AFMC - Inflation Is Yesterday's News

2023-04-12 22:30:00 ET

Summary

• Headline inflation is now running at about a 3.5-4% rate, not the 5% rate cited by most news sources today.
• If Owners' Equivalent Rent continues to moderate, as it almost undoubtedly will, headline inflation will all but vanish in coming months.
• Given the behavior of M2 in the past year, the CPI is on track to fall to 2% or less by the end of this year, if not sooner.

Here's Bloomberg's take on today's March CPI release: "data showed inflation moderated last month, but not enough to forestall the Federal Reserve from raising rates at least one more time this year."

My take: There are only two things you need to know about inflation today: 1) without the Owners' Equivalent Rent component (which makes up about one-third of the CPI), the CPI would have declined at a -1.6% annualized rate in March, and 2) OER inflation has peaked and will almost surely decline significantly in coming months. In short, our national inflation nightmare is over. If the economists at the Fed can't understand this, they should be fired. There is absolutely no reason the Fed needs to raise rates further, and every reason they should begin cutting rates—beginning with the May 3rd FOMC meeting if not sooner.

Chart #1 shows the 6-mo. annualized growth of the Consumer Price Index and the ex-energy version of the CPI. Both show that on the margin, inflation has declined significantly from its June '22 peak. Headline inflation is now running at about a 3.5-4% rate, not the 5% rate cited by most news sources today.

Chart #2 shows the one- and three-month annualized rate of change of the Owners' Equivalent Rent component of the CPI. Here we see a dramatic slowing in this major source of CPI inflation that has only just begun. And as mentioned above, without the 6% annualized March increase in this component, the overall CPI would have actually declined. If OER continues to moderate, as it almost undoubtedly will, headline inflation will all but vanish in coming months.

Chart #3 shows how changing housing prices feed into the OER component of the CPI. It takes about 12-18 months for changes in housing prices to show up in OER. Nationwide housing prices peaked almost a year ago, and now OER inflation has peaked. This is a big deal. It's almost as if we have advance knowledge of what the CPI will be doing in coming months: CPI inflation will almost certainly decline, given the weakness in housing prices (which won't go away unless and until mortgage rates come down significantly).

Chart #4 shows another reason why the CPI is going down in a big way. Growth in the M2 money supply foreshadows changes in the CPI by about one year. Given the behavior of M2 in the past year, the CPI is on track to fall to 2% or less by the end of this year, if not sooner.

To paraphrase Wayne Gretsky, the Fed should be focused on where CPI is going, not on where it has been. It's on its way to zero, and that means the Fed should cut rates—and the sooner the better.

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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