The Inflation Report: Just Not Getting Better

From the Federal Reserve Bank of Cleveland:

According to the Federal Reserve Bank of Cleveland, the median Consumer Price Index rose 0.3% (3.6% annualized rate) in February.  The 16% trimmed-mean Consumer Price Index rose 0.3% (3.6% annualized rate) during the month.  The median CPI and 16% trimmed-mean CPI are measures of core inflation calculated by the Federal Reserve Bank of Cleveland based on data released in the Bureau of Labor Statistics' (BLS) monthly CPI report. 

Earlier today, the BLS reported that the seasonally adjusted CPI for all urban consumers rose 0.4% (4.5% annualized rate) in February.  The CPI less food and energy rose 0.2% (2.9% annualized rate) on a seasonally adjusted basis. 

Over the last 12 months, the median CPI rose 3.6%, the 16% trimmed-mean CPI rose 2.8%, the CPI 2.4%, and the CPI less food and energy 2.7%.

Here's the table:

   

   

The somewhat startling nature of inflation measured by the median CPI is a result of the continuing strangeness in the distribution of the expenditure-weighted components of the index:

   

   

That's a whopping 67.6 percent of prices (weighted by their importance in the CPI market basket) that rose at a better than three percent annual rate in February.  That just can't be good.

UPDATE:  The Capital Spectator says "As warning bells go, this one looks pretty convincing."  The Skeptical Speculator believes "the Fed will be hesitant about cutting rates."  Dean Baker thinks we should be keeping our eye on the Producer Price Index.  I think Barry Ritholtz concurs, and says there is "good cause" for concern. Michael Shedlock ponders the PPI, and offers you the raw material for your stagflation office pool.  The Nattering Naybob suggests the data already reveal "raging stagflation."   Calculated Risk puts the inflation report together with retail sales and looks ahead to real consumption growth for the first quarter.

Comments

[calmo]

Do crude oil price increases that seem to register almost instantly at the pump, now find faster response times for any goods that need to be delivered?
The decreases not so responsive.
But could be, with a slowing economy, a drop in fuel consumption will create a drop in crude prices and we will see more pacifying CPI stats.

[bailey]

Come on Dave. It's a new year I thought we're agreed to try to be positive. I see a real positive in this.
For some time I've been suggesting it's not necessary for the FED to raise the ff rate to address real inflationary concerns, only to quickly & adamently put an end to the growing for easings this year.
Now's the time. I say let the markets do the lifting.

[UrbanDigs]

Bailey - Thats the problem. The fed's # job is to control inflation and price stability. They should not be looking at the other markets to see if that will do the job.

If the fed fails to do their job against inflation then:

A: they are not doing their job

B: we will be facing much more severe issues later on

The fed has to be worried about inflation fears right now and shouldnt be looking at housing's issues or at a possible economic slowdown to solve this problem.

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[spencer]

In a low inflation world firms tend to raise prices once a year--typically at the start of the year or the season. As a consequence over half of the annual increase in the not seasonally adjusted core cpi occurs in the first quarter.

The January and February increase in the not seasonally adjusted core cpi was 0.88%, the largest combined January & February increase since 1996. Over the past decade the 2 month increase has averaged 0.75%. So this is not a signal that core inflation is accelerating sharply. However, it argues extremely strongly that the core inflation rate is not moderating.

[bailey]

Urbandigs, Believe me, I agree. I agree so much I ascribe a large portion of why our Treasuries are so low to the belief (right or wrong) the FED will quickly-come-a-running to lower rates to keep our economy spinning. I'm afraid it's commented way too many times in support of this thesis to allow for any other view.
We'll see.

[Dave Iverson]

UrbanDigs: "The fed's # job is to control inflation and price stability. They should not be looking at the other markets to see if that will do the job."

Both Bailey and I have been harping for a long time that the Fed not turn a blind eye to "asset inflation" along with what they do now consider.

Our intent is to stop the "helicopter drops" of money that plagued the system as "quick fixes" during the Greenspan era. See recent commentary by Stephen Roach and others on this lingering problem. Here are two links:

Roach (yesterday), The Great Unraveling:
http://www.morganstanley.com/views/gef/index.html#anchor4577

NPR (today): Living in the land of the 'liar loan':
http://www.npr.org/templates/story/story.php?storyId=8972571

Both stories reiterate that in the last 8 years we have had two major bubble episodes that directly, or indirectly, implicate US monetory and fiscal authorities.

And both stories are interrelated with my recent notion of Bernanke's Puzzle -- what to do now?
http://forestpolicy.typepad.com/economics/

That question is even more interesting in light of these indicators (in this post) of traditional inflation that seems to be spilling-over from the bubble markets, related to "easy credit" that seems to be on the verge of collapsing.

[Dave Altig]

bailey -- "... it's not necessary for the FED to raise the ff rate to address real inflationary concerns, only to quickly & adamently put an end to the growing for easings this year."
I'm on exactly the same page. (There -- that's pretty positive isn't it?)

[UrbanDigs]

Dave - Let me see if I am hearing you correctly?

