This unlocked research note was originally published June 06, 2014 at 16:58 in Macro
“The Perils of Falling Inflation.” Like clockwork, that phrase was on the cover of the November 9th – 15th issue of The Economist right after headline CPI bottomed at +1% YoY in OCT ’13. Fast forward to today, domestic consumer price inflation – on the government’s conflicted and compromised metric – is running +100% higher at +2% YoY (APR ’14).
Inflation doubled, lol!
Ok, that’s probably not very funny – especially if you’re a consumer that is feeling the pinch of rising inflation. Growth in real incomes in America has slowed from its cycle-peak of +1.3% YoY in OCT ’13 to +0.3% YoY as of APR ’14.
As a late-20s working professional living in Manhattan, I can say honestly that just about everything I buy – from rent, to clothes, to food, even down to the occasional Bud Light – has gone up in price on a YoY basis at rates well north of +2%. Some things, like taxis and train tickets, are tracking up mid-to-high single digits from a YoY rate-of-change perspective. Obviously this is all specific to my consumption basket, but when I speak to people all across the country – be it the cab driver in San Francisco or the Midwestern woman on the plane ride next to me – all everyone wants to talk about these days is how expensive everything has gotten.
Again, anecdotal data is what it is, but I challenge you to find me someone who genuinely believes inflation is running at or below +2% or decelerating. Moving along, here are a few non-anecdotal data points that have hit my inbox in recent weeks (copy/pasted directly from StreetAccount):
- The WSJ reported that the Organization for Economic Cooperation and Development (OECD) said the annual inflation rate in its 34-member states rose to 2% in April, from 1.6% in March. It noted that in the Group of 20 leading industrial and developing nations, inflation rose for a second month to 2.8% from 2.5%.
- The WSJ reported that rents rose at shopping centers and malls for the 12th consecutive quarter in a sign that landlords are getting a boost from the improving economy and low level of commercial real-estate construction. Data from Reis showed asking rents at strip centers rose 0.4% q/q in Q1, to $19.42 per square foot, the highest level since late 2008. Asking rents at large regional malls rose 0.5% to $40.15 per square foot, also the highest since the end of 2008.
- Bloomberg cited a report from Trulia, which showed none of the 100 largest metro areas had increases of more than 20% in residential asking prices last month - the first time in almost two years. It compares with seven metro areas that had such y/y gains in May 2013. The report said national asking prices gained 8% y/y in May, the slowest pace in 13 months, amid slumping demand from both traditional buyers and investors. Meanwhile, rent growth is accelerating. Rents are up 5.1% nationally, with apartments climbed 5.8% and single-family homes gaining 2.1%... #InflationAccelerating AND #HousingSlowdown in the same data point(s)… #awesome!
Perhaps I’m not alone…
INTERMEDIATE-TERM TREND VIEW
Luckily you, unlike the vast majority of Americans, can do something about it. In line with our #InflationAccelerating macro theme (introduced in JAN ‘14), we continue to anticipate that reported inflation will accelerate throughout 2014. There are three primary reasons we hold this view:
One: Holding current prices flat, the US dollar on a trade-weighted basis will dip into negative YoY territory in 2Q14E and will remain negative through 3Q14E, only returning to marginally positive by 4Q14E. This is a sharp deterioration from the +3-4% trend we’ve seen since the start of 1Q13. That should provide a material shock to the rate of change in import price inflation, which, at -0.3% YoY, is currently accelerating off the lows of late-2013 (-1.8% YoY in NOV).
Two: We do not, however, think it’s prudent to hold current market prices flat. While most of Wall St. continues to anticipate higher rates amid tighter policy out of the Federal Reserve, we believe rising inflation will continue to slow consumption growth at the margins – which is ~70% of US GDP. That, coupled with the precipitous decline in both activity and price appreciation in the housing market, should eventually force the Fed to pare back their guidance on eventual monetary tightening. A cessation of their existing policy to taper is not out of the question by the third quarter. Commodities, which hold a -0.70 correlation to the USD (CRB Index vs. US Dollar Index; trailing 6M), should continue to grind higher. It’s worth noting that the CRB Index is up +9% YTD, besting the sub-6% return for the S&P 500.
Three: If none of our market-based forecasts come to fruition, we still have confidence in CPI accelerating over the intermediate term – if for no other reason than base effects. Without getting too geeked out on differential calculus, “simple” math would suggest that as comparative base rates decline sequentially – which they do throughout the balance of the year – the probability that the rate of change accelerates from the base rate (i.e. t₀) increases substantially.
LONG-TERM TAIL VIEW
In line with our #StructuralInflation macro theme (introduced in APR ’14), we continue to think structural inflationary pressures are building up across the US economy. While we cede the point that considerable slack remains in the labor market, we do not think investors are paying nearly enough attention to the following supply-side pressures that are likely to perpetuate cost-push inflation over the long term:
- S = I. Savings equals investment. That’s the most basic, underappreciated formula in all of the borderline useless economic theory we’ve all had the “great privilege” of learning at some of the world's best (i.e. overpriced) collegiate institutions. With rates being held at zero for such a long time, it should come as no surprise that real nonresidential fixed investment is up only +3.3% on a trailing 5Y CAGR basis. That’s the slowest rate of growth this far into an economic expansion over at least the last 30Y.
- Again, when the central bank cuts rates to zero and leaves them there for the better part of six years, savings are naturally pulled from traditional investment vehicles that encourage investment (e.g. growth stocks) and into investment vehicles that actually encourage disinvestment – such as MLPs – in search of higher yields. Duh. Moreover, corporations – which have been increasingly rewarded by investors to buy back stock and ramp dividends – have largely done so in lieu of investing in their businesses. Now, as we approach what may be the end of economic cycle, many corporations streamlining trailing peak GDP growth rates and are scrambling to ramp up production into the inevitable result of seven years worth of broad SG&A deleveraging: relatively depressed production, transportation and storage capacity.
- Q: What happens when company A acquires company B in industry C? A: There are fewer companies operating in industry C, effectively creating marginal headroom for company A to hike prices on its customers. This phenomenon has been happening all throughout the post-crisis era and is now accelerating to a hilt here in 2014. The total number of domestic enterprises has declined -6% since the pre-crisis peak, with larger firms leading the decline at -10%. For example, Airlines and Hotels are two obvious industries in which consumers are feeling the pricing pinch of decreased competition. Newsflash to whomever just bought the all-time high in the US equity market at 10-VIX: You can’t be long the Airlines on a tired industry consolidation thesis and say that there’s [going to be] no inflation. That’s disingenuous at best… Another newsflash: With the retail sales control group measure declining -0.1% in APR, it’s interesting to see that revolving consumer credit grew at a +12.3% SAAR pace in APR. It is likely that consumers are feeling the pinch of rising, underreported inflation and levering themselves up to keep pace!
Buy TIPS. Protect yourself and/or your clients from a likely acceleration in CPI. Please note that we are not making a hysterical call for hyperinflation born out of serial money printing. That’s not our style. Rather, our style is to call it like it is: the US economy is likely to experience a run-of-the-mill pickup in reported inflation. A 3-handle on headline CPI – which remains a conflicted and compromised calculation – is probable over the intermediate term.
Inflation tripling, lol!
Have a great weekend. If you get hungry at the beach, grill an iPad!
Associate: Macro Team