Powell Plays Down Inflation Threat Sees shortages fading over time, bringing inflation closer to the Fed’s 2% long-run target
(…) “If you look behind the headline and look at the categories where these prices are really going up, you’ll see that it tends to be areas that are directly affected by the reopening,” Mr. Powell said in a hearing before a House subcommittee. “That’s something that we’ll go through over a period. It will then be over. And it should not leave much of a mark on the ongoing inflation process.”
Fed officials last week increased their median forecast for inflation this year. They project consumer prices in the fourth quarter of 2021 will rise 3.4% from a year before. That is up from their 2.4% forecast in March. The change came after a spate of high inflation readings pushed the 12-month gain in the consumer-price index to 5% in May, its highest level since 2008.
Mr. Powell said that while he has “a level of confidence” in the prediction that inflation will start to subside, “it’s very hard to say what the timing of that will be.” (…)
Bloomberg’s piece on Powell’s testimony is more informative than the WSJ’s (my emphasis):
“A pretty substantial part, or perhaps all of the overshoot in inflation comes from categories that are directly affected by the re-opening of the economy such as used cars and trucks,” Powell said Tuesday in response to a question before the House Select Subcommittee on the Coronavirus Crisis. “Those are things that we would look to to stop going up and ultimately to start to decline.” (…)
“I will say that these effects have been larger than we expected and they may turn out to be more persistent than we expected.” (…)
“We will not raise interest rates preemptively because we think employment is too high, because we feared the possible onset of inflation,” he said. “We will wait for actual evidence of actual inflation or other imbalances.” (…)
Let’s acknowledge that it is a challenging exercise to read inflation clearly amid conflicting trends in various components, base effects and imputed prices. FOMC members rely heavily on the Fed staff to decipher and analyse data from all over the statistical sphere. Two examples of what policymakers feed from:
- The St-Louis Fed staff published a rather weak and superficial piece (Putting Recent Inflation in Historical Context) in which it focuses on the CPI because “Although the Fed uses a personal consumption expenditures (PCE) inflation target, CPI inflation is highly correlated with that PCE target and is seen as a leading indicator of PCE inflation.” Its conclusion:
(…) Should the April CPI report cause concern? While the analysis in this article establishes that the April 2021 inflation report is one of the highest inflation readings since the Fed instituted inflation targeting in the mid-1990s, there are other factors at play. As inflation is measured as the percentage change in the price of a basket of goods from the prior year, by construction the April inflation report is comparing prices in 2021 with depressed prices from April 2020, which was during the COVID-19 lockdown. While the April 2021 inflation report is undeniably historically high, it also follows an unprecedented turbulent period for the economy for which the historical evidence might provide imperfect guidance.
- In What’s Behind the Recent Rise in Core Inflation?, the San Fran Fed staff zeroes in on two main culprits:
The recent rise in inflation is attributable to the same COVID-sensitive categories that declined the most during the onset of the pandemic last spring. Assessing individual categories within the COVID-sensitive component shows that much of the increase in inflation comes from two categories: health-care services and used cars and trucks.
Health-care services is one of the largest components of core PCE inflation, representing close to 20% of core expenditures. (…) In the five years preceding the pandemic, health-care services contributed approximately 0.22pp on average to core PCE inflation.
The prices of health-care services in the PCE price index are based on payments made by health insurers to providers, such as physicians and hospitals. As the single largest payer to health-care providers, Medicare directly contributes to measurable changes in health services inflation. Furthermore, changes in Medicare prices tend to spill over directly into private prices, impacting overall health-care services inflation (Clemens, Gottlieb, and Shapiro 2014).
A number of pandemic-related legislated changes to Medicare payments have gone into effect over the past year. These include a 20% add-on payment for COVID treatments, a temporary moratorium of the 2013 Medicare sequestration 2% payment cuts, and a temporary 3.75% increase in payments to physicians. Overall, these factors have led to a 0.6pp increase in the contribution of health-care services, triple its average contribution between 2015 and 2019.
Importantly, these payment changes are temporary and are expected to either roll off or reverse by early 2022. Thus, what is now a boost to inflation coming from health-care services is likely to become a drag by next year.
(…) Owing to this category’s [Used autos and trucks] very stable prices, its contribution hovered close to zero between 2015 and 2019. In April 2020, prices became strikingly volatile. The contribution declined to to -0.1pp but then reversed course and began surging upwards.
