Rotten Only At The Core

By: Michael Ashton | Wed, Apr 14, 2010
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The financial news networks are abuzz about earnings, but for me the focus is on the fact that Core CPI matched the lowest year-on-year core print in 44 years, as it printed flat and +1.1% y/y. Now, when Core hit that level a few years ago, as I have discussed previously, it was more of a concern because Shelter was actuallybiasing the number higher; for all of the angst we will hear about deflation threat this time around there really isn't much of one. Core inflation, ex-housing, is still +2.5% year/year, a bit down from the highs but still well above the +1.6% of last January and still clearly rising. The scary spike may have passed, though about 57% of the core-ex-housing index is still rising faster than 3.5%, including core Transportation, Medical Care, and Other Goods & Services. Going slower than general core inflation? Only Housing, Recreation, and Apparel...and these latter two are only about 12% of the ex-Housing core.

Still, the downward pressure on core inflation, which is coming largely from housing, ought to be ebbing soon. The model I follow perceives pressure into early Q4, but the low could come as early as next month when the y/y number ought to drop simply because the +0.25% print of April '09 print exits the data window. That might even push core inflation below 1% as measured.

The Cleveland Fed Median CPI, which is normally a superior measure to the core CPI but also suffers from the "Shelter bias," is already at +0.6%.

Less important than what these screen prints imply for future inflation - which is to say, not very much, since they are polluted by the bubble unwind - is what they imply for monetary policy. There is, in my mind, almost no chance that the Federal Reserve will tighten policy while core inflation is under 1% (even if that's not the right measure) and at 44-year lows at the same time that unemployment is over 9% and still near 80-year highs. It just isn't happening.

The Chairman, of course, can't say that, and so he and the Committee need to make it sound as if they are very focused on the mission of restraining inflation. The forward inflation curve, as I noted a few days ago, doesn't entirely believe them, but so far they have an amazing amount of credibility considering that it's hard to figure out how the country survives this amount of debt without at least a modest amount of inflation...unless, of course, Congress balances the budget (ha! ha! ha!).


Speaking of Congress, I saw today that some chucklehead on the Hill has proposed a bill to prohibit airlines from charging fees for carry-on luggage (as a discount airline recently proposed). I might have missed that day in Civics class, but what exactly is the State's compelling interest in carry-on luggage fees? For myself, I could care less whether there are luggage fees or not, because it isn't like having them (or not) will change the cost of air travel on average. It will just change how those costs are distributed, and if it gives me another way to potentially avoid my share, then bully for me. But it does frighten me that anyone in the Legislative branch perceives that the government has anything to say about how a private business in a competitive industry charges for its services.


The soft inflation numbers, strong Retail Sales figures (+0.7% ex-auto, with an upward revision to last month), and jubilant Intel earnings gave equity shorts no chance. S&Ps ended +1.1%, with TYM0 -9.5/32nds and the 10y yield at 3.86%. Tomorrow, Intial Claims (Consensus: 440k) are expected to retrace last week's jump to 460k, which was quite a buzzkill for those expecting robust growth. Consensus estimates for Empire Manufacturing are at 24.0 (vs 22.86 last month), and Industrial Production and Capacity Utilization (Consensus: +0.7% and 73.3%) are also expected to be strong. The Philly Fed index anchors the list of important releases (Consensus: 20.0 from 18.9), but also keep an ear out for Volcker at 3pm. He is speaking on Financial Risks, and my guess is that he'll say we should solve that problem by stopping banks from trading. It will help the Administration to have the former Chairman paint a scary picture of the risks, so that's what I expect to hear.


The Fed's weekly H8 report released several days ago showed that bank credit had jumped nearly $400bln in the week ended March 10th. If this was a legitimate jump, it would be a huge development as it would indicate that banks were suddenly lending. Alas, it turns out that the rise in total commercial bank credit includes $377.8bln that are merely off-balance-sheet vehicles coming on-balance-sheet and being included in reports to the Fed. According to a note in the Fed's H.8 report:

As of the week ending March 31, 2010, domestically chartered banks and foreign-related institutions had consolidated onto their balance sheets the following assets and liabilities of off-balance-sheet vehicles owing to the adoption of FASB's Financial Accounting Statements No. 166 (FAS 166), Accounting for Transfers of Financial Assets, and No. 167 (FAS 167), Amendments to FASB Interpretation No. 46(R). Domestically chartered commercial banks consolidated $377.8 billion in assets and liabilities.

I point this out so that, if you read somewhere about the huge jump in commercial bank credit, you won't get super excited. The chart below shows that bank credit is still contracting at previously-unprecedented rates on a year-on-year basis (source: Federal Reserve; green area is corrected for the discontinuity caused by the conversion of Morgan Stanley and Goldman Sachs to bank holding companies).

Bank Credit of All Commercial Banks
Bank Credit continues to contract; recent jump was caused by definition change

So I will amend what I said above, to strengthen the conclusion: the Fed isn't about to start pulling back when every indication of Keynesian stress is absent and credit continues to contract while the FOMC still has pedal-to-the-metal. It isn't necessary that they do so for rates to rise, however.



Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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