Belated March CPI analysis

I've only recently returned from several weeks in Argentina. I didn't have access to my charts, and besides, I was rather more interested in people, food, and wine than in blogging. Time now to catch up on the market's latest focus: Is inflation still stubbornly high? Does the Fed need to tighten more?

The March CPI release was, in retrospect, the one that apparently convinced the Fed and the market that "disinflation has stalled." More recently, the market, with encouragement from numerous Fed governors, has come around to thinking that instead of cutting rates five times by the end of this year, we might see, at best, one cut, because the Fed has more work to do. "Higher for longer" is now the interest rate mantra that is driving the market; it's made people nervous, so an equity market correction is underway.

You won't be surprised to learn that I disagree. I still think the great inflation bubble that started three years ago has long since popped. And the main reason inflation is still marginally higher than where the Fed would like to see it is the way shelter costs are calculated. I think the following charts make that clear.

Chart #1

Chart #1 compares overall inflation to inflation less its shelter component, which is about one-third of the total. Both are calculated on a 6-mo. annualized basis, which is the best way to see if recent developments mark a change in the broader trend. My first take when looking at this chart is that if there is an inflation problem in today's numbers, it pales in comparison to the numbers we saw in the 2005-2009 period. 

Looking closer, I note that the 6-mo. annualized rate of inflation less shelter has averaged 1.6% for the past 16 months, and it has been more than 2.0% in only four of those months. Moreover, there is no sign of any meaningful recent acceleration: it has averaged only 2.01% over the past 4 months and it was 2.06% in March '24. As for the overall CPI, it has averaged 3.3% over the past 16 months, and it was 3.3% in March '24. The difference between the two is due entirely to shelter costs, which, arguably, have been artificially inflated by the way BLS calculates them.

Chart #2

Chart #2 shows that the year over year increase in shelter costs as calculated by the BLS is driven almost entirely by the year over year change in nationwide housing prices 18 months prior. (The red line has been shifted to the left by 18 months, and the two lines match up almost exactly.) Even though housing price inflation has dropped significantly from its peak two years ago, and nationwide rents have been flat to down over the past year, the BLS calculates that shelter costs currently are rising at the rate of 5.9% per year. If the relationships in this chart hold, then the rise in shelter costs will reach a low point this coming October (which is the point where the blue line falls to zero). In other words, shelter costs will almost certainly continue to decline every month from now until October, and that will subtract significantly from the increase in the overall CPI.

Inflation is not a problem. The Fed once again is late to the party, as usual. If the Fed keeps short-term interest rates higher for longer it will only push inflation lower, and there's nothing necessarily bad about that. In any event, I'm willing to bet that interest rates don't remain at current levels for as long as the market is currently forecasting. At some point the Fed is going to figure out that it's done enough. 

MAGA down south

Before you read this post, please first read this post from 18 months ago. We are back in Argentina, and there have been some notable changes since our last visit.

By far the most significant change is Argentina's new President, Javier Milei. He's a libertarian and believes strongly in limited government and free markets. He is attempting a hard, far-right turn in Argentina's left-wing-damaged economy, which, if successful, could have ripple effects throughout the globe. He's only been in office since December, so the results are only visible if you know where to look, and I'll expand on that later. His objectives are straight out of the libertarian, free-market playbook: shrink Argentina's bloated government, kill inflation, gut regulations, eliminate subsidies, and root out corruption.

Since our last visit, the price level in Argentina has gone up over 4-fold; in percentage terms that's 4,430%. But the exchange rate has only increased almost 3-fold, or 260% (from 300 pesos per dollar then to about 1100 pesos per dollar now). As a result, Argentina is more expensive for a US tourist today than it was then. But it's still pretty cheap. The fish BBQ for four (actually four of us couldn't finish it) we had back then was $33, now it's $47. Excellent wine back then was $27, now it's $39 at our favorite Buenos Aires restaurant.

The most curious thing is that back then the largest denomination peso bill was 1000 pesos. A 2,000 peso note was subsequently released, but they are few and far between. In fact, I have only seen one after a week of looking—and I have yet to see any smaller bills. The 1000 peso bill today is worth about one US dollar, so let's call it Argentina's one dollar bill, and it's effectively the only bill you will see in circulation. Virtually all cash transactions are conducted with this bill, which means that everyone is walking around with a huge wad of $1000 peso notes in their pocket or purse. This also means that credit cards are essential for anyone expecting to make a payment of more than, say, $40-50 dollars.

Ubers are all over, and they are unbelievably cheap. My most expensive ride took us across town for about 20 minutes at 1:30 am. Uber charged me $5. I couldn't resist giving the driver the maximum tip Uber was willing to allow: $2.50. I would have loved to see his face when he saw that pop up on his screen! Most other rides of a couple of miles cost less than $2. Today's lunch at our small local hotel consisted of a glass of wine, a huge milanesa with an equally huge portion of real mashed potatoes, and an empanada. Total cost $12.

Any American who has heard of Milei will want to know the answer to this question: are the people willing to undergo a significant degree of hardship while he implements his draconian policies (e.g., slashing government spending, eliminating subsidies, firing tens of thousands of government workers, eliminating rent control)? Right now there is no question they will endure, because they know he is doing the right thing. Besides, they've suffered through so many hardships that one more is not going to be a deal-breaker.

I got together with a group of 8 local friends last night to talk about this and other things. The evening kicked off around 10 pm with some wine and hors d'oeuvres, followed by a delicious asado (bbq). Followed by more wine and some heated discussions. They were all quite positive about the future. I got back to the hotel at 3:20 am. I'm still recovering, but they all had to work today. These are the things I love about Argentina: great food, great wine, and great friends. Unfortunately the economy is anything but great.

Milei really should adopt Trump's MAGA slogan: "Make Argentina Great Again."

Moderate growth and disinflation still alive and well

A quick update to focus on some market-moving stats released today.

Chart #1

Chart #1 shows the results of the March survey of purchasing managers in the service sector (by far the largest part of the economy). It is consistent with the view I've maintained for well over a year, which is that the economy continues to grow at a non-spectacular pace.

Chart #2

Chart #2 shows that the number of firms that report paying higher prices continues to decline. This same statistic surprised to the upside in January, thus fueling speculation that maybe the Fed was right to move slowly on rate reductions. But as often happens, sudden jerks in monthly numbers are just flukes and subsequently reversed. Inflation pressures remain quite subdued; disinflation is still in place.

On balance, the picture is one of an economy that continues to grow while inflation continues to subside. The market, unfortunately, continues to harbor a long-ingrained reflex that says that in order for inflation to decline, the economy needs to weaken. Not so. Inflation is not growth-friendly. Low and declining inflation and moderate to strong growth can coexist indefinitely if the Fed is acting correctly.

Nothing in these recent stats argues for the Fed to refrain from lowering short-term interest rates.