Trick, No Treat: No Good News In The September CPI Summary
Trick, No Treat: No Good News In The September CPI Summary
Inflation Rolls Right Over Powell's Rate Hikes
It would be difficult to state just how bad the September Consumer Price Index Summary report is. Every major aspect of the report was bad news, as inflation continues to roll right over Fed Chair Jay Powell’s interest rate hikes as if they were not even there.
The Consumer Price Index for All Urban Consumers (CPI-U) rose 0.4 percent in September on a seasonally adjusted basis after rising 0.1 percent in August, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 8.2 percent before seasonal adjustment.
Increases in the shelter, food, and medical care indexes were the largest of many contributors to the monthly seasonally adjusted all items increase. These increases were partly offset by a 4.9-percent decline in the gasoline index. The food index continued to rise, increasing 0.8 percent over the month as the food at home index rose 0.7 percent. The energy index fell 2.1 percent over the month as the gasoline index declined, but the natural gas and electricity indexes increased.
Core inflation rose. Natural gas and electricity prices rose. Food price inflation barely declined one-tenth of a percent. Headline inflation rose month on month and barely declined year on year.
Inflation was on the march in September literally on every front. One might almost think Jay Powell had not been raising rates since March, had not made some of the steepest rate hikes since the Volcker Recession, had not tightened the money supply at all.
If there was any doubt that the current inflationary crisis is not solely a monetary phenomenon and not amenable to resolution solely by monetary policy, the September CPI Summary should lay those doubts to rest once and for all.
Inflation Rising Both Year On Year And Month On Month
The most distressing part of the September inflation report is the shelter price inflation components of the CPI rose not just year on year but also month on month.
The Rent of Primary Residence index rose .12% MoM while rising just under 0.5% YoY on an unadjusted basis.
The Shelter Index rose 0.03% MoM while also rising over 0.3% YoY on an unadjusted basis.
Even though headline inflation inched down by 0.05% on an unadjusted basis YoY, it rose 0.24% MoM on an unadjusted basis, from a slight August decline to a September increase to 0.21%
Even when components of the CPI did decline on either a MoM or YoY basis, the declines were at best marginal.
Food price inflation declined MoM by 0.03% on an unadjusted basis, and by 0.14% YoY.
Core consumer price inflation declined MoM by 0.09% on an unadjusted basis, while rising 0.3% YoY.
In September, consumer price inflation was felt across the board, either due to minimal declines or to actual increases. No category was spared.
Yields Are Not Keeping Pace With Inflation
By far the strongest signal that Powell’s interest rate hikes are not working out as planned is the divergence between both headline and core consumer price inflation on the one hand, and long term treasury yields on the other.
This is a phenomenon that began when inflation first took off in early 2021, with both headline and core consumer price inflation rising while both the 10 Year and 30 Year treasury yields holding more or less steady until Powell began raising the Federal Funds rate earlier this year.
This is a markedly different trend between consumer price inflation and treasury yields during the Volcker Recession of the early 1980s. Up until October of 1980, treasury yields and consumer price inflation remained fairly close together.
Only after peak consumer price inflation had passed, during the second phase of Volcker’s draconian rate hikes, did inflation and treasury yields diverge, with yields rising into the second part of the Volcker Recession while consumer price inflation continued to trend downward.
A further sign of the fundamental weakness of Powell’s rate hike strategy has been the collapsing yield spread between long term treasury yields and the federal funds rate. Even though the Federal Funds rate sits in a target range of 3.00%-3.25%, the spread between the Federal Funds rate and the 10 year is at 1.27%, and between the Federal Funds rate and the 30 year Treasury the spread is 1.23%, after peaking in April at 2.5% and 2.6% respectively.
In effect, each rate hike in the Federal Funds rate Powell has executed has produced a smaller and smaller rise in long term Treasury yields, If the spread between Treasury yields and the Federal Funds rate continues to collapse, Powell will have to push the Federal Funds rates to levels the markets have not contemplated in 40 years just to pull treasury yields to the desired higher levels.
This softness in treasury yields may help explain why Paul Volcker pushed the Federal Funds Rate to the heights that he did in the early 80s. The spread between treasury yields and the Federal Funds rate moved into negative territory in late 1978, and largely remained there until July 1982, when the spreads moved into positive territory and remained there.
During the Volcker Recession, Paul Volcker effectively used the Federal Funds Rate to pull treasury yields above inflation.
If this history is repeating itself in 2022, Jay Powell’s 75bps rate hikes are simply not large enough increments, and even a 100bps rate hike might not be large enough. Volcker’s first rate hike in October 1979 was over 200bps. Does Powell dare push rates that high that fast—and could financial markets today withstand such a systemic shock?
Signs Of Demand Destruction: Rising Spreads Between Treasury Yields And Mortgage Rates
One area where Powell’s efforts to cause demand destruction are likely succeeding is in the residential mortgage market. While Treasury yields continue to soften relative to the Federal Funds rate, no such softness exists in residential mortgage rates, with the 30-year fixed rate mortgage just under 7%.
More significantly, the spread between mortgage rates and long-term treasury yields is increasing, with the spread between the 30 year mortgage and the 30 year Treasury, currently at 2.85%, at the highest level since 1986, with only the Volcker Recession showing higher spreads.
Rising mortgage rates, and in particular the rising spread between mortgage rates and treasury yields, are likely contributors to the cooling of housing markets in the US, as the Case-Schiller National Home Price Index has been trending down approximately since Powell’s rate hikes began.
While shelter price inflation within the CPI is still rising, this cooling trend in the Home Price Index indicates shelter price inflation will peak in coming months, although the inflation rate within the National Home Price Index is still at significantly higher than its previous peak in September 2005, at the height of the housing bubble.
Even With Certain Policy, Uncertain Effects
As Ben Bernanke ironically observed in 20041, monetary policy is a diffident macroeconomic tool, prone to “respond uncertainly”, and by itself of questionable efficacy. In the September Consumer Price Index Summary, we are seeing that uncertain and uneven response in spades.
Despite Powell’s repeated rate hikes, treasury yields are not catching up to consumer price inflation, and the decreasing spread between treasury yields and the Federal Funds rate means Powell will have to resort to increasingly larger Federal Funds rate hikes in order to move the needle appreciably on treasury yields.
If Powell does resort to increasingly larger Federal Funds rate hikes, the rising spread between mortgage rates and treasury yields indicates that such hikes will push mortgage rates into the stratosphere, potentially crushing the housing markets in the US. Yet if rising mortgage rates choke off home sales, one network effect will be to have more people remaining in the rental market for real estate, which will push the rent component of shelter price inflation higher.
The net effect will be as it has been: Powell’s rate hikes have failed to contain consumer price inflation, and external forces are likely to continue to outpace the monetary dimensions of inflation for some time to come. Powell may exert masterful control over the policy of rising interest rates, but he continues to have zero control over the consequences and outcomes of that policy.
Bernanke, B. S. FRB: Speech, Bernanke “The Logic of Monetary Policy” December 2, 2004. 2 Dec. 2004, https://www.federalreserve.gov/boarddocs/speeches/2004/20041202/default.htm.
My sense is that yields remain below inflation because the bond market believes that the Fed will pivot when things start to go south. Whether this is correct or not remains to be seen.
I do agree that 75 bps hikes are not enough.
Since the average time a mortgage remains active has been around seven years, mortgage rates should be compared to the 10 year Treasury rate, not the 30, although there isn't much difference right now.
The Fed could easily force long term rates much higher if it wanted to by dumping treasuries onto the market at whatever price the market was willing to pay for them.