A steady increase in the demand for cars, in tandem with a shortage of semiconductors—a key production input for new cars—led to severe upward price pressure for used vehicles. Overall, the contribution of used vehicles to core PCE inflation has surged to 0.5pp, significantly higher than its pre-pandemic contribution.
It remains unclear how long car production will remain constrained, however, a consensus of market participants expect some easing by the second half of 2021 (Fitch 2021, IHS Market 2021).
I hope FOMC voting members get more thorough analysis than these two, with less emphasis on YoY data because of the base effects and most emphasis on sequential changes to catch the true ongoing trends.
Core Goods inflation is up 6.5% YoY and 16.5% annualized in the 3 months to May. Removing the infamous Used Cars and Trucks component, it’s up an acceptable 2.1% YoY but a more worrisome +5.3% annualized in the last 3 months.
- Furniture and Bedding +8.6% YoY +25.9 % a.r. last 3 months
- Appliances +6.9% + 4.4%
- Apparel +5.6% + 4.8%
- Televisions +4.5% +14.3%
- Sporting Goods +9.0% + 5.7%
Another form of inflation from Reuters: “Data from Goldman Sachs shows the average discount on appliances around Memorial Day weekend this year was just 7%, lower than 19% a year ago. Whirlpool was the least promotional, with discounts of only 2%, down from 9% a year ago, the data showed.”
Core Services are up a low 2.9% YoY but 5.3% a.r. in the last 3 months.
There are also items where prices have fallen during the pandemic, perhaps also in a transitory fashion:
- Health Insurance -5.0% -11.3% a.r. last 3 months
- Educ. & Comm. Goods -1.4% +7.0%
Lastly, there are the divergent trends in housing related data with the imputed CPI Housing inflation rates having sharply decelerated from their 3-4% pre-pandemic range to 2% while house prices are skyrocketing. A similar phenomenon occurred in the early 2000s but sharply reversed in the following 3 years. Not a moot point considering that shelter costs are 32% of the headline CPI and 40% of core CPI.
The Cleveland Fed builds a 16% Trimmed-Mean Consumer Price Index to weed out the outliers at both ends of the inflation spectrum. It has been hovering between 1.9% and 2.3% YoY since 2017. It was +2.6% in May after having accelerated at a 4.1% a.r. in the last 3 months, +4.9% in the last 2 months. This acceleration should be worrisome to the FOMC.
All headline and core indices (indexed at February 2020 = 100 to eliminate base effects) are now above trends by roughly 1.0%. That is what the Fed is wishing for…as long as it settles down, about now.
I don’t pretend to know the future but a detailed analysis of recent trends should be of concerns. The fact that Powell now admits that the FOMC has been surprised by the inflation numbers and that “they may turn out to be more persistent than we expected” is reassuring, until we hear “We will wait for actual evidence of actual inflation” before acting.
Yesterday, Powell acknowledged that they have been wrong, but they will wait for clear evidence that they are clearly wrong. Only then will they use “the tools” to reign in the inflation beast, “tools”, whatever they may be, that always take a while before becoming effective.
What seems clear to me is that
- demand for goods is exceptionally strong against restricted and costlier supply; a rare case of demand pull meeting cost push;
- demand for services is now recovering, also with more limited supply;
- demand for labor is very high but supply, for whatever reasons, is restricted;
Business people are confidently raising prices/wages to fulfill that strong demand and offset their inflated costs. Consumers understand the situation and are willing/able to pay more chanting YOLO jingles.
Confronted with higher food and labor costs, restaurants are trying to lock in profits while consumers are so hungry to get out and about, they’ll pay just about anything. (Bloomberg)
This while Congress is debating the size (large or huge) of the next fiscal packages that would come into play if and when the Fed decides it needs to start using its “tools”.
The seeds of policy mistakes are all laid out but nobody cares. We are all betting that it will all be transitory.
