Morning Report: Inflation moderating?

Vital Statistics:

  Last Change
S&P futures 4,666 -21.2
Oil (WTI) 78.72 0.08
10 year government bond yield   1.68%
30 year fixed rate mortgage   3.31%

Stocks are lower this morning after some inflation data came in higher than expected. Bonds and MBS are down.

 

The second estimate for third quarter GDP was revised upward to 2.1%. The PCE price index was unchanged at 5.3%. Ex-food and energy, it rose 4.5%. The PCE price index is the Fed’s preferred measure of inflation, and it is obviously higher than their 2% target rate. Wages and salaries were revised upwards as well.

 

Personal incomes rebounded in October by 0.5% after falling 1% in September. Consumption rose 1.3%. The PCE inflation index rose 5%, and if you strip out food and energy rose 4.1%. Note that this is below the averages for the third quarter (which we saw in the GDP report). This is at least one indication that inflation is beginning to moderate.

Just one quick note on inflation – home price appreciation does get incorporated into the inflation data via rents and “owner’s equivalent rent” which is a proxy for homeowners. That said, it generally shows up with a 12 – 18 month lag, so the current inflation numbers have yet to capture the torrid price appreciation we have been seeing this year.

It is important to note that inflation is as much a psychological phenomenon as it is a monetary one. It is more than simply “too much money chasing too few goods.” It is people wanting to get ahead of demand as well. Say for example, if you heard COVID cases were rising and we might be heading towards another lockdown, would you stock up on TP? Of course you would. So would everyone else. That would create shortages and increase prices.

Workers seem to be in the driver’s seat for the first time since the 1970s. Automatic cost-of-living increases were built into union contracts, and even non-union workers began to expect annual cost-of-living wage increases. Depending on how long this worker shortage lasts, these things may become a feature of the landscape going forward. It will be hard for the Fed to hit a 2% inflation target if wages are rising 4% a year.

At any rate, even if commodity prices begin to fall, home price appreciation is going to start showing up in the numbers starting next year. While some of that is certainly not “real” inflation – your cost of living doesn’t increase just because your home value rises – consumers are going to focus on the headline number and demand wage increases going forward. Unless the supply chain issues magically disappear we have the pieces in place for a long-term secular increase in prices.

 

New Home Sales rose 0.4% MOM in October, but are 23% lower than they were a year ago. The median home price rose 18% to 407,700.

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