"Both stories reiterate that in the last 8 years we have had two major bubble episodes that directly, or indirectly, implicate US monetory and fiscal authorities."

So, the dot com bubble and eventual burst was a result of monetary policy?

In my opinion, you really cant look at the dot come bubble and eventual burst, or what Greenspan decided to do to slow the red hot growth that was going on at the time; as this was a one time freak event that might not happen again for another 50 years. The internet revolution brought such a drastic change in every aspect of our economy that its not surprising, in hindsight, that the street overestimated its growth potential. In addition, Greenspan's reaction of rising rates to try and slow things down seems warranted. If he didnt, things would have got much worse.

Looking back, the top of the run was in March of 2000 yet monetary policy didnt start its fast run downward until early 2001, well after the stock market started pricing in risks to future economic growth.

So, I dont think monetary policy is to blame for this first bubble. Rather, a revolution that was so little understood was the real problem which led to, here it comes, the irrational exuberance that created the stock bubble. In short, if the company had a dot com name, its business model was expected to make millions! It couldnt have been more wrong and so much wealth was bet on such a mis-understood trend at the time.

Now, I DO believe the real estate bubble was caused in part by such prolongated loosening of monetary policy and easy credit. And its hard to argue that real estate historically doesnt move like it did in the past 5 years or so. But hey, thats part of our system and those who put 2 + 2 together and saw low interest rates as a catalyst to a ripe housing run, good for them.

Looking at right now, it just seems inflation pressures cant be overlooked and that the biggest weapon we have to combat this problem is tightening monetary policy. If food/goods/commodities prices continue to rise, the cycle will hurt economic growth more than if the fed raises interest rates. The stock market should want this problem to get under control now, rather than deal with it later on and face a much more severe environment.

In short, I think we need tighter FF rate closer to 5.75% - 6%, which historically is still very close to that neutral range where it isnt restrictive or stimulative. Im very curious to see how things play out and Im sure many will disagree with this thinking.

[calmo]

I change my mind after looking at the stats which list the components of the basket and their weightings.
So it wasn't the 2nd hand truck purchase that kept the CPI in the danger zone (3-4%), but that weighty (and oh so fudgable) OER.
Imagine the monthly change on that item increasing by 3.6% last month given the reported plummet of housing starts and the exodus of real builders that go with that.
Hard to believe the vacancy rates are not at all time highs --confirming the miserable housing starts.
Hard to believe that rents did increase last month and harder to believe that supply and demand won't force this stat negative shortly.

[bailey]

Dave A., Thanks for the early morning smile! Lest you forget, many of my questions are at best, meant to remain rhetorical. Your method at times is challenging, but never without merit.
If I were in your area, I'd stand in the quad with a placard inciting ALL interested & able students to accept your challenge - They'll be better for it.
For readers new to the site, let me repeat: DAVE A. DOESN'T SPEAK HERE FOR THE FED.

[Dave Iverson]

UrbanDigs: "I dont think monetary policy is to blame for this first bubble. Rather, a revolution that was so little understood was the real problem which led to, here it comes, the irrational exuberance that created the stock bubble."

I agree with you about the "revolution" so little understood. In some weeks I will review Carlota Perez's "Technological Revolutions and Financial Revolutions (2002): The Dynamics of Bubbles and Golden ages". Maybe then I can shed more light on these matters. Until then here is a link to her book:
http://www.carlotaperez.org/

For now I believe that Minsky (and Kindleberger) and some of their disciples get it right.

Still, I blame Greenspan and Co. for thinking, or acting like he/they could talk us out of our irrational exuberance. AND for at one time championing the "new era" productivity thinking. AND for leading the sheep to slaughter via ARMs. AND for not effectively warning against dangers from (in addition to benefits from) derivatives, hedge funds, and risk concentration.

Greenspan is finally getting the criticism he deserves. See, e.g. today's MSNBC "Greenspan Changes Tune, Wall Street Cries Foul"
http://www.msnbc.msn.com/id/17344110/

As I said earlier, I blame a combination of mistakes, misjudgements by fiscal AND monetary authorities. The "irrational exuberance" should have been dealt with about 1995, but wasn't: (Keynes/Minsky "leaning against the current" or just good old fashioned "taking the punch bowl away").

UrbanDigs: "Looking at right now, it just seems inflation pressures cant be overlooked and that the biggest weapon we have to combat this problem is tightening monetary policy."

James Hamilton may have said it best, yesterday: "Choose your poison, Ben: inflation or recession. Or perhaps you'd like a little of each?"
http://www.econbrowser.com/archives/2007/03/disappointing_n.html

I believe that nobody has dared kill the irrational exuberance -- until perchance now -- because they were afraid of the next depression or "Financial Armageddon"
http://forestpolicy.typepad.com/economics/2007/03/financial_armag.html

Now we may get a chance to see what BB is made of and just how resilient our economy really is.