Meanwhile, in the real world, Americans keep spending if we can trust the Chase Consumer Card Spending Tracker (data through June 18):
Even Travel and Entertainment is booming now:
James Mackintosh (Streetwise: Confused by the Fed? So Are Markets) yesterday argued that the Fed is not actually blindly walking all Powell’s talk:
(…) Instead of a calm response to the Federal Reserve’s slightly more hawkish tone, the 10-year yield first leapt by the most in months, then plunged. On Monday, it dropped during Asian trading hours to the lowest since February, before bouncing all the way back and then some. (…)
For me, the most extraordinary shift was the $235 billion deposited in the Fed’s reverse repurchase facility after it raised the rate it pays from zero to 0.05%, because it was concerned that it was losing control of the lower bound of rates.
This is a true tightening of monetary policy, not the mere technicality the Fed presented it as. For monetarists who care about the amount of money in circulation, in one day it drained reserves equivalent to two months of quantitative easing, and showed just how much cash is sloshing around the system looking for even the tiniest yield.
For those, including me, who prefer to focus on the price of money, it is now higher—albeit not very much, it is a tightening. Secured overnight rates in the money market had been stuck on the floor of 0.01% since March, according to the New York Fed, with some borrowing at negative rates. It rose to 0.05% after the Fed’s announcement, and negative rates vanished.
After the initial volatility, the bond market’s considered reaction was in the right direction for tighter policy: Higher short-term real rates reduced the longer-term inflation threat and so led to lower 10-year and 30-year Treasury yields—until the reflation trade returned on Monday. Higher rates pulled down stocks most sensitive to the economy—cyclicals and cheap value stocks—until Monday’s reverse. Growth stocks did fine thanks to lower long-term rates, before lagging behind on Monday.
Yet, 0.05% is a very small tightening, to put it mildly. Usually, the Fed moves in 0.25-percentage-point increments, so this was equivalent to one-fifth of a normal rate increase. What mattered for Treasurys wasn’t the immediate shift in the price of money, but the prospect of a bigger change by the Fed. (…)
U.S. Existing Home Sales Ease in May but Prices Strengthen
The National Association of Realtors (NAR) reported that sales of existing homes eased 0.9% (+44.6% y/y) to 5.800 million (SAAR) during May after declining 2.7% to an unrevised 5.850 million in April and 6.010 million in March. Sales have fallen 13.8% since their peak last October. The Action Economics Forecast Survey expected May sales of 5.730 million. Data are compiled when existing home sales close.
The median price of an existing home increased 2.8% (23.6% y/y) to a record $350,300. The median home price in the West rose 0.9% (24.3% y/y) to $505,600. In the Northeast, prices improved 0.8% (17.1% y/y) to $384,300. The median home price in the South rose 3.9% (22.6% y/y) to $299,400. In the Midwest, prices strengthened 3.5% (18.1% y/y) to $268,500. The average sales price of all existing homes rose 2.1% last month (17.0% y/y) to $371,900. The price data are not seasonally adjusted.
The number of existing homes on the market gained 7.0% (NSA) to 1.23 million last month. The number declined, however, 20.6% y/y and remained near the record low of 1.03 million units in January and February. (The figures date back to January 1999.) The months’ supply of homes on the market rose slightly to 2.5 months but remained well below its recent high of 4.6 months in May of last year.
Sales declined across most of the country last month. Existing home sales in the West weakened 4.1% (+61.6% y/y) to 1.180 million, the fifth decline in six months. In the Northeast, sales fell 1.4% (+46.9% y/y) to 720,000 units. In the South, sales eased 0.4% (+47.2% y/y) to 2.590 million units, the fourth consecutive monthly decline. Working 1.6% higher (27.2% y/y) were sales in the Midwest to 1.310 million after rising 0.8% in April.
Sales of existing single-family homes fell 1.0% (+39.2% y/y) to 5.080 million units, down for the fifth straight month. Sales of condos and co-ops held steady at 720,000 units, but have doubled y/y.
- Blackstone Bets $6 Billion on Buying and Renting Homes The investment firm’s deal for a company that buys and rents single-family homes is the latest sign Wall Street believes the U.S. housing market is going to stay hot.
Warehouse Rents Surge on Bidding Wars for Scarce Space Competition is driving up industrial rents as retailers and logistics providers race to move goods closer to population centers, with some engaging in bidding wars for the most coveted sites.
(…) Demand for industrial real estate is so strong that taking rents—the initial base rent agreed on by a landlord and tenant—are rising faster than asking rents, according to real-estate firm CBRE Group Inc. Industrial taking rents were up 9.7% in the first five months of 2021 compared with the same period last year, while industrial asking rents rose 7.1%, according to CBRE, which tracks 58 U.S. markets.
