Wall Street wasn’t enamored with the BLS’s inflation update, delivered to loud jeers in the US on Tuesday.
To be honest, nobody should be that surprised to discover that price pressures are still percolating across the world’s largest economy. The labor market’s still adding jobs, Americans are as addicted to spending as ever, consumer sentiment inflected sharply since November and existing home prices continue to make new highs. There’s a sense in which it’d be surprising if inflation didn’t re-accelerate. Indeed that’s why the juxtaposition between a robust economy and disinflation is described in divine terms: In theory, it isn’t possible. Or at least not without a productivity boom or some other facilitator.
“Yikes. The ‘immaculate disinflation’ narrative takes a throat punch,” Nomura’s Charlie McElligott remarked, of the CPI release. He flagged some nuance (i.e., a few mitigating factors as expounded by a colleague), but the market wasn’t in any mood to look through or otherwise write off upside surprises on all the aggregates that matter. The Fed likewise won’t be inclined to look the other way. “This CPI surprise is at risk of throwing a giant wrench into everything… with the first full Fed cut now pushed out into July,” McElligott said.
In rates, the front-end sold off hard, bear flattening the curve. As discussed here, aggregate rate-cut pricing for 2024 was trimmed inside of 100bps. Stocks responded by falling the most in nearly a year at the lows. It was, as Bloomberg pointed out, shaping up to be the worst CPI day since September of 2022, when the Fed was still in the process of making believers out of market participants convinced the inflation fight would be a fleeting affair. Equities managed to pare losses later in the session.
“Key here will be to see if clients resume [their] willingness to sell puts into this pullback and arrest the selloff or if, instead, we see a behavioral change, and people actually start hedging downside more actively,” McElligott went on.
At session highs, the VIX was up the most in quite a while, but with VIX-pery looming, it was hard to get a good read on that. On Nomura’s estimates, 68% of total VIX dealer gamma was set to roll off after Wednesday. “The location of spot VIX on expiry will have major impact on the equities trade in and out,” Charlie said.
Coming back to the inflation report, an encore next month would be a game-changer, which is to say another update like today’s and assumptions about first-half rate cuts would need to be reevaluated. “In the event February’s CPI report is a repeat of January’s, then one needs to seriously consider a second half start to normalization,” BMO’s Ian Lyngen and Vail Hartman wrote Tuesday, calling OER upside “one of the more concerning aspects.” “A bounce in shelter costs would leave policymakers reluctant to cut rates until there was greater confidence that housing costs won’t prove to be the stickiest component of inflation during the post-pandemic period,” they added.
Remember: The Case-Shiller 20-City gauge notched another 12-month increase in the last update. It was the fifth straight YoY gain following a brief, and ultimately negligible, correction.
Lael Brainard on Tuesday sought to place some of the blame for lingering inflation with corporate greed. “If you look at some of the staples, like eggs or milk, they have come down. But consumer brands, instead of actually lowering prices, they’ve shrunk packaging,” she told CNBC, referring to Joe Biden’s new favorite macro buzzword: “Shrinkflation.”
“The president is going to continue emphasizing that input costs have come down [now that] supply chains have healed,” Brainard said. “He’s going to keep calling on corporations to pass those savings on to the American consumer.”
I imagine such calls will fall on largely deaf ears in the C-suite. This is shareholder capitalism, after all. And shareholders would much rather your candy bar be a little light (if you’re an American, there’s a good chance you’re obese anyway) than their bottom line come up a little short.
Meanwhile, Janet Yellen suggested things should be fine. “To make something of month-to-month variability is something I am very loath to do,” she told the media. “I see… continuing progress in bringing inflation down.”
So is the “soft landing” now in a holding pattern, or is this what a “no landing” scenario actually looks like?
I’ve always been in the higher for longer camp. After today’s report, I’m moving to the higher for much longer camp. It’s a tale of two economies, haves and have-nots, and the haves are feeling pretty flush.
I lucked out with the VXX calls bought yesterday. Still kicking myself for missing out on the AI melt up. Reading too many perma bears 😉 just kidding, H. I look forward to your writings, cheers
Why would the C-suite listen to a president whom voters think is leading a bad economy? Are voters going to blame the C-suite? No, they are conditioned to “blame it on Biden” no matter what. So they get a free pass and freedom to boost profits however they see fit. Nice job voters, way to engage the grey matter between your ears. We are our own worst enemy for religiously following nonsensical outrage performance artists.
I have been puzzling over why the Rent of Primary Residence inflation monthly measure sank while the Owners Equivalent Rent monthly measure popped.
