"The first lesson of economics is scarcity: There is never enough of anything to satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics."
-Thomas Sowell
Recently, I signed up for Peacock TV’s streaming service. I wasn’t planning to, but my son wanted to watch live Premier League games on the weekends and having cut the cord on cable and taken Andrew Freedman’s advice to instead opt into YouTube TV (which was a great call), I didn’t see any good alternatives. Plus, it was only 2.99/month.
One unexpected benefit of signing up for Peacock is that I finally got to watch the show, Yellowstone. Bear with me, I’m only six years late as the series first aired in 2018. For those who haven’t seen it, it tells the story of a seventh-generation Montana rancher named John Dutton who owns the largest contiguous ranch in the United States. Each season of the show introduces some new threat to Dutton holding onto his land against all manner of would-be usurpers.
I couldn’t help but think of John Dutton’s various battles when I took a long hard look at the base effect setup for inflation over the coming 12 months. The would-be rate-cut usurpers are back!
Later this morning, we’ll host our Q1 Macro Themes Mid-Quarter Update Call at 11am, and we’ll review this topic among many others shaping the probabilistic path of Macro progression over the coming year. Contact if you’d like access.
Back to the Global Macro Grind ...
I’ll attempt to summarize one of the important takeaways here. Base effects act like powerful magnets on future outcomes. The larger the base effect, the more powerful the magnet. In the case of inflation, looking back at the past 40 years, there exists a very strong inverse and proportional relationship between the directional RoC in Y/Y inflation and the nature of the comparative two-year base effect. Is it perfect? No. Is it far more often predictive than not? Yes.
Interestingly, when the quarterly Headline CPI comp eases by 50bps or more, which has happened 16 times since 1983, the RoC of inflation has accelerated 81% of the time (13 out of 16 times). Perhaps of equal interest, the three exceptions saw inflation decelerate by just -19bps, -8bps and -26bps, respectively. In the 13 of 16 times that the base effects eased by 50bps or more, the average acceleration in inflation was +117bps.
The reason I bring this up is because 2024 will see quarterly Base Effects on Headline CPI ease by -58bps in Q2, -39bps in Q3 and -75bps in Q4. No one is talking about that. Two of those three (Q2 and Q4) meet the criteria above (easing by more than 50bps) and would therefore be expected to fall within the 81% framework. Importantly, even if wrong, the max error since 1983 under those circumstances has been -26bps (average error = -18bps). So, what does that mean?
Consider where January Headline CPI just came in: +3.09% Y/Y. Our updated estimate for Q1 Headline CPI is 3.07%. This means even if the base effects don’t produce a RoC acceleration in Headline CPI in Q2 (a 19% probability), CPI is unlikely to decelerate by more than high-teens basis points. In other words, Q2 inflation very likely won’t average less than 2.9%.
This is set to happen again in Q4. That base effect is a whopping -75bps. The Q3 base effect, meanwhile, is probably the last great hope for the Fed, but it too eases by -39bps. Not exactly encouraging.
This is why a) our updated estimate for Q2 2024 is now Quad 3 (whereas it had been Quad 4), and b) why we expect 8 of the 12 months of 2024 to be either Quad 2s or Quad 3s (aka accelerating inflation environments).
Now, it’s not all that cut and dry, although it kind of is. If base effects are in one corner of inflation’s 2024 Thunderdome, standing in the other corner is disinflation’s chief protagonist, shelter. The big rocks of shelter inflation include owners equivalent rent (OER) and rent. In Rate of Change terms, these lag massively home prices. For example, OER lags Case Shiller by fully ~18 months, while rent lags Case Shiller by ~21 months. This means that OER should be disinflating sharply in the first 6-9 months of 2024 and rent in the last 6-9 months of the year.
Interestingly, OER was actually inflation’s protagonist in the January print, decelerating by a measly -12bps from December to January. Compare that with the previous month, when it slowed by -33bps. My expectation is that OER will disinflate at an average rate of ~25-35bps per month in Q1-Q3, but I won’t be surprised if it unfolds in a choppy way, like what we’ve seen these past two months. For example, the trend is lower, but if one month it’s lower by 10-20bps, the next month shouldn’t surprise if it’s lower by just 30-40bps, and vice versa. With that in mind, it shouldn’t be a surprise to see February’s OER play catch up and play disinflationary hero, dropping by 30-40bps in Y/Y RoC terms.
That’s the good news about next month’s print – a flat monthly base effect coupled with a likely OER catch-up may produce a decently dovish number. The bad news is that that will likely be the last favorable inflation print until the August print is reported in September. It’s worth noting that the two monthly prints that appear most “concerning” are October and November, which will be released in November and December. Why? Those two prints face easing monthly base effects of -46bps and -37bps, respectively, and are going to be particularly challenging from a Fed easing standpoint.
As a quick final point on inflation, it’s interesting to look at used vehicle prices as a sort of proxy/corollary. Used cars have been a microcosm of the broader inflationary backdrop since 2019, reflecting all the supply chain constraints, deurbanization followed by re-urbanization, etc. One proxy for used car prices is the Manheim Index, which is an index put together by the Manheim Auction business (named after its location in Manheim PA) and is now owned by Cox Automotive. Manheim has reported Y/Y declines in used vehicle prices for 17 months in a row through January 2024. Interestingly, looking ahead from January 2024 through January 2025, Manheim’s two-year base effects are set to ease dramatically, falling from +16% to -11%. It’s largely linear, but not perfectly linear. The big drops happen from February 2024 through May 2024 and then again from September 2024 through November 2024.
Sound familiar? It should. The dynamics at Manheim reflect almost perfectly the backdrop of broader inflation looking out across the next 12 months.
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets
UST 10yr Yield 3.96-4.36% (bullish)
UST 2yr Yield 4.28-4.66% (bullish)
High Yield (HYG) 76.26-77.37 (neutral)
Investment Grade (LQD) 106.47-109.18 (bearish)
SPX 4 (bullish)
NASDAQ 15,345-16,056 (bullish)
RUT 1 (bearish)
Tech (XLK) 199-209 (bullish)
Insurance (IAK) 105.22-108.43 (bullish)
S&P Momentum (SPMO) 70.83-75.42 (bullish)
Healthcare (PINK) 28.59-30.11 (bullish)
BSE Sensex (India) 71,011-72,452 (bullish)
VIX 13.44-16.96 (bearish)
USD 103.37-105.19 (bullish)
Oil (WTI) 72.28-78.80 (bullish)
Nat Gas 1.63-1.99 (bearish)
Gold 1 (neutral)
Uranium (URA) 28.37-32.25 (bullish)
MSFT 400-422 (bullish)
AAPL 181-190 (bearish)
NVDA 640-750 (bullish)
Bitcoin 45,217-52,833 (bullish)
To your continued success and risk management,
Josh Steiner
Managing Director
