An Inflation Downtrend Quickly Evaporates

Some inflation analysts have enthusiastically contorted the inflation data to dismiss today’s inflation problem and/or conclude that inflation’s run came to an end months ago (since last year’s peak). One method of dismissal came in the form of a downtrend in the monthly change in the core Personal Consumption Expenditures (PCE) starting conveniently at the peak as far down as November’s relatively benign reading. (Alan Binder used a related method dividing inflation into different time periods). Suddenly, with two consecutive up months that inflation downtrend has evaporated. The mist leaves behind what essentially looks like a random walk in the land of higher for longer.

Source: U.S. Bureau of Economic Analysis, Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index) [PCEPILFE], retrieved from FRED, Federal Reserve Bank of St. Louis; February 24, 2023.

The chart above shows how the pandemic disrupted a serene post financial crisis range for monthly core PCE largely between 0.0% to 0.2%. Since PCE’s breakout two years ago (which the Fed ignored as transitory), core PCE has effectively settled into a higher range from 0.2% to 0.6%. Inflation may have indeed peaked, but it remains stubbornly high in the aggregate. The eagerly anticipated pre-pandemic serenity remains as elusive as ever.

Higher for longer inflation aligns with the Federal Reserve’s insistence on maintaining restrictive monetary policy higher for longer. The stock market may finally be catching on to the notion of higher for longer for inflation. When the core Consumer Price Index (CPI) came in hotter than expected in the previous week, the S&P 500 (SPY) wavered from intraday highs to lows and even increased the next day. Sellers took over the next 5 of 6 trading days with today’s 1.0% loss seemingly confirming a change in sentiment.

The S&P 500’s loss would have been worse except traders decided to defend support at the 200-day moving average (DMA) (the blue line above). This important trend line separates the index from more churn and a continuation of selling back down to the bear market line (20% down from the all-time high).

The bond market sniffed out the hotter inflation environment ahead of the stock market. Bond yields have steadily risen all month. For example, the iShares 20+ Year Treasury Bond ETF (TLT) is down 5.8% month-to-date (lower TLT means higher yields). The hot PCE brought an abrupt end to a 2-day relief rally in TLT.

Of course, the inflation story does not end here. The recent experience with inflation surprises suggests inflation will continue to confound the over-confident. A humbled Federal Reserve seems validated in taking a “risk management” approach to monetary policy in this haze of uncertainty. Still, if monthly core PCE takes a fresh drop next month, I am guessing a chorus will resume the inflation dismissals. If monthly core PCE continues higher from here, I will ring fresh alarm bells. I am watching the bond market’s next moves for potential clues. Moreover, I cannot wait to hear what the Federal Reserve and Chair Jerome Powell have to say about these developments in next month’s meeting!

Be careful out there!


Did Alan Blinder Suggest the Fed Should Have Done Nothing About Inflation?

The Claim

Former Fed Governor and current Princeton Economics professor, Alan S. Blinder wrote an opinion piece in the Wall Street Journal that essentially implied the Federal Reserve need not have raised rates to battle inflation. In a piece with the click-worthy title “What if Inflation Suddenly Dropped and No One Noticed?“, Blinder makes the following claim:

“Was the rest of the stunning drop in inflation in 2022 due to the Fed’s interest-rate policy? Driving inflation down was certainly the central bank’s intent. But it defies credulity to think that interest-rate hikes that started only in March could have cut inflation appreciably by July. There is an argument that monetary policy works faster now than it used to—but not that fast.”

Blinder goes on to explain that relief from supply and energy shocks were the biggest drivers of plunging inflation. Going forward, he thinks that the current five month decline in inflation is “…still too short a time to declare victory,” but he gives no explanation as to why going forward further Fed rate hikes will matter for getting inflation down this last mile of the way. I would have expected Blinder to argue that the Fed has already over-corrected for inflation.

Chasing the Trend In Inflation

It is pretty well accepted that inflation peaked several months ago. However, when Blinder worries that “no one will notice” the drop in inflation, he is worried about the finer technical details of trends. He breaks out the difference between earlier and current inflation to show how the year-over-year rate blurs the story.

“…the CPI inflation rate over the past 12 months has been an alarming 7.1%. But the U.S. economy got there by averaging an appalling 10.6% annualized inflation rate over the first seven months and a mere 2.5% over the last five. The PCE price index tells a similar story, though a somewhat less dramatic one. The 5.5% inflation rate over the past 12 months came from a 7.8% rate over the first seven months followed by a 2.4% rate over the last five.”

Blinder acknowledges that using this more refined (I will call it less lagged) approach would have also warned the Fed much earlier about inflation in 2021. In fact, it was recent trends that made loud skeptics of the Fed’s reassurances about “transitory” inflation.

