Author Topic: Inflation & Interest Rates: share your data sources, models, and assumptions  (Read 23878 times)

maizefolk

  • Walrus Stache
  • *******
  • Posts: 6804
Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #300 on: September 19, 2022, 08:44:56 PM »
Forecasting future interest rates out with a precision of one one-hundredth of a basis point. It's bold. I'll give them that.

wageslave23

  • Handlebar Stache
  • *****
  • Posts: 1361
  • Location: Midwest
Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #301 on: September 20, 2022, 07:55:10 AM »
I don't know anything about The Center for Macroeconomic Forecasts & Insights but they predict 5%, 10-year treasury rates next year:

2022-09   3.7321
2022-10   4.2966
2022-11   4.9352
2022-12   5.2070
2023-01   5.3777
2023-02   5.5382
2023-03   5.5636
2023-04   5.6144
2023-05   5.6005
2023-06   5.5721
2023-07   5.5390
2023-08   5.4865
2023-09   5.4492
https://econforecasting.com/forecast-t10y
Seems aggressive? I would lock in on some of that.

If 10 yr yields reach 5+%, stocks would probably be down another 20+%. I think I'd rather buy stocks and ride the wave up. Either way it would be a great buying opportunity for everything at that point.

MustacheAndaHalf

  • Walrus Stache
  • *******
  • Posts: 5452
Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #302 on: September 20, 2022, 09:19:49 AM »
I don't know anything about The Center for Macroeconomic Forecasts & Insights
At the bottom of their main page, they have a broken link that I tracked down.  You could do worse than listening to economics professors.
https://www.clucerf.org/who-we-are/team/


... but they predict 5%, 10-year treasury rates next year:

2023-04   5.6144
2023-05   5.6005
2023-06   5.5721
That may look aggressive, but it's based on using the current market consensus of a 4.5% peak Fed funds rate.
https://econforecasting.com/forecast-ffr

They predict inflation will be between 8.6% and 8.7% for the rest of 2022!  Since their other forecasts reflect market expectations, I wonder if the market expects 8.7% inflation in 3 weeks?  Could be time to invest in a market surprise.
https://econforecasting.com/forecast-cpi

ChpBstrd

  • Magnum Stache
  • ******
  • Posts: 4564
Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #303 on: September 20, 2022, 03:35:29 PM »
The observation that the overnight rate and the 10y yield routinely invert right before recessions is messing with my head a bit. We cannot draw a straight line between our projections for the FFR and the 10y yield, because the FFR and 10y yield routinely invert prior to recessions. We therefore don't know the discount rate we will be applying to stock earnings six months or a year from now, even if we can correctly estimate the FFR. Six months or a year from now, stocks will be discounted / priced based on expectations for the future which are held at that time - which themselves may or may not be correct.

Optimistic near-future expectations could cause us to be correct about the higher-than-expected path of inflation and the FFR, and yet never see stocks or long-duration bonds fall to attractive valuations. Perhaps all the modeling I've done so far justifies is a speculation in the futures market for short-term debt - which I don't want to do.

What's really needed for stocks to reach compelling values is a sense of doom and pessimism to snuff out those expectations. I remember 2008-2009, and that's how it was. However there are not many ways to quantify investor sentiment, or identify a good value when sentiment seems low. Also there's no guarantee sentiment will actually get low.

Maybe I should just buy puts in USO and UNG in anticipation of recession.

I think the reason people are not adjusting their inflation expectations is because inflation has been so low for the past 20 yrs. I think the question is why was it so low during that time? And what has fundamentally changed about the economy since then? People are assuming nothing has fundamentally changed.  And should revert once excess demand has been flushed out or supply catches up. Supply hasn't caught up because of several factors that aren't as temporary as people keep thinking.

The U.S. still has a declining labor participation rate and an aging, static population. During the "Great Moderation" years from 2009 to 2019 labor participation fell from 65% to 63% of the workforce. This reflected an aging population, longer lifespans, and a higher dependency ratio. Many people, including me, interpreted this as a sign of Japanification. A graying population would have to increase its savings rate, slowing down the velocity of money. That's a big part of the reason inflation went nowhere during those years, despite the FFR being below inflation. Money flowed into assets instead of CPI items.

The pandemic further knocked down the labor participation rate by leading families to in-source childcare, by disabling potentially millions of workers, and by killing 1.1 million adults - 250k of which were in the workforce. These factors have led to "persistent reductions in labor supply".

https://fred.stlouisfed.org/series/CIVPART/
https://www.nber.org/system/files/working_papers/w30435/w30435.pdf

Pandemic-related risks should have increased the savings rate as consumers hunkered down for an emergency, but instead the massive stimulus programs led to skyrocketing demand - which of course hit the wall of decreasing supply from problems at production plants. Consumers also did not stay home from stores, malls, car lots, and restaurants during the pandemic to the extent one might think was rational. Sure, a lot of those consumers and the people around them died, but the misinformation kept the economy afloat.

