I wanted to highlight a superb Substack blog post by Joseph Politano, an analyst at the Bureau of Labor Statistics. I’m going to briefly summarize article and pepper in my own graphs and commentary, but as always, please read and support his work. His blog is called “Apricitas Economics,”; his Twitter is also full of excellent insights.
Point 1: Annualized prices depend heavily on the ‘base’ effect, i.e., what happened at the start of the period going back 12 months. He writes,
“April, May, and June of 2021 had the fastest pace of core CPI growth in nearly 50 years thanks to a spectacular increase in used vehicle and other durable goods prices.”
Because those spectacular increases will exit the window of calculations for annual inflation, there will necessarily be a reduction in measured inflation (all else held equal). This isn’t a guess as much as a mathematical consequence. See Graph 1 here from his article.
Point 2: The limited Fed tightening and communications have already tightened financial conditions. Proof: Graph 2 depicting the Piper-Sandler index, Graph 3 of 30 year fixed mortgages, and Graph 4 from Joseph’s article of the Chicago Fed’s measure of financial tightness.
Point 3: Bond markets are swiftly pricing in dampening inflation (relative to their previous estimates). See Graph 5 of 5 Year, 5-Year Forward Inflation Expectation rate and Graph 6 the 10 Year Break-even. The 5 Year Break-even is also falling. I explain more in my comment here what these mean and provide some additional sources. Here is Joseph’s plot, Graph 7.
Point 4: This is really an extension of Point 1, but the massive increases in used car prices has slowed down dramatically. See Graph 8.
Thus, inflation will remain elevated for a few months, but the extraordinary factors in the spring of 2021 will no longer be represented in upcoming annual calculations of inflation. Further, the Fed is now finally walking the walk. You can argue that 0.5% increases in the interest rate are minuscule historically, but Graph 3 through 7 show that the market is taking it seriously and tightening on its own (e.g., 30 year fixed mortgage rate hitting 5.6%). The Federal Funds Rate and QT doesn’t need to have a simple, linear relationship with actual financial conditions.
The caveat is that we still have upcoming issues with the supply chain, such as in the diesel sector, but there have been meaningful improvements in trucking and shipping, as I wrote about in my previous posts. But I believe the other factors mentioned imply that inflation has peaked, as Joseph more convincingly argues.
Whatever you believe about the Fed’s past actions, they leave me reasonably bullish for say 3 months from now. What do you think?
