To The Moon

Since Powell started talking about disinflation it has started to look more like disillusionment, while the arguments for disinflation still stand straight. Disinflation is sharply declining inflation, and although inflation has been clearly declining over the past few months, better-than-expected unemployment figures and better-than-expected inflation rates are increasingly calling into question the process of disinflation. Early last week, there was even a 70 percent chance that the Federal Reserve will raise interest rates by 50 basis points at its March 21-22 meeting. By the end of the week, that had dropped to a 30 percent chance, helped by the bank run on Silicon Valley Bank. That misfortune was caused in part by the Fed's tightening. Meanwhile, the money supply in the United States is shrinking and, in that context, it seems inevitable that inflation will continue to decline.

Falling inflation as much as rising inflation also fits the historical pattern. When inflation rises, it does not stay at a continually higher plateau thereafter. It strongly tends to fall again. First, this is because of the way inflation is calculated. It is the price trend over the past 12 months. That means that with each monthly publication, 10/12 of the inflation rate is already known and it is really about monthly inflation a year ago versus monthly inflation now. Since a year ago prices rose sharply due to the Russian invasion with even monthly rates of 1 percent and or 1.2 percent, chances are that inflation rates are lower now. Over the past seven months, month-on-month inflation has averaged 0.28 percent. Then the inflation rate goes down quickly.

Furthermore, Shelter makes up more than 30 percent of the inflation basket in the United States. This breaks down into rental housing and owner-occupied housing. The rental price of owner-occupied homes is derived through the owners’ equivalent rent (OER), which ensures that after a period of sharply rising home prices, OER also rises with some delay. In recent months, this provided the main contribution to the inflation rate. At the same time, the housing market is certainly interest-rate sensitive and we can already see the market turning. The problems are not as great as during the Great Financial Crisis, but the affordability index has deteriorated significantly. Now even this does not say everything. The affordability index now does assume total household income, but it does not take into account inheritances and far fewer children per see. Whereas inheritance in the U.S. used to be relatively small, the sharply increased price of housing now makes for a larger inheritance that has to be divided among fewer children. We also see in several Asian countries in the most favored cities that families could never afford a house based on joint income, but that dot is eventually possible with money from the family. Moreover, the affordability index looks at an average, but due to increasing income (and especially wealth) disparities, there are still plenty of people who can afford homes in the best locations.

There are also many one-time effects such as the inflation basket adjustment, the recalibration of unemployment rates, the corona pandemic (a year ago), and the economically relatively favorable weather in key parts of the U.S. and Europe that play a role. Furthermore, last year consumption shifted from products to services, and this is continuing much longer than previously expected. It is still hard to book hotel rooms or a restaurant, and that consumption is creating jobs. In fact, many more people work in services than in factories. Also, the rapidly growing role of government ensures that the job market remains tight. Unfortunately, these people are not going to work in education and healthcare, but the number of policy workers in the field of the energy transition is growing rapidly. Furthermore, we are waiting for higher interest rates to cause the "crap jobs" to end. Take for example the people who now take care of 10-minute deliveries. The moment they have to pay the unsubsidized price for that, many customers will drop out.

Next Tuesday, the United States inflation rate for February will be released. After the 0.41 percent increase (month-on-month), a rise of 0.38 percent is now expected for core inflation. This leaves the annual rate at 5.5 percent. Both energy and food are up 0.4 percent month-on-month. That moves the annual rate from 6.3 percent to 6.0 percent. Recall that the Russian incursion began a year ago on Feb. 24 and thus had little impact on the inflation rate. The month-on-month figure for a year ago for March is at 1.0 percent. Shelter is likely to come out at 0.67 percent, bringing the service component down to 0.44 percent over February. However, new and used car prices do rise, bringing goods inflation to 0.23 percent (month-on-month).