Regardless, there is little magic or revelation in this breakdown. Blinder is simply providing a more technical description of what happens when a metric that quantifies changes over time peaks: the earlier components of that measure are, on average, higher than the more current ones. The graph below of the PCE (personal consumption expenditures) excluding food and energy juxtaposes the monthly change (grey line and vertical axis on the left) in the PCE with the annual change (black line and vertical axis on the right) in the PCE.

Source: U.S. Bureau of Economic Analysis, Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index) [PCEPILFE], retrieved from FRED, Federal Reserve Bank of St. Louis, January 19, 2023.

Note how the pre-pandemic stability in the monthly change supported stability in the annual change of the PCE. The annual change started to rise once the monthly changes started to rise to higher levels post-pandemic. The annual change reached a new, higher stability after the monthly changes stopped rising. Now, the monthly changes are finally producing a higher frequency of much lower numbers. Thus, the annual change looks like it has finally peaked. Stare hard enough, and you can even see the early makings of a declining trend.

Blinder worries that no one may notice the sudden drop in inflation. However, I suspect plenty of people have noticed the decline. There is a healthy collection of Fed critics and related folks who think the Fed over-reached after its first rate hike last March or May who are twisting the numbers every possible way to make the case that the inflation problem died a few months ago and/or the Fed has taken interest rates far too high, too fast. Again, because inflation has apparently peaked, it is easy to fathom that more recent inflation pressures are milder than earlier inflation pressures.

Where Is the Policy Implication?

Blinder’s WSJ piece avoided giving direct advice on monetary policy. However, he gave more clues in an interview with Marketplace. At the very end of the discussion, Blinder essentially said that the Fed should stop now, but they cannot do so because market’s will prematurely ease:

“The Fed is in a very ticklish position. They can’t be as frank as I just was with you. I could say anything, and I don’t move markets. If Jay Powell sneezes, he moves markets. It is too early to declare victory over inflation, it’s only six months. And that’s what Jay Powell or any of the Fed people would say if you had them on the radio. But I say it’s six months. Six months is not a week, six months is not two months. This is not a trivial length of time. I think it might take a year of this or, say, another six months to convince the Fed to declare victory. They’re not about to declare victory yet.”

Note how his advice here directly contradicts his caution in the WSJ piece that the timeframe for the inflation decline is too short to support victory laps. No wonder monetary policy can be so confusing.

Moreover, the Fed has been very clear about the metric it uses for the 2% inflation target: a year-over-year change that is demonstrably sustainable. The Fed cannot declare victory because the target as previously defined still sits out in the future. To suddenly change the timeframe to inflation over the last X months would undermine Fed credibility even more than the retreat from the “transitory” episode.

Ironically, with the Fed already effectively programming itself to end rate hikes in March, Blinder’s technical examination could be nearly moot…at least without specific policy prescriptions.

Be careful out there!

The Federal Reserve Fears On-Going Inflationary Pressures from Rents

I recently complained about the Fed’s belated sense of urgency in trying to get inflation under control. The Federal Reserve Bank of St. Louis shed some light on the specific points of concern for the Federal Reserve. In an economic article titled “Breaking Down the Contributors to High Inflation“, the St. Louis Fed described a 12-month lag for housing price dynamics to feed into rents. Given the soaring prices of housing for over a year, rents are due to soar from already high levels for at least the next year or so. Here is the instructive chart:

The Fed’s core concern comes from the out-sized influence of housing services on the PCE (Personal Consumption Expenditures): “Given that housing services constitutes the largest subcomponent of PCE, accounting for roughly 18% of total consumption expenditures, the impact of housing services inflation on overall PCE inflation is always significant.” In other words, I interpret the Fed’s recent religion on normalizing interest policy as a belated attempt to cool down price appreciation in the housing market.

The St. Louis Fed also put this concern in context by comparing today’s inflation with the inflation from the last economic expansion from July 2010 to January 2020. Interestingly each of the three components of the PCE – durable goods, non-durable goods, and services – have contributed around the same amount of extra inflationary pressure in absolute terms, ranging from 1.46 to 1.71 percentage points. However, with a 65% of total consumption expenditures, the promise of on-going upward pressure on services inflation promises to drive the overall PCE ever higher. The Fed finally could no longer sit still on rates.

(For a good read on belated inflation concerns, review Jason Furman’s critique of the economics profession: “Why Did Almost Nobody See Inflation Coming?“)

Be careful out there!

Full disclosure: no positions

The Fed Asks “What Inflation?”

