Understanding Inflation Rates

…It has begun. Over the last year, I have made the strongest possible case for the Fed to be proactive. Rates should have been cut this week – indeed, the rates should have been cut in January. We have seen this movie before. The Fed was very late to take inflation seriously in 2021. They brushed it off as “transitory”. However, it seemed obvious that inflation was surging. Real-time shelter inflation was increasing at a double-digit rate. Shelter has the largest weight in the CPI. Shelter operates with a lag. Hence, it was easy to forecast the surge. The Fed was forced to react after the damage was done. The same mistake has been repeated – despite many warnings. The recent CPI print was 3% year-over-year (YOY). Nearly two thirds of this print was driven by one component – shelter. Shelter inflation is reported at 5.2% YOY. This number is far from reality. For example, Apartmentlist.com rents are running -0.8% YOY - a full 6% below the official CPI number. Suppose we believe the real-time shelter inflation is 2%, not 5.2%. This means the real-time CPI would be 1.8%. If you believe shelter is 3%, then real-time CPI would be 2.2%. These numbers are well within the Fed’s target. The Fed prides itself on making data-driven decisions. However, it is unwise to make decisions based on stale data. The shelter inflation happened in the past. Keeping rates high will not impact what happened last year. It is always best to look at forward-looking indicators for policy decisions. ·      My yield curve indicator has been inverted for 20 months. It is 8 of 8 with no false signals since the 1960s. The maximum historic lead time has been 23 months (before the great recession). Ignore it at your own risk. ·      The Sahm Rule has been triggered. This indicator is not necessarily predictive because employment moves with the business cycle – but it is useful in telling us whether we are in a recession or not. We know that hiring has slowed and unemployment has risen – though the absolute rate is still relatively low. ·      Retail sales are highly correlated with personal consumption expenditures. Retail Sales are flat. Many do not realize that Retail Sales are not inflation adjusted. Taking inflation into account recent sales growth as well as YOY sales are negative. ·      There is considerable evidence that COVID-era savings have been drawn down. A recent release from Philadelphia Fed carried the headline: “Share of Delinquent Credit Card Balances Reaches Series High”. (The same report shows an alarming plunge in mortgage originations.) People are paying 20%+ interest on a card because their savings have run out. Indeed, if people are cutting back on fast-food expenditures, you know this is serious.  Drawing down the savings has fueled consumption expenditures over the past two years. That source of growth has ended. Now the Fed will have to play catch-up and cut by at least 50bp in September. Any recession is a self-inflicted wound. 

Inflation edges higher while tariff effects begin to emerge June’s CPI report came in a bit better than expected, with core inflation surprising to the downside. Early signs of tariff effects are beginning to emerge in the data, but remain limited so far. 🔹 Headline CPI rose 0.3% m/m while Core CPI rose 0.2%, just below expectations. 🔹 On a year-over-year basis, headline inflation accelerated to 2.7%, core to 2.9%. Underneath the surface: ➡️ Tariff effects are starting to emerge. Categories like clothing, household appliances, toys, and coffee saw price pressure--all sectors more dependent on imports in production. ➡️ Disinflation is still prominent. Travel and tourism continues to see weakness, and despite auto tariffs, new and used car prices fell. In services, owner’s equivalent rent registered its slowest annual increase since early 2022 while transportation services inflation cooled further. ➡️ Energy was a big driver, with gains in Gas and electricity prices. Grocery items were mixed — eggs fell 7.4% but those July 4th hot dogs were 9% higher. Despite new tariffs, the pass-through to consumers remains limited so far. Companies are navigating higher costs through: (1) Lower effective tariff rates (~9% actually paid vs. 14–18% headline rates) (2) Front-loading imports and timing lags between new tariff rates and collections. (3) Exporters abroad absorbing part of the tariff burden (i.e. Japanese carmakers) A better-than-feared report offered reassurance for markets today, but the risk of inflation either biting into margins or squeezing consumer purchasing power remains elevated. For the Fed, this report doesn’t bring decisive new clarity, keeping policymakers in wait-and-see mode as they look for further evidence of economic softness or reacceleration. 