Prices are rising at a particularly strong rate for logistics space near ports and cities, and for big-box warehouses such as those used in large online fulfillment operations. First-year base rents in Northern New Jersey jumped by a third year-over-year through May, while those in Southern California’s Inland Empire rose 24.1%, according to CBRE. Taking rents for bulk warehouse space of 500,000 or more square feet increased 13.2% from the same period in 2020. (…)
“There’s just a few viable options and occupiers really want those options, and they’re willing to pay more for them because they’re so strategically important.” (…)
Logistics providers, retailers and wholesalers that supply those merchants are adding more warehouses to serve as regional hubs, Mr. Breeze said, to deliver goods faster and cut transportation costs. Companies are also looking to keep more inventory on hand to guard against shortages.
“It’s e-commerce, it’s inventory control and general demand from the public on an improving economy,” he said.
The amount of available industrial land for new warehouses near urban centers has declined over the past decade, according to a June research report from Prologis Inc., the largest owner and manager of logistics real estate by square footage. (…)
Bubble Expert Jeremy Grantham Addresses ‘Epic’ Equities Euphoria
(…) The last 12 months have been a classic finale to an 11-year bull market. Peak overvaluation across each decile by price to sales, so that the most expensive 10% is worse than it was in the 2000 tech bubble and the remaining nine deciles are much more expensive. all measures of debt and margin are at peaks. Speculative measures such as call option volumes, volume of individual trading and quantities of over-the-counter or penny stocks are all at records.
Robinhood and commission-free retail trading have driven a surge of new investors with no experience of past bubbles and busts. So the scale of craziness is larger. Cryptocurrencies represent over $1 trillion of claims on total asset value while adding nothing — pure dilution. (…)
Finally, Dogecoin, AMC and Gamestop — worth billions in the market and not even pretending to be serious investments. AMC is up nearly 10 times since before the pandemic even though box office is down nearly 80%! Dogecoin was created as a joke to make fun of cryptocurrencies being worthless, and not only has it taken off, but it’s such a success that second-level joke cryptocurrencies making fun of Dogecoin have gone to multibillion-dollar valuations. Meanwhile, other cryptocurrencies have seen success purely on the basis of their scatological names.
“Meme” investing — the idea that something is worth investing in, or rather gambling on, simply because it is funny — has become commonplace. It’s a totally nihilistic parody of actual investing. This is it guys, the biggest U.S. fantasy trip of all time. (…)
This current event is particularly dangerous because bonds, stocks and real estate are all inflated together. Even commodities have surged. That perfecta and a half has never happened before, anywhere. The closest was Japan in 1989 with two hyper-inflated asset categories: record land and real estate, worse than the South Sea bubble, together with record P/E’s in stocks recorded at the time as 65x. The consequences for the economy were dire, and neither land nor stocks have yet returned to their 1989 peaks!
The pain from loss of perceived value will only get more intense as prices rise from here. In short, the Fed since Volcker has been pretty clueless and remains so. What has been more remarkable, though, is the persistent confidence shown toward all of these four Fed bosses despite the demonstrable ineptness in dealing with asset bubbles. (…)
FYI via Bloomberg:
Fewer babies. Nine months after the first lockdown, U.S. births fell by 8% in a month. The December drop marked an acceleration in declines in the second part of the year. For 2020, the number of babies born in the country fell 4% to about 3.6 million, the largest decline since 1973. Births have been on the decline for years as people choose to have children later.
Warning shots. Russia used bombs and gunfire to warn off a British Navy destroyer in the Black Sea, the Defense Ministry in Moscow said. An aircraft dropped four bombs in waters near the H.M.S. Defender and a border patrol ship fired its gun to divert it after the vessel entered Russia’s territorial waters off Crimea and refused to heed radio warnings. The U.K. doesn’t recognize Russia’s annexation of Crimea in 2014.
Jack Ma’s Ant in Talks to Share Data Trove With State Firms Ant Group is in talks with Chinese state-owned enterprises to create a credit-scoring company that will put the fintech giant’s proprietary consumer data under regulators’ purview.
(…) Until recently, Ant had resisted pressure from financial regulators to share its data or feed it into a central repository accessible by other financial institutions, saying that it didn’t have its users’ consent to do so. (…)