The list of worldwide inflation causes includes a lot of items that seem temporary, including:

-Stimulus checks and welfare payments
-Emergency loans
-QE
-Low interest rates
-Production bottlenecks
-Transportation bottlenecks
-Labor shortages

The first 3 of these causes are already gone, rates are heading up fast, and the last 3 causes will be resolved if there is even a slight dip in consumption (consider how high inventories are). I didn't include the Russian war on this list because inflation was high before the war, and because the impact on US energy prices is unclear now that oil prices are lower than before the war. There is a case to be made that inflation will return to prior trends, rather than feeding upon itself like in the 70's. Powell's vow to keep rates higher for longer - and his general theory of delaying action until trends are about a year old - draw an image of a severe recession in which inflation goes to near zero as the FOMC resists pressure to cut rates. That's the path to low inflation or deflation a year from now!

ChpBstrd

  • Magnum Stache
  • ******
  • Posts: 4564
Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #304 on: September 20, 2022, 03:57:47 PM »
Thanks for the forecasting links @blue_green_sparks and @MustacheAndaHalf . I'm adding these to my ridiculously long collection of economics bookmarks.

This particular committee seems to be forecasting a recession starting in H1 2023 when CPI starts dropping precipitously. Some really interesting details are in their yield curve forecast. They expect the 3mo / 10y curve to invert next month, and the 1mo / 10y curve to invert in November.

They don't expect these curves to un-invert until mid-2025, and from there the model is for a perfectly flat yield curve from 1mo to 30y until at least 2027. That's probably less of an actual prediction and more of a fill-in-the-blank, because the fall in CPI does not seem extreme or quick enough to justify a very severe recession that could cause chaos for that long. Most inversions have historically tended to to resolve before or during the recession.
https://econforecasting.com/forecast-treasury-curve

I suspect stocks could bump upwards tomorrow if the risk of a 1% hike is taken off the table, but I sold a few SQQQ puts anyway. I also took a shot at and missed a ZROZ bear put spread.

PDXTabs

  • Magnum Stache
  • ******
  • Posts: 4907
  • Age: 39
  • Location: Vancouver, WA, USA
Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #305 on: September 21, 2022, 01:48:17 PM »
An interesting day in the markets. I noticed in the FOMC press conference that Powell said we can expect positive real rates across the entire yield curve:
https://www.youtube.com/watch?v=E34J0b5xt60&t=1199s

ChpBstrd

  • Magnum Stache
  • ******
  • Posts: 4564
Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #306 on: September 22, 2022, 09:29:50 AM »
An interesting day in the markets. I noticed in the FOMC press conference that Powell said we can expect positive real rates across the entire yield curve:
https://www.youtube.com/watch?v=E34J0b5xt60&t=1199s
I re-watched that segment 4 times. It completely clashes with the direction the yield curve is actually moving, and the historical likelihood of an upcoming FFR/10y yield curve inversion. Perhaps the FOMC will only cut rates when the entire yield curve is again positive. The 10/2, for example, remained inverted for about 9 months on and off in 1989, 10 months in 2000, and 17 months on and off in 2005-06. In today's cycle, we're at month 3. Forecasters are eyeing April or May as "the top" for the FFR:
https://econforecasting.com/forecast-ffr

In response to a question at 42:10 about whether 4.6% rates would be restrictive a year from now, he said he thinks "that's likely" and that in such a situation the FFR might have a real yield of maybe 1%.

Powell also said at 40:57 that "we probably in the housing market need to go through a correction to get back to that place" where houses are affordable. I agree, and I think the forecasted 7.5% mortgages by April should lead to such a correction:
https://econforecasting.com/forecast-mort30y

However, we cannot underestimate the damage this housing "correction" will cause. When 30y mortgage rates go from 3.5% to 7.5%, the P&I increases by nearly 50%. Consumers have been buying absolutely all the house they could afford, so for every $100k in purchasing power they had at 3.5%, they will only be able to afford $64,400 at 7.5%. That implies a 35.6% decrease in prices, even before we account for the competition factor that led to offers over the asking price in 2020 and 2021. Yet housing prices are sticky, and buyers may be willing to pay more under the assumption they can refinance to a cheaper loan in the future (assuming they can qualify). Even with that caveat, I think we're looking at 25%-30% housing price declines, minimum, with a concentration in HCOL areas, due to interest rates alone. How will people react?

Low locked-in mortgages will become a form of golden handcuffs for those who need to move for work or who bought too much house during the mania. Their breakeven on selling might not come for another 5+ years. The question for banks is whether higher unemployment will force a lot of these homeowners - who were already stretched - into foreclosure anyway, and what the recoveries on those homes will be in a world of >6% mortgages.

Mr. Green

  • Magnum Stache
  • ******
  • Posts: 3771
  • Age: 39
  • Location: Wilmington, NC
Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #307 on: September 22, 2022, 04:49:51 PM »
@ChpBstrd there is definitely a scenario where this turns into a mini 2008-09 for housing. If rising rates drop values to where people can't refinance because they're now significantly underwater, we could see significant foreclosure activity if there are major layoffs. Expecting a huge drop in home prices certainly feels like a rational rebalancing in the face of high interest rates, especially after the runup of the last couple years. We know the world revolves around monthly payments. There is just no way monthly payments can go up by 50% or more without having a significant impact on pricing. Maybe in the first year prices will be somewhat sticky while there's still an expectation of lower rates immediately ahead. But as that sentiment wears off prices are going to fall in earnest. And this is not considering what happens if inflation continues to be stubborn. What if the FFR needs to push to 6-8% to really kill it?

