The idea that inflation could ever possibly be transitory is to completely ignore what inflation is. Inflation is NOT the YoY change in price level. Inflation is the lasting trend of the price level in response to the trend in the level of money and credit. PERIOD. Ergo, it is impossible for a fiat currency under a fractional reserve banking system to ever have transitory inflation. Inflation is an inexorable march higher, every year, at varying degrees of severity. There is NEVER a correction in the general price level. There will never be a restoration of value in the unit of account. Transitory? HAHA NO
Thank you for another thoughtful piece. However, I have a bit of a bone to pick regarding rent, and not OER, but actual rent. At this point, why would anyone expect rents to decline at all? Consider, landlord's expenses have clearly risen sharply over the past several years, Unemployment remains extremely low, although I grant the weekly claims data is starting to point to a bit more slack, and there is not, as yet, an overabundance of rental units available in most cities. As such, what would incent landlords to cut rents? Even if housing prices are beginning to decline, the lag between house price changes and rental rates is pretty substantial.
Add to this the idea that rent has a built-in 12 month lag based on the BLS methodology and it feels to me that it will be quite a while before the rental piece of CPI starts to decline in any meaningful way. Given that the Fed is focused on these lagging indicators, I would not be optimistic that they are going to be concerned about a housing crisis anytime in the near future.
Great note Mike, but I have some push back. Where does the price level come from? I would suggest interest rates have an important, if not leading role. The cost of funds must be imputed in the forward price curve. How else can one explain the experience of Japan and the developed world post GFC? Low rates seem to beget low inflation outside of exogenous induced shocks.
Lastly, why are we only focusing on the borrowing side of the economy? Interest rates have distributional effects for sure (winners and losers), so measures of credit should reflect some stress somewhere, but what about the income side? With the fiscal pump in full force (in large part from regressive Interest payments), incomes and household balance sheets look very healthy from my perspective. And there is gobs of capital laying idle able to scoop up distressed assets off the "losers". Just some random guys thoughts and always I always look forward to your notes. Cheers.
It’s interesting that unemployment bottoms before delinquency. It makes sense that consumers have difficulty in servicing their debt, which leads to a drop in consumer demand, which leads to higher unemployment. BUT, I thought people would get laid off before delinquencies.
A close relative got "terminated" Friday (arguably a more accurate use of the root of terminal than the Fed uses for terminal rate). He's age 64. This was not a tech company, but in the consumer products space. Bloomberg reported that his company was only laying off white collar/management workers and not production, blue collar workers. The chances for someone his age getting a new corporate job at an equivalent salary are slim (which he acknowledged to me as he used to be the one who approved new hires for his group). So now he's going to be drawing down on his 401K and not making new contributions. While it's admittedly early days in assessing the impact of Fed rate hike policy, it strikes me that most layoffs so far have been white collar workers. White collar workers typically contribute more to their 401Ks. That led me to think about your passive investing analysis - how the inelasticity (and its multiplier effect) works both ways, magnifying prices upward when flows are positive and doing the opposite when flows are negative. So perhaps we're on the cusp of seeing what happens to the major indicies that many passive funds are based on when flows go negative. Time will tell.
It makes sense to remove shelter from inflation indices because shelter is measured (and imputed for owner occupants) from rent, and the cost of rent is only updated when a lease expires or the occupant leaves (sense to measure consumption more than inflation). So that creates a long measurement lag, plus they only survey people once every six months. Which means the shelter index of inflation was probably terribly understated a couple of years ago, helping the Fed ignore incipient inflation.
However the Fed really should have noted that housing costs were up 40% in repeat sales indices (which implicitly controls for sq ft), and laid off the QE much earlier. Particularly when OAS yields on MBS were through Treasuries.
What bothers me now is the resoluteness that the Fed says they will NOT lower interest rates anytime soon. That's in contrast to the periods before past recessions when the Fed starts to cut rates a couple of quarters before the recession because they see that employment growth is weakening, normalizing the inverted yield curve at the last minute and providing false hope to some. So we've got 450 bps of rate increases inside the past 12 months, which probably haven't been fully felt in the economy, a Fed that is still raising rates, and says they absolutely will not cut. Which means there's one hell of a lot of downward inertia in the economy when we enter this recession. It almost certainly won't be a brief recession.
Finally, we all tend to cherry pick macro indicators to make our point on recessions. The US Leading Indicators has a consistent list of variables, and it is loudly signalling a recession. One of the few bright spots in the LEI is rising stock prices. Ha ha.
It has bothered me that airplanes fly to terminals given the possible meaning of terminal. Now, I'm bothered by the notion of a terminal rate, too. Thanks for that... sort of.
