Lending markets

“Calm down your enthusiasm”; Despite evidence to the contrary, Fed worries about CPI ‘false head’

Larry David is best known for his role in creating and producing the Seinfeld Comedy series. After SeinfeldDavid then created and starred in another such series called Calm your enthusiasm. We think the title of this series is very fitting for what the Fed is saying to the markets in the face of last week’s very strong inflation numbers (ending August 12) and the evidence that those numbers will continue.

Of course, the markets appreciated the Consumer Price Index (CPI) and Producer Price Index (PPI) readings, both of which came in below consensus estimates. The S&P 500 rose 3.2% on the week, the Dow Jones (DJIA) 2.9%, the Nasdaq 3.0% and the Russell 2000 4.9%. The chart shows that the July/August rally has recouped about half of the losses from January to June. Bear market rally?

The peak of inflation was in June

Judging by the inflation data and the forecast indicators, July seems to be the first of several months of good inflation news. As we’ve written in several previous blogs, we thought June would be the peak inflation for this business cycle and, after July’s inflation data, that seems to be the case. The CPI came out on Wednesday August 10 flat (0%) on an M/M basis (consensus: +0.2%), bringing the Y/Y rate down to +8.5% (consensus: +8.7%) . Core CPI (excluding food and energy) was +0.3% (consensus: +0.5%) with the Y/Y rate falling to +5.9% (consensus: +6.1%).

Digging into the details, in July energy prices fell -4.6%, with gasoline prices falling -7.7%. Note that gasoline prices have continued to fall since the July price surveys! Food (+1.1%) and rents (+0.5%) continued to climb, but forward-looking data indicates August will show flattening in both categories. Meanwhile, in July, we saw lower prices for appliances, clothing, airline tickets, used cars, rental cars, and education and communication costs. We expect the August CPI to show further declines in energy costs (gasoline has fallen another -11% at the time of this writing) and food prices should start to rise. decline because we are witnessing a collapse in agricultural prices, dairy product prices and egg prices. and chicken futures.


Rents represent a weight of 30% in the CPI, therefore quite significant. As shown above, they rose by +0.5% M/M, or an annualized rate of +6.2%. While that’s not exciting, it’s a far cry from the +13.2% year-on-year number that the Fed and the media are worried about. But the figure of +13.2% is retrospective. As you can see on the graph, this has gone down.

The National Multi-Housing Council has a diffusion index of rental market tension (50 and above on the index means getting tighter, while below 50 and falling means getting easier). The table shows the last five quarters. Note the diffusion index for Q3 2022!

As we’ve discussed in previous blogs, the newly finished multifamily product now hitting the market is likely the reason the spread index has moved so quickly from narrow to easy. With the cracks now appearing in the home building industry, we are now seeing a downward trend in new and existing home prices. Thus, the Implicit Owners Equivalent Rent (OER) imputed by the BLS to the CPI will also stabilize soon.

Healing Supply Chains

We have been of the view (expressed several times in this blog) that much of the current inflation would be “transient” if an appropriate time frame was set, long enough for supply chain issues to resolve. (i.e. 12 – 24 months). We now see that supply chains are mostly healed. A sign of such healing is that shipping rates have dropped dramatically. For example, the cost to move a container from Shanghai to the Port of Los Angeles is around $6,600. A year ago it was over $18,000 (i.e. -63% reduction). The journey now takes 74 days, compared to 99 before.

The two graphs below, taken from the Institute for Supply Management (ISM) survey, show dramatic reductions in backorders and supplier lead times. They are roughly back to pre-pandemic levels of 2018, very reliable indicators of the state of the supply chain.

Producer prices – another leading indicator

Producer prices (PPI) are leading consumer prices, and the July index also crushed expectations, coming in at -0.5% M/M (-5.8% annualized ). The consensus was +0.2% M/M. Core PPI (excluding power and energy) was +0.2% M/M. The consensus was up again at +0.3%. The reading of +0.2% M/M (+2.4% annualized) is not far from the Fed’s +2% annual inflation rate target! The consumer goods portion of the PPI was -0.7% M/M (-8.1% annualized). This was the first negative reading since April 2020 for this particular sub-index. For gross production stages, the PPI was -6.9% M/M in July alone and -1.1% Y/Y. Four months earlier (March), that Y/Y number was a whopping +26.2%!

Productivity and employment

The productivity numbers are terrible. They were -7.3% productivity in Q1 and at least -3.5% in Q2. Y/Y productivity is above -2%, the worst reading since the 1970s. Companies have little choice but to cut staff, especially if sales are stagnating, in order to protect profit margins. We have already started to see the drift in the initial data on unemployment insurance claims.


There really is a lot to celebrate. It looks like much of the inflation will go away as the supply chain recovers. Yes! It really was “ephemeral” after all. The following chart only assumes a CPI M/M of 0% for the next 12 months and shows what the Y/Y changes in the CPI would be. Forward-looking data indicates that the CPI will “fall” over the next few months (assuming there are no major geopolitical events), so the picture could actually be a worst-case scenario.

Where is the head of the Fed?

Despite the good news, this Fed seems to have a different view. Every FOMC member who has made a public statement since the CPI was released has warned that the Fed will raise rates significantly. The last FOMC member to make a statement was Mary Daly (San Francisco), normally a dove. She said the FOMC didn’t want to be “rigged” into improving the data and favored a rate hike of 50 or 75 basis points for the September meeting. There are still August jobs, CPI and PPI reports before this meeting. Another reading of 0% on the CPI would put the Y/Y inflation rate at 8.1% by the time they meet, but that may not be enough progress for this Fed, which seems to be looking at the past ( i.e., Y / Y CPI) and driving while looking in the rearview mirror)!

Moreover, not only does the Fed intend to raise rates, but it has not yet reached its pace of reducing the monetary aggregates (i.e. quantitative tightening (QT)). The economy’s reaction to QT is unprecedented since the last time they tried it (2018), they pulled back as loan markets froze. All forward-looking data points to a recession – just a matter of depth and duration.

We will learn more about the Fed at its Jackson Hole Symposium (August 25-27). Because they are now trying to manage the yield curve, normally the job of the free market, we suspect they will be signaling markets to raise rates, not stabilize or lower them like inflation data l have now reported. Their message to the markets: Calm your enthusiasm! Shame! They originally had the right (“transitional”) idea, just the wrong timing. Now, it all seems to be a matter of appearances – they believe, for their credibility, that they must convince the public that they are “inflation fighters” – regardless of the economic consequences!

(Joshua Barone contributed to this blog)