[calmo]

Reviewing the graph 'CPI Component Price Change Distribution' and consulting the list of components together with mulling over Dave's assessment:

"That's a whopping 67.6 percent of prices (weighted by their importance in the CPI market basket) that rose at a better than three percent annual rate in February. That just can't be good."

made me reconsider the heavy, OER and whether or not 3.6% rental increases were in fact exacted from renters who may have no pricing power...owing to the widespread practice of 'Burning down those vacancies/houses' to keep renters where they belong.
Or maybe that's next month's headlines: "Arson Adds to Global Warming".

[jm]

Calmo writes:
"Hard to believe the vacancy rates are not at all time highs --confirming the miserable housing starts."
"Hard to believe that rents did increase last month and harder to believe that supply and demand won't force this stat negative shortly."

The problem is that, although the fraction of the nation's housing stock sitting vacant is at a record level, much of that is being held for sale at fantasy prices no one will ever pay, while much of what is being offered for rent is likewise being offered at prices no one will ever pay. And both of those vacant home classes include numerous apartments that were formerly for rent at realistic prices until they were removed from the rental market by being converted into bubble-priced condos.

About two years ago I was thinking of cashing out on my modest home here in the NW suburbs of Chicago and renting while waiting for prices to crash. But the MLS showed not only no single-family rental homes such as might interest me, but almost nothing of any sort. Homes that in the past might have been rented were being bought and renovated for quick-flip profits. Around the same time, a number of apartment complexes in the area started into condo conversions, shrinking the local supply of rental apartments.

Now there are 68 rental listings on the MLS, but most at asking rents as high as bubble peak price mortgage payments, so the properties just sit vacant as the months go by and the seasons change. Clearly, the people who own these places are not real landlords in the business of renting homes, they are people who bought at the top of the bubble and are doubly demonstrating their lack of business acumen by fantasizing that someone is going to cover 100% of their mortgage costs while they await the next bubble.

Until the huge stock of unrentable vacant housing passes through foreclosure and is sold off at prices that will allow real landlords to get positive cash flow from rents people can and will actually pay, OER will not fall.

[calmo]

Thanks jm.
So those vacant houses will need high priced insurance and/or security details to protect property that owners are so far unwilling to rent...or am I being block-headed in not recognizing the sanctity of "unrentable"?
Of that portion of empty houses where the bank owns the house, are they willing to rent for current market rates or somewhat less while they wait for a selling opportunity? The costs of renting are higher than the costs associated with vacant housing...seems to be the message I am having trouble digesting.
But you have empirical data that shows it's hard to find affordable rents. How can this not be atmost a local and/or temporary phase while owners reassess the falling market?

[jm]

"How can this not be at most a local and/or temporary phase while owners reassess the falling market?"

Although I do believe that this is a temporary phase, I also believe that the people who made speculative purchases during the bubble years are exactly those people who believe real estate is a "can't lose" investment. So they believe any sluggishness in the market can be only temporary, and if they just hold on through the slump, they are sure to make huge profits when prices take off again. This belief system is inevitably reinforced by the way prices rose after the mid-90s slump.

When these people advertise a home for rent, it's not with intent to become a professional landlord. They only want to reduce their losses until they can sell at a profit.

It's a safe bet that many of these people are in dire straits, paying out mortgage, insurance, heating/cooling and maintenance costs month after month both on a vacant home plus the one they live in, but unwilling or unable to sell because they would then have an immediate additional loss of $100k or more due to falling prices and transaction costs -- a loss which many of them probably do not have the resources to cover.

And because it was greed that got them into the situation, they're going to strongly resist renting for anything less than mortgage payment amount.

Eventually, those whose income from other sources is enough to support the lower rate of negative cash flow they'll have if they actually rent the home will swallow their pride and cut their asking rent. But this probably won't happen until they've gone through this year's "hot spring selling season" without a sale.

Regarding banks renting out foreclosed homes, I have read that they rarely do that, though some have rented in cases where the slump was so bad that selling would have led to losses near 100% and the market price impact would have endangered other loans. I suspect that it will get just that bad in many parts of the country, but not until later this year at the earliest.

[calmo]

Thanks jm, I'm not ever absolutely sure but my anecdotal evidence comes from reading reports of REO "auctions" that produce no sales as prospective buyers refuse to entertain even the "25% off" prices. It may not be possible to rent all of these houses, but surely a large portion of them will be...driving rents down and with that CPI...and recalibrating GDP, it seems to me.

[jm]

Calmo, I quite agree with you, except in regard to timing. Actually, my long-term outlook is probably even more bearish than yours. When we get to September with most of this vacant inventory still unsold and unrented, and the owners out six months more of mortgage, tax, and maintenance payments, some serious price cutting is going to start, and it's going to get really ugly. During the early-90s downturn, the home ownership rate was only 64%, and the ownership rate among the under-30 set was particularly low. Now the overall rate is near 69%, and among the under-30 set in particular it's far above the early-90s rate. So when the coming recession starts pushing those young people back to their parents' homes and into doubling or tripling up with roommates, the already-glutted condo market is going to be just awash in bank-owned vacancies. The banks will probably have no choice but to offer them for rent at realistic levels.