Lot's of hyperbole like "death sentence"...not even close! Two words do not come out of my mouth...Never & Always! This economy is way more resilient than most are given it credit for primarily because of political beliefs and the I'm the smartest person in the room crowd. The only thing that will get the Fed or Congress's attention is when/how inflation structurally heads higher and it will given "Geopolitical Risk" and "Policy Rick." But that process will/would be a slow grind and politicians in Congress can/will change much faster than the Fed, and in my opinion will give into doing what they do best by passing out handouts to their chosen winners...You make some very good points but this environment given the dynamic factors driving it has a unpredictable current where the swarm and the narratives that drive it is headless and gravitates toward the path of least resistance...ignorant beliefs, misinformation by all and an incentive structure that is lacking to say the least...TBD, Lots of pain coming...GL
Note by the Squirrel: you need a hedge against a world of higher for longer interest rates and long end getting out of control. In my “What if JPOW lost control of the long-end?” Acorn report, I mentioned PFIX as an alternative to the put structure on TLT that I wrote up.
All central banks know very well about leading/lagging indicators. The BoE communicated the expected future slowdown in inflation publicly, but that communication might have contributed to (not the only reason of course, Brexit, Nat gas, etc.) still having above 10% headline inflation. Imo Powell is just purposefully communicating a very lagging indicator such as headline CPI to the public in order to talk the market down so it doesn’t rally too early.
Mike, I appreciate your normalization of home prices by size, but I cannot ignore the wide gap between home prices and incomes, reminiscent of the GFC era. So, shelter inflation might be overstated, due to a lack of hedonic adjustment, to your point, but we likely still have a deep affordability issue - even without high interest rates.
Great piece Michael! I have a genuine question regarding the recent rise in credit delinquencies—why is it necessarily different from the rise observed in 2016-2017? I see that the pace of increases is more rapid this time, but wasn't the drop preceding it also due to relatively *sudden* fiscal stimulus—once it was withdrawn, one would expect credit delinquencies to rebound to the level they were at before, no? In that case, could we potentially expect that the delinquency rate would, like it did in 2017-2018, plateau without necessarily heralding an impending rise in unemployment?
The idea that inflation could ever possibly be transitory is to completely ignore what inflation is. Inflation is NOT the YoY change in price level. Inflation is the lasting trend of the price level in response to the trend in the level of money and credit. PERIOD. Ergo, it is impossible for a fiat currency under a fractional reserve banking system to ever have transitory inflation. Inflation is an inexorable march higher, every year, at varying degrees of severity. There is NEVER a correction in the general price level. There will never be a restoration of value in the unit of account. Transitory? HAHA NO
Thank you for another thoughtful piece. However, I have a bit of a bone to pick regarding rent, and not OER, but actual rent. At this point, why would anyone expect rents to decline at all? Consider, landlord's expenses have clearly risen sharply over the past several years, Unemployment remains extremely low, although I grant the weekly claims data is starting to point to a bit more slack, and there is not, as yet, an overabundance of rental units available in most cities. As such, what would incent landlords to cut rents? Even if housing prices are beginning to decline, the lag between house price changes and rental rates is pretty substantial.
Add to this the idea that rent has a built-in 12 month lag based on the BLS methodology and it feels to me that it will be quite a while before the rental piece of CPI starts to decline in any meaningful way. Given that the Fed is focused on these lagging indicators, I would not be optimistic that they are going to be concerned about a housing crisis anytime in the near future.
Excellent work here. You just summed up and provided data for so many aspects of the current environment that I’ve been contemplating.
It's the MBS, sir... Fed bought More Bull Shit than forever...everything else is hedon icks, but at least Mary Daly feels our/your/someone's pain
Great note Mike, but I have some push back. Where does the price level come from? I would suggest interest rates have an important, if not leading role. The cost of funds must be imputed in the forward price curve. How else can one explain the experience of Japan and the developed world post GFC? Low rates seem to beget low inflation outside of exogenous induced shocks.
Lastly, why are we only focusing on the borrowing side of the economy? Interest rates have distributional effects for sure (winners and losers), so measures of credit should reflect some stress somewhere, but what about the income side? With the fiscal pump in full force (in large part from regressive Interest payments), incomes and household balance sheets look very healthy from my perspective. And there is gobs of capital laying idle able to scoop up distressed assets off the "losers". Just some random guys thoughts and always I always look forward to your notes. Cheers.
“I shit you not,”. Shouldn’t that be I fig you not?
It’s interesting that unemployment bottoms before delinquency. It makes sense that consumers have difficulty in servicing their debt, which leads to a drop in consumer demand, which leads to higher unemployment. BUT, I thought people would get laid off before delinquencies.
