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It’s a big Inflation week

| July 11, 2023

As you know, the FED allowed inflation to get out of hand in 2021 and started raising rates in March of 2022. It has raised rates by 5% and is very likely sticking to raising rates one or two more times. In fact, it’s the fastest rate increase in over 40 years (see the graph below).

As the FED keeps fighting inflation, we are seeing inflation come down into an area we have been arguing is reasonable and sustainable (the 3%-3.5% range). We would argue that the FED should be done raising rates and let the economy absorb the past increases. Remember, it takes 6-12 months for rate hikes to filter through the economy. That means we have 2%-3% that hasn’t fully been factored into the economic mix. I might argue that is why the FED continues to make policy mistakes, because of that lag between rate increases and effect on the economy. Case in point.

Average car payments are now $730 per month, with almost 17% of car payments over $1,000 per month. Those numbers are finally showing in car sales.

Used car prices are back to where they were 2 years ago. Used trucks are posting the best numbers, but as a whole, the used car market is down over 10% from a year ago. How about this for those looking for a new pickup truck.

Remember not long ago when you had to pay a “market adjustment” on vehicles? The law of supply and demand is starting to work in the economy.

So why isn’t it showing in some of the inflation numbers published by the government? Well, it is – except for one big piece right now. That big piece is what the government calls “Owner’s Equivalent Rent.” That is feeding through the economy slowly. As leases come due and new leases are signed, we will most likely see this number continue to go down. 

Wednesday and Thursday we will get the CPI and PPI for the month of June.  Here are the estimates for each.

Rental equivalent is not in the PPI, and you can see that is already down where the FED wants it.  The CPI is slightly higher because of the Owner’s equivalent rent (OER), but if we factor in real time rent, the CPI would actually be negative. Take a look at the following chart.

If we look at the Zillow rent index, that started to roll over earlier this year. It’s now down from a high of 17% to now “only” 8%. That may seem like big numbers still, but as we get closer to the end of the year, we will see these numbers actually become negative (remember they are year-over-year numbers).

So, you’ve got energy costs that have been coming down, owner’s equivalent rent coming down, and auto prices coming down. What’s left to hold things up? Now in all fairness, we mentioned in our May 30th blog that August inflation was going to show a bounce. June and July inflation in 2022 was 2.3%. If we replace those two months with 0.4%-0.6%, we will see inflation come down from 4% in May to around 2.8%-3.2% by the time July numbers come out. Then in August will see a bump because we are replacing a 0.0% month with presumably something like 0.2%-0.3%, which would take the inflation rate to somewhere in the 3%-3.5%(ish) range.

Here’s a chart from Bank of America and Bloomberg.

While certain components of inflation may start to have unfavorable comps going forward, the Owner’s Equivalent Rent will likely continue to contribute to modest inflation prints for the rest of this year (my opinion, I’m certainly no economist). In addition, we still have money supply negative.

If you remember what Milton Friedman said.

If we don’t have money being printed out of nowhere, we likely will not have an inflation problem. We will see how this week’s reports come out. If they are better than expected, you will likely see the market react positively to them. If they are worse, we might get a pullback in the markets.

On another note, the big week is finally here for Seattle. We’ve moved the homeless encampments and cleaned the streets surrounding the stadiums, so that all the visitors to the MLB All-Star Game will see what a beautiful city Seattle is and can be. Or maybe we could treat our city like someone important is always coming to town. Just saying…

Enjoy the Home Run contest tonight and the All-Star Game tomorrow. Please let us know if you have any questions…