Healthcare costs for a family of four now exceed what that family will spend on food, gas, and education combined. --- For the 20th year in a row, the Milliman Medical Index (MMI) was released for 2025, tracking the cost of care for a hypothetical American family of four with employer-sponsored insurance. Back in 2005, the same family's cost was $12,214. Now it's $35,119. That's a nearly 3x increase in 20 years, far outpacing inflation and wage growth. --- Two categories continue to drive this trend: #pharmacy and outpatient facility care. Pharmacy costs rose 9.7% this year alone, largely fueled by #GLP1s and high-cost specialty drugs. Outpatient facility care jumped 8.5%, with expensive #MedicalPharmacy drugs and surgical innovations leading the way. These two areas now make up 37% of total costs (and 69% of the 2024-2025 increase), up from 30% in 2005. --- Behind the numbers are real structural issues. -Outpatient drugs billed as a percent of list price. -Rebated pharmacy pricing. -Plan designs shifting more premium costs to employees. All of this feeds into a system where even stable cost-sharing masks the actual growth in spending. Employers still carry the bulk of costs (58%), but employee payroll contributions have grown from 21% in 2005 to 27% today. Rebates now make up roughly a third of allowed drug costs, but that benefit often bypasses the patient at the point of sale. --- Milliman’s new interactive tool (link in the comments) allows users to model cost impacts based on different family compositions. The question for benefit leaders and policymakers is what structural reforms will address the rising costs tied to drug pricing and outpatient services? Or will we continue with plan designs that just redistribute the costs? --- The 2025 #Milliman Medical Index gives us a crystal-clear trendline. Now we have to do something about it.

The Federal Open Market Committee (FOMC) has strongly signaled that they won’t cut the Federal Funds Rate until September at the earliest, and likely only once in 2025 (unless the employment data shows significant deterioration). One reason for this is the FOMC is quite worried about sharp increases in inflation expectations exhibited by both consumers and businesses. Two charts below show these dynamics. Thoughts: •The top chart shows the median point prediction for the year-over-year inflation rate one year from now from the New York Fed’s Survey of Consumer Expectations (https://lnkd.in/g4Tsdtej). As recently as November, inflation expectations were back to 3%, which was the stable, pre-COVID level. Since then, inflation expectations have surged to 4.79% as of April. We know the culprit: tariffs. •The bottom chart shows the expected change in prices paid over the next 12 months for inputs from the Richmond Fed’s manufacturing survey (https://lnkd.in/gvHt3VQa), with data through May. While May’s reading came down to 6.75% from 8.38% in April (likely due to the China tariff pause), we can again see a sharp increase in inflation expectations that can only be due to one thing: tariffs. •Why do inflation expectations matter? In the FOMC’s mind, inflation expectations can turn into a self-fulfilling prophecy. For example, if firms expect to pay more for inputs, it makes it easier for suppliers to raise prices. While I think inflation expectations are often incorrectly predicted (e.g., consumers in 2022 were expecting 8% inflation over the next year, something that certainly didn’t come to pass), the FOMC gives these data weight in their decisions on the Federal Funds rate. Implication: the impact that tariffs have had on inflation expectations this time around, relative to 2018 and 2019, has been far more pronounced. Such increased expectations make the FOMC less likely to cut interest rates before multiple additional months of CPI, PPI, and PCE data are available (barring a sharp deterioration of the job market). I'll be curious if the ruling of the Reciprocal and Trafficking tariffs as unconstitutional has any effect. #economics #markets #supplychain #ecommerce #freight

Today’s CPI data indicates that inflation is running cool again, with very little impact from tariffs so far. However, while the data indicates businesses that import goods are likely eating the cost of tariffs thus far, those companies won’t be able to shoulder that burden forever – which still strongly suggests that consumer price inflation will tick up in the coming months. Some more insights below: ▪️ Core CPI inflation was 0.13% month-over-month in May. That points to core PCE (the Fed’s preferred measure) coming in at around 0.10-0.15%, which would put the three-month annualized growth rate in core PCE at 1.2-1.4%, comfortably under the Fed’s 2% target. ▪️ The data shows that almost none of the cost of tariffs has been passed on to consumers so far. Core goods prices were about flat in May, which is consistent with 2% overall inflation in a normal environment (goods inflation tends to run lower than services). ▪️ There are some smaller signs of tariff impact if you squint at the data; toy prices jumped by 1.3% month-over-month in May. Durable goods prices excluding vehicles increased by 0.2%. But apparel prices dropped 0.4%. ▪️ On the other hand, the notion that foreign manufacturers are paying for the tariffs is not supported by the broader economic data; the US dollar hasn’t strengthened and import prices excluding tariffs haven’t fallen. Who then, is paying for the tariffs right now? By process of elimination, US businesses who import goods.   The Fed might be tempted to jump on today’s data to cut in its upcoming meeting this month, but we still expect them to wait for more data before reacting. We anticipate the next cut to come in July, but altogether we expect only two rate cuts over the whole of 2025.