A close relative got "terminated" Friday (arguably a more accurate use of the root of terminal than the Fed uses for terminal rate). He's age 64. This was not a tech company, but in the consumer products space. Bloomberg reported that his company was only laying off white collar/management workers and not production, blue collar workers. The chances for someone his age getting a new corporate job at an equivalent salary are slim (which he acknowledged to me as he used to be the one who approved new hires for his group). So now he's going to be drawing down on his 401K and not making new contributions. While it's admittedly early days in assessing the impact of Fed rate hike policy, it strikes me that most layoffs so far have been white collar workers. White collar workers typically contribute more to their 401Ks. That led me to think about your passive investing analysis - how the inelasticity (and its multiplier effect) works both ways, magnifying prices upward when flows are positive and doing the opposite when flows are negative. So perhaps we're on the cusp of seeing what happens to the major indicies that many passive funds are based on when flows go negative. Time will tell.
It makes sense to remove shelter from inflation indices because shelter is measured (and imputed for owner occupants) from rent, and the cost of rent is only updated when a lease expires or the occupant leaves (sense to measure consumption more than inflation). So that creates a long measurement lag, plus they only survey people once every six months. Which means the shelter index of inflation was probably terribly understated a couple of years ago, helping the Fed ignore incipient inflation.
However the Fed really should have noted that housing costs were up 40% in repeat sales indices (which implicitly controls for sq ft), and laid off the QE much earlier. Particularly when OAS yields on MBS were through Treasuries.
What bothers me now is the resoluteness that the Fed says they will NOT lower interest rates anytime soon. That's in contrast to the periods before past recessions when the Fed starts to cut rates a couple of quarters before the recession because they see that employment growth is weakening, normalizing the inverted yield curve at the last minute and providing false hope to some. So we've got 450 bps of rate increases inside the past 12 months, which probably haven't been fully felt in the economy, a Fed that is still raising rates, and says they absolutely will not cut. Which means there's one hell of a lot of downward inertia in the economy when we enter this recession. It almost certainly won't be a brief recession.
Finally, we all tend to cherry pick macro indicators to make our point on recessions. The US Leading Indicators has a consistent list of variables, and it is loudly signalling a recession. One of the few bright spots in the LEI is rising stock prices. Ha ha.
It has bothered me that airplanes fly to terminals given the possible meaning of terminal. Now, I'm bothered by the notion of a terminal rate, too. Thanks for that... sort of.
Lot's of hyperbole like "death sentence"...not even close! Two words do not come out of my mouth...Never & Always! This economy is way more resilient than most are given it credit for primarily because of political beliefs and the I'm the smartest person in the room crowd. The only thing that will get the Fed or Congress's attention is when/how inflation structurally heads higher and it will given "Geopolitical Risk" and "Policy Rick." But that process will/would be a slow grind and politicians in Congress can/will change much faster than the Fed, and in my opinion will give into doing what they do best by passing out handouts to their chosen winners...You make some very good points but this environment given the dynamic factors driving it has a unpredictable current where the swarm and the narratives that drive it is headless and gravitates toward the path of least resistance...ignorant beliefs, misinformation by all and an incentive structure that is lacking to say the least...TBD, Lots of pain coming...GL
Note by the Squirrel: you need a hedge against a world of higher for longer interest rates and long end getting out of control. In my “What if JPOW lost control of the long-end?” Acorn report, I mentioned PFIX as an alternative to the put structure on TLT that I wrote up.
Cem Karsan gets it...
https://www.youtube.com/watch?v=VHQpZIOpZlM&ab_channel=ExcessReturns
Great article.
Regarding central banks:
All central banks know very well about leading/lagging indicators. The BoE communicated the expected future slowdown in inflation publicly, but that communication might have contributed to (not the only reason of course, Brexit, Nat gas, etc.) still having above 10% headline inflation. Imo Powell is just purposefully communicating a very lagging indicator such as headline CPI to the public in order to talk the market down so it doesn’t rally too early.
Mike, I appreciate your normalization of home prices by size, but I cannot ignore the wide gap between home prices and incomes, reminiscent of the GFC era. So, shelter inflation might be overstated, due to a lack of hedonic adjustment, to your point, but we likely still have a deep affordability issue - even without high interest rates.
See the following for the relevant chart: https://open.substack.com/pub/rubino/p/two-experts-agree-home-prices-are?utm_source=share&utm_medium=android
Great piece Michael! I have a genuine question regarding the recent rise in credit delinquencies—why is it necessarily different from the rise observed in 2016-2017? I see that the pace of increases is more rapid this time, but wasn't the drop preceding it also due to relatively *sudden* fiscal stimulus—once it was withdrawn, one would expect credit delinquencies to rebound to the level they were at before, no? In that case, could we potentially expect that the delinquency rate would, like it did in 2017-2018, plateau without necessarily heralding an impending rise in unemployment?