Last week, headlines and pundits were hot and bothered about the potential for the Federal Reserve to fall behind the curve on inflation. While my on-going assumption is that the Fed will indeed chose much higher inflation rather than risk ending the economic recovery with higher rates, I think the current hand-wringing by some is premature. In fact, it seems more the result of either boredom with the Fed’s business as usual policy stance and/or the anxiety on the part of some stock market bears looking for any kind of catalyst to shake the market out of its low volatility slumber

I was so surprised at all the hand-wringing over a “business as usual” policy statement that I rolled the tape on the press conference. I was wondering what I missed, I actually listened to the conference call a second time (yes, it was painful). The experience made me even more convinced the market over-reacted just as much as it did when Yellen carelessly suggested rates might increase earlier than the late 2015 market projection.

Recent inflation numbers apparently increased expectations that the Fed might show a more hawkish tone. This is reflected best in the first question of the press conference from Steve Liesman of CNBC:

“Is every reason to expect, Madam Chair, that the PCE inflation rate, which is followed by the Fed, looks likely to exceed your 2016 consensus forecast next week? Does this suggest that the Federal Reserve is behind the curve on inflation? And what tolerance is there for higher inflation at the Federal Reserve? And if it’s above the 2 percent target, then how is that not kind of blowing through a target the same way you blew through the six and a half percent unemployment target in that they become these soft targets?”


This was a leading question, especially considering that Yellen made it very plain in her introduction that the inflation readings remain benign. Moreover, long-term expectations for inflation remain tame (also see the Fed’s latest projections). Most importantly, the year-over-year change in the PCE, the Personal Consumption Expenditure, reached the 2.0% target in early 2012 only to quickly plunge from there. Not only might it be premature to project a 2% reading for next week’s release, but there is nothing to suggest that this time is different. The Federal Reserve has the least control over the non-core prices of food and energy, so the escalation of violence and turmoil in Iraq is definitely not the kind of event that the Fed would try to offset with monetary policy.



The Fed still can’t tease the market into sustaining pre-recession inflation levels…
Source: St. Louis Federal Reserve

Perhap’s Yellen’s poor response ignited the flames of disappointment. Yellen did not address PCE directly and instead talked about the noise in the Consumer Price Index (CPI) while reiterating the Fed’s standard guidance on inflation:

“So, I think recent readings on, for example, the CPI index have been a bit on the high side, but I think it’s–the data that we’re seeing is noisy. I think it’s important to remember that broadly speaking, inflation is evolving in line with the committee’s expectations. The committee it has expected a gradual return in inflation toward its 2 percent objective. And I think the recent evidence we have seen, abstracting from the noise, suggests that we are moving back gradually over time toward our 2 percent objective and I see things roughly in line with where we expected inflation to be.”

Ironically, Yellen could have just pointed to the longer-term trend in the CPI. This view dominates any shorter-term noise….


The overall trend on CPI continues to point downward
Source: St. Louis Federal Reserve

The most bizarre part of the buzz on the Fed’s supposed willingness to ignore inflation is that Yellen re-affirmed, re-emphasized that the Fed is all about meeting its price target. It will not tolerate deviations in EITHER direction for long:

“…we would not willingly see a prolonged period in which inflation persistently runs below our objective or above our objective and that remains true. So that hasn’t changed at all in terms of the committee’s tolerance for permanent deviations from our objective.”

This was Yellen’s response to Liesman asking about the Fed’s tolerance for higher-than-target inflation.

I feel irony in my skepticism about a Fed ignoring a budding inflation threat: this is the core scenario that has kept me long-term in the gold (GLD) and silver (SLV) trades. My thesis/assumption back in 2009/2010 was that the Federal Reserve would be extremely reluctant to tighten policy even as the economy strengthened out of fear that rate hikes would quickly kill the economy. By the time the Fed was ready to hike rates, the “inflation genie” would already be out the bottle. Granted, I am not nearly as rabid about this view, especially since I have come to appreciate the deep entrenchment of the lingering post-recession deflationist psychology in the economy.

 So, overall, I am very skeptical that this episode is the long-awaited lift-off of inflation and a lagging Fed. I actually think the Fed is right to look through the current “warming” in inflation readings, and I think it will find vindication just as the Bank of England did during a similar episode under former Governor Mervyn King. When the Fed asks “what inflation”, I find myself surprisingly agreeing for now…

To me, the data do not support the notion that broad-based inflation is taking hold in the economy. We do not even have wage pressures, not to mention all the slack that remains in the economy as evidenced in part by extremely low levels of housing production. Just do a web search or read mainstream financial magazines to see anecdotally how many people are still worried about the sustainability of the so far very weak housing recovery. I find it hard to believe we will get strong inflation with all this weakness and deflationary fears. On the commodity side, copper and iron ore have experienced major price declines in recent months that also fly in the face of any kind of sustained inflationary pressure in the economy.

Full disclosure: long GLD, SLV.