The July CPI data imply that the Fed can no longer use inflation as a rationale to keep rates elevated. Today’s inflation data reflects yesterday’s monetary policy. That inflation has already been slowing implies the Fed has tolerated a dramatic increase in real interest rates. That policy rates are running well above most estimates of neutral lowers the threshold for larger moves, all else equal. Given the changing of the winds in the labor market, the trade-offs have now clearly shifted for the Fed. The risks between growth and inflation are moving away from balance. Growth is the main risk now. I think moving in 25bp increments is too slow given the evolution of the data. That said, what I have seen about the Fed’s first move implies the labor market data, not CPI, will determine whether the Fed moves 50bps at the September FOMC. Core CPI inflation rose just 0.165% over the month despite an unexpected increase in housing rents. Over the last three months, core CPI has climbed just 1.6%, the slowest pace since February 2021. Because CPI housing rents are based on leases signed a while ago and because new leases are rising at slower rates, there is good reason to assume that housing rental inflation slows in the months ahead, a temporary setback in July notwithstanding. 

My Inflation Outlook: 1. Perfection: Consumer Price Index rose 0.2% month-over-month and 2.3% year-over-year in April, following a 0.1% decline in March; clean print that reinforces the disinflationary trend. 2. Perfection: Producer Price Index declined 0.5% m/m in April — the first monthly drop since October 2023 — while still rising 2.4% y/y; meaningful signal that pressures are easing. 3. Perfection: The Fed’s 2% inflation target is no longer aspirational; it’s coming into view. 4. Defect: Inflation expectations measured by University of Michigan survey is to be ignored showing a +6% inflation forecast that defies credibility. 5. Complication: Tariffs will begin to push up the cost of goods (not services), creating a one-time bump in inflation starting in June. Goods represent 30% of Personal Consumption Expenditures, while services account for 70%. This is a mechanical adjustment, not a shift in the inflation regime, which should be discounted/better understood as to long-term implications. 6. Forecast: Inflation will trend slightly higher as the cost of tariffs are absorbed, with PCE 1% higher by year end, as PCE moves from 2.3% to 3.3% by year-end 2025. Then next year, PCE will gradually decline back to 2.3% trending lower into 2027. Remember, tariffs represent a 1x adjustment. 7. Forecast: Fed will remain vigilant as Powell and the FOMC observe the tariff impact on inflation. Once they see that tariffs do not create ongoing higher prices, it has room to ease most likely in late-2025 — though they’ll stay cautious until the path is clear. 8. Investing: While 10% tariffs represent a one-time price adjustment that many businesses can absorb through various strategies like supply chain diversification and productivity improvements, the economic impact varies significantly by sector, with some consumer goods categories and import-dependent sectors facing more substantial challenges than others. S&P 500 earnings were up 10% in Q1 (y-o-y), however, many midsized companies with less pricing power, will find it challenging later this year. Slower growth, no recession is my call. Credit Spreads to be well behaved. I remain reasonably confident in my inflation outlook.

🚨 Fed Policy News - Interest Rates Unchanged 🚨 Today, the Federal Reserve announced a pivotal decision to maintain the federal funds rate at its current range of 5.25% to 5.50%. While this outcome aligns with market expectations, the Fed's tone was notably less dovish than many had anticipated. 🔍 Analyzing the Fed's Stance The Fed's hesitation to initiate interest rate cuts stems from a strategic outlook. Despite projections from December 2023 suggesting three rate reductions in 2024 and four in 2025, the current economic climate doesn't warrant immediate action. 🚀 Inflation continues to remain above the Fed's 2% target, challenging the narrative of rapid monetary easing. Moreover, the economy, buoyed by robust GDP growth and a resilient job market, seems to be withstanding the high-interest regime, albeit with a deceleration in payroll growth. 📝 Fed's Statement Insights In their recent statement, the Fed emphasized: "The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent." The meaning? The Fed isn't ready to cut rates and wants to see more easing inflation data. 🏦 Understanding the Fed's Dual Mandate The Fed's core objectives are twofold: fostering full employment and maintaining stable prices. The current unemployment rate of 3.7% in December, coupled with over 9.0 million job openings, indicates a robust employment scenario. However, the battle against inflation is ongoing, justifying the unchanged interest rates. 📊 Inflation: A Key Factor in Future Decisions Today's Fed statement was clear: "Inflation has eased over the past year but remains elevated," and, "The Committee remains highly attentive to inflation risks." This persistence of high consumer inflation implies that the Fed is prepared to maintain high interest rates for an extended period. 🔮 Forecasting Ahead We anticipate a gradual decline in both Total CPI and Core CPI, alongside Total PCE and Core PCE. However, reaching the Fed's 2% inflation target might take until mid-2024 for Total CPI and the latter half of 2024 for Core CPI. Given these projections, our expectation is that the first Fed rate cut may not occur until Q3 2024, with June 2024 as a potential earlier date, contingent on substantial progress in curbing inflation. 💡 Stay Informed Navigating these economic trends requires keen insight and strategic planning. For continuous updates and analyses, stay connected. Share your thoughts on how these developments impact your business strategies in the comments below. #InterestRates #Finance #Economy