The methodology used by BLS is complicated. https://www.bls.gov/cpi/factsheets/owners-equivalent-rent-and-rent.htm
I was surprised to see that the infamous questioned asked of homeowners, “what do you think your house would rent for”, is only used to set the weighting of owner-occupied vs rented residences, not to determine the price change. To determine price change, BLS surveys only renters, estimates and eliminates utilities from rent, and somehow allocates some of the responses to “Primary Rent” and some to “Owners Equivalent” based on, I think, characteristics of the residence – e.g. responses from renters of apartments may be allocated to the former while responses from renters of single-family houses may be allocated to the latter, although I’m not positive of that.
Few residences are surveyed per geographic segment (a segment is a couple of Census tracts) and each residence is surveyed every six months. The infrequency of surveying contributes to shelter CPI’s lag to “asking rent” indices, as does the relatively small percent of rental units that turn over each month. In all but the most extreme cases, renewal rent goes up every year even when new asking rents are falling; the hassle and expense of moving make existing tenants a semi-captive audience.
The above doesn’t explain why the responses allocated to Primary Rent show less monthly inflation than the responses allocated to Owners Equivalent.
One possibility is that rents of houses are indeed rising faster than rents of apartments. Houses and apartments are distinct markets. The supply of rental houses is not growing as much as the supply of apartments. INVH (largest rental SFR REIT) reported 4Q23 new rent flat and renewal rent +6.8% for blended Same Store rent +4.6%. This compares to 4Q23 average blended Same Store rent +3.6% for the seven largest apartment REITs, where new rent growth was -1% to -2% and renewal rent was about +4% to +5%.
Another possibility is there might be a difference in how estimated utilities are backed out, noting that utility rate increases typically take effect in January and utility consumption is weather-influenced.
Also, rent-controlled units are allocated to Primary Rent and not to Owners Equivalent, which may matter in certain areas.
Great research JL, but ultimately useless. Refer to our Dear Leader’s post today citing McElligot. The algos rule the markets.
True, but the algos respond to the headlines, so useful to (try to) understand what drives the headlines.
I previously thought OER was mostly an echo of homeowners’ vague impression of their house value – now that I realize I was wrong, I can find market measures for SFR rents.
For example, Zillow has separate ZORI for SFR and MFD.
In general, looking at the two ZORI datasets makes me more worried about shelter CPI. Since houses are weighted higher than apartments (OER is 27% in CPI, Rent of Primary Residence is 8%), house rent inflation is higher than apartment rent inflation (per ZORI and the public REITs), and rental house supply growth is (I think?) lower than rental apartment supply growth, shelter CPI may be stickier than I’d thought / hoped.
Most models respond to the price action and the impact on implied volatility. So during the course of the day, the algos create the price action. The price action in the last hour yesterday was yet another example.
The reason I endlessly harp on this is that the flows they engender eclipse totally dwarf the flows in and out of funds (which include hedge funds). Not by a few percent but by factors as high as 10 times.
If I was 40 years younger, I’d spend my time trying to write models which would allow me to front run the algos. No doubt many better minds are already doing so. That will EVENTUALLY render the vol-driven models less and less useful. Perhaps leaving the market to the trend-following CTAs.
Until then, focusing on “fundamentals” is a quaint vestige from the past.
I agree, but the algos initially respond to something to create the price action, right? Suppose the CPI print had been much lower than expected, wouldn’t the algos’ initial response likely have been in the opposite direction, before follow-on price action including derivative flows kicked in?
I also think the effect of the algos declines with longer time frames. Since my typical holding period is 1-2 years, the intraday and short-term price action is more enervating than relevant for my process. It is alternately irritating and entertaining, and there is the “irrational vs solvent” dilemma, but at the end of the day the largest factor in my longer term absolute performance is still whether I guess right or wrong on the stock-specific fundamentals. Relative performance – that’s another story.
I speculated “responses from renters of apartments may be allocated to [Rent of Primary Residence] while responses from renters of single-family houses may be allocated to [IOwners Equivalent Rent]”. After checking with BLS, my understanding is that is “generally” correct.
Yeah, even the idea that what the C-Suite matters in terms of corporate pricing decisions is naive. But hey, voters believe it and go : “he is leading and telling corporations what to do, he is wonderful”. And that’s what it’s about, NOTHING else. Every realist knows that. There are few actual realists in our world. If you have hope for society, you are not a realist !
Spot on, sir. Instead of trying to engage in solutions when we had some chance 50 years ago, we ran the other way denying the existence of the problem. Now that it’s too late to fix this, we want to take a bunch of impractical steps, take credit for our good intentions, and holler, mission accomplished so we can get back to the next level in Candy Crush or see what the Karen next door is spewing on Facebook. As Bugs Bunny often said, “What a bunch of Maroons.”
Looking at it now, you could argue it’s fairly hilarious that after nearly a decade and a half of ZIRP, interrupted only modestly AND briefly in the few years leading up to the pandemic, that the usual 6-12 months of terminal rate pricing would prevail. Put me in the high (but not higher) for longer camp.