will take a pass in the first or possibly the first couple of meetings in 2016. If that happens, it will be harder to get started again. So I'd be careful to price a long string of tightening actions here.
Fourth, and finally: I have been calling it "tightening" but the Fed of course is not tightening policy. They are only raising interest rates. There will still be plenty of money in the system, and rates will be going up not because demand for money outstrips its supply, but because the Fed says so. The result of this will be very different from the results that followed prior Fed tightenings.
Inflation will rise, because velocity rises when interest rates rise and that leads to higher inflation - and this generally happens when the Fed starts to tighten - but since the Fed will not be reining in money growth inflation will continue to rise. That's unusual, but it will happen because the deviation from the script is important: ordinarily, it is the slowing of money growth rather than the increasing of interest rates that restrains inflation; the increase of interest rates actually accelerates inflation. The Fed has no plans to slow money growth, nor any way to really do it - so inflation will continue to rise.