PCE Inflation Preview: Signs of Disinflation Ahead 📅 March is set to show another month of steady monthly PCE inflation at 0.3%, with expectations holding firm. However, the year-over-year inflation rate might edge up slightly to 2.6% from 2.5%, as we await Friday's data release. 🧐 Despite this uptick, the narrative remains focused on disinflation, especially significant for the Fed given the prominence of the PCE metric over the CPI for policy decisions. The past three months have shown challenging inflation data, but the outlook is shifting. Starting in the second quarter, we predict a noticeable decline in housing inflation, which could be a game-changer. ⏳ Assuming other components maintain their current inflation contributions—still high by historical standards—we anticipate the 12-month inflation rate to retrace back to 2% in the upcoming quarter. 🔄 However, the complete data set required to confirm these trends won't be available until as early as July or August. Given the Fed’s tendency to base decisions on retrospective data, immediate policy adjustments seem unlikely, making a June rate cut increasingly improbable. 📉 In a climate where a few months of higher-than-expected inflation can reshape the trajectory of interest rates, a sustained period of disinflation could wield a similar influence, but in reverse. Keep an eye out, as these developments could significantly impact economic forecasts and market expectations.

Lately I've seen a lot of takes about our recent spike in inflation, and I think some of them are missing the mark. Let's go back to basics and figure out what really happened. In the simplest example, inflation is the response of prices to the amount of money people have to spend. Imagine if we instantly added a zero to every form of currency in circulation. Most likely, every merchant would just add a zero to their prices. A tenfold increase in the money supply would lead to a corresponding increase in prices, with no change in economic activity. But we know that prices can also respond to changes in supply and demand. All other things equal, an increase in demand raises prices in the short term. All other things equal, a decrease in supply will do the same. So inflation can result from at least three different forces in the economy – monetary policy, demand, and supply. Sometimes monetary policy and demand are grouped together, since monetary policy can affect the supply of credit and thus people's spending power. During the Covid-19 pandemic, the government tried to counteract the downturn in the economy via both monetary and fiscal policy. The Federal Reserve Board expanded the money supply enormously, lowering both short- and long-term interest rates. The federal government provided unprecedented levels of income support. There was more money in people's hands. Yet there was another enormous change that affected supply and demand. Because people were stuck in their homes, a huge amount of consumption shifted from services to goods. There was no way the supply of goods could respond instantaneously, especially with Covid-related drags on supply chains. Then the invasion of Ukraine by Russia made matters worse by restricting the global supplies of fuels and grains. The early manifestations of inflation were primarily in these commodity markets. It surprises me that some economists now attribute this inflation to demand rather than supply. When people have more money, they don't necessarily buy a lot more fuel or grain. The consumption of these items tends to be pretty steady over the economic cycle. Their prices still skyrocketed. Later on, housing became a key driver of inflation. Demand may have contributed to this change. But we also know that supply fell, with existing home sales in 2022 dropping to their lowest level since 2014. New housing starts also dropped sharply in 2022 as rising interest rates made construction more costly. Overall, which factors dominated? The Federal Reserve Bank of San Francisco has an entire line of research breaking down inflation into demand- and supply-driven components. They find a mixed picture throughout the inflationary period (see chart). So if you're going to claim – as some economists have – that one factor or another was dominant, you'd better have a really good explanation for why they're wrong! #inflation #economy [Chart: FRBSF]