Most People Calling CPI Professionally Are Not Comparing Apples To Apples

By Michael Every of Rabobank

Barley; sugar; and apples and bananas

Obviously, inflation is the main focus today.

• Not the report that Egypt might be preparing to send 40,000 rockets to Russia, which is a huge geopolitical shock for those who can find the Suez canal on a map outside of periods when Taiwanese container ships are stuck in it.

• Not China saying it’s ‘ready to fight’ after 3 days of large-scale military drills around Taiwan.

• Not China agreeing to take Australian barley imports again.

• Not the headlines from Europe and the US suggesting a Butlerian Jihad against AI and de facto in favor of butlers.

• Not Twitter now being part of ‘X’, which might be part of a WeChat-style uber-app.

No, just US inflation – which is more than enough. Yesterday already saw weak Chinese CPI, down 0.3% m-o-m and up only 0.7% y-o-y, and weak PPI,  down 2.5% y-o-y, both of which are seeing calls for more stimulus: which in China means more supply, not more demand, which is why it never generates any inflation, except in commodity prices. Relatedly, we also saw sugar hitting a decade high yesterday – and it’s not as if sugar goes into anything we eat nowadays, right?

We heard that ‘cut rates now!’ Tenreyro at the BOE is to be replaced by Megan Greene, who appears more hawkishly inclined. Then again, the Chicago Fed’s Goolsbee, the new Obama-era appointee, just argued bank credit tightening already underway is equivalent to 50-75bps of Fed hikes, conflicting with the New York Fed’s Williams, who said he didn’t see any such problem. Some readings of the NIFB small business survey backed the pessimistic credit view yesterday. Yet the same survey also showed SMEs had already seen loan conditions tightening, and are used to it; their actual planned capex remains at pre-Covid levels; and they still struggle most with inflation and finding staff, with pay deals still at elevated levels.

So to the US number, where the consensus is 0.2% m-o-m and 5.1% y-o-y headline, and 0.4% m-o-m and 5.6% y-o-y core: and we will get core services ex-housing, core core, core core core, and ‘excluding everything going up’ measures that everyone will seize on to back their particular view on inflation dynamics, as they do with all other data. Indeed, nobody will change their minds after the CPI number, whatever it is. Markets might move, but minds will remain rigidly fixed.

For some, inflation is always transitory. 2% CPI, or lower, is a natural law like gravity, either because central banks are credible –no laughing at the back!– or ‘because Marx’ – no screaming at the back! Yes, CPI can overshoot for years, but it will eventually crash again. A high print now just means a low print in T+12. So, buy the long end of the yield curve regardless of the carnage at the short end and/or in stocks, or because of it.

For others, inflation is a problem, on the demand side (in services now) and/or the supply side, because the world has changed: post-Covid; post joining fiscal and monetary policy; post-Ukraine; mid structural changes to the labour market and demography; and mid US-China decoupling and worries of worse. Every high CPI print risks becoming more entrenched in our psychology, as the New York Fed’s median 1-year ahead inflation expectations survey just increased 0.5ppts to 4.7%, the first increase in the series since October 2022, and the 3-year edged up 0.1 pp to 2.8%.

On which note, it is worth ironically worth sharing a pre-CPI long read spotted by my eagle-eyed BOE-watching colleague Stefan Koopman – ‘Inflation is Conflict’ (Lorenzoni and Werning). This paper makes the eponymous claim that even absent any economic model, or the Friedman argument of “too much money chasing too few goods,” or the supply-chain argument of “too few goods being chased by too much money,” inflation is at root always all about conflict over compromise.

As the authors note, “The contribution of this stylized model is to isolate the role of conflict in inflation. Indeed, it is meant as a shock to the system that may sow the seeds of doubt in economists, like ourselves, raised on the notion that to speak of inflation requires first and foremost a discussion of money and interest rates, complemented perhaps with the concepts of natural levels of output, employment or interest rates. The results of our stylized model attempt to leave no easy way out of this traditional mindset, leave no natural interpretation for inflation except conflict.”

If you are of an economic bent, read it in full. Of course, you still won’t change your mind on what drives inflation, but it will kill an hour or two before the US data release. If you aren’t of an economic bent, the simple introduction to the paper can be best summarized here via their analogy to two parties selling apples and bananas.

Simply, if the two take turns to set the relative price of their goods (i.e., the apples to bananas ratio), then they can say: “1”, “1”, “1”, “1”, and we have zero inflation. Or, the pattern can be “1”, “1.1”, “Ah, so 1.1 back at you!”, “Ah ha, so 1.2 to you!”, “Really? How do you like 1.3?!” and an escalatory cycle. Note this absent money, interest rates, supply-side shocks, profits, or nominal or real wage growth, some of which the paper slots in later – and all of which are extremely pertinent at the moment. How are these conflicts going to be resolved?

This simple apples and bananas model ironically again makes the point that most people calling CPI professionally are not comparing apples to apples.

• If you think ‘Marx’, CPI always come down: but, to be consistent, so does capitalism, which doesn’t make the most compelling argument for long government bonds, or fiat currency, long term.

• If you think ‘Friedman’, CPI must be crushed via higher rates or higher taxes and lower spending: that makes a compelling argument for long government bonds down the curve and fiat currency, especially if you think the world is actually Marxian.

• If you think ‘Lenin’, the rise of geopolitics and war as inflationary supply-side disrupters adds a new dimension to current internal conflicts: and to how you should respond in markets.

Or, one can have no secular or fundamental view on inflation whatsoever, and just play ‘The price is right’ (“Higher than 0.2% – bingo!” “Lower than 0.2% – you’re a genius!”) Which is frankly bananas in a different way.