ChpBstrd

  • Magnum Stache
  • ******
  • Posts: 4564
Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #308 on: September 23, 2022, 12:07:31 PM »
Let's work backwards from expectations.

Here in September 2022, the Bank of New York's consumer inflation expectations survey indicated that people think inflation will be 5.7% a year from now, down dramatically from 6.8% in June.
https://tradingeconomics.com/united-states/inflation-expectations or
https://www.newyorkfed.org/microeconomics/topics/inflation

This is another data point to make the case that the inflation phase of panic is over, and we are moving on into the recession phase. If we suppose the survey respondents are 100% correct we can chart what the trailing-twelve-month CPI will look like between now and next September, and consider the implications for rate hikes / rate cuts. This simulation assumes a recession does not hit in the next 12 months. The recession might not start within 12 months given the historical lag between inversions or rate hikes and the onset of recession!

I added the CPI index values to a spreadsheet and solved for the flat monthly percent change that would equal an annualized 5.7% increase from here. The solution, which would lead to the forecast number, is roughly 0.465% per month. If the CPI index grew that much each month, annualized CPI would be 5.7% next September (i.e. 0.465%/mo is roughly 5.7%/yr).

Here's what that would look like on a month-to-month basis:

Based on Consumer Expectations
Date            CPI           MoM chg    Annual chg
2022-09-01   296.99   0.465%   8.31%
2022-10-01   298.38   0.465%   7.88%
2022-11-01   299.76   0.465%   7.63%
2022-12-01   301.16   0.465%   7.51%
2023-01-01   302.56   0.465%   7.32%
2023-02-01   303.96   0.465%   6.96%
2023-03-01   305.38   0.465%   6.14%
2023-04-01   306.80   0.465%   6.28%
2023-05-01   308.22   0.465%   5.75%
2023-06-01   309.66   0.465%   4.85%
2023-07-01   311.10   0.465%   5.36%
2023-08-01   312.54   0.465%   5.72%
2023-09-01   314.00   0.465%   5.72%
2023-10-01   315.46   0.465%   5.72%
2023-11-01   316.92   0.465%   5.72%
2023-12-01   318.40   0.465%   5.72%

Now the question is, in this no-recession scenario, in which of these months does the FOMC decide to stop raising rates? Where is it first defensible to stop the hikes?

The obvious caveat is the consumers know next to nothing about inflation. An estimate from the smart money would involve "a model that uses Treasury yields, inflation data, inflation swaps, and survey-based measures of inflation expectations." FRED publishes this metric and it is currently 4.17%:
https://fred.stlouisfed.org/series/EXPINF1YR

Based on 1 Year Market Inflation Expectations
Date            CPI           MoM chg    Annual chg
2022-08-01   295.620   0.12%   8.25%
2022-09-01   296.63   0.341%   8.17%
2022-10-01   297.64   0.341%   7.61%
2022-11-01   298.65   0.341%   7.23%
2022-12-01   299.67   0.341%   6.98%
2023-01-01   300.69   0.341%   6.65%
2023-02-01   301.72   0.341%   6.17%
2023-03-01   302.75   0.341%   5.23%
2023-04-01   303.78   0.341%   5.24%
2023-05-01   304.82   0.341%   4.58%
2023-06-01   305.86   0.341%   3.57%
2023-07-01   306.90   0.341%   3.94%
2023-08-01   307.95   0.341%   4.17%
2023-09-01   309.00   0.341%   4.17%

If this is how it turns out, I can imagine the FOMC tapering its rate hikes down to 0.25% by about March. I'm guessing the FOMC's first opportunity to make a "hold and wait" decision would be in about June or July.

Possible future FFRs:
Sept: 3.25%
Nov: 4% (+0.75%)
Dec: 4.5% (+0.5%)
Feb: 5% (+0.5%)
Mar: 5.25% (+0.25%)
May: 5.5% (+0.25%)
Jun: 5.5% (hold)
Jul: 5.5% (hold)
The CME futures markets assigns 0.2% odds to this terminal rate.
https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html

As we can see, if the FOMC takes a break in June according to this scenario, the FFR would have been higher than CPI for only a month or two. We might even have a positive yield curve by then, which is one of the things Powell said the FOMC is looking for.

In the broader picture, this 4%+ drop in inflation within a year would rank among the biggest moves since 2008, which was itself the biggest drop since 1982-83. Similarly, a hike from 0.25% to 5.5% would exceed the magnitude of the +4.25% 2004-06 campaign. We haven't seen +5.25% of rate hikes in a single campaign since 1980-81.

The economy is a lot more "financialized" now than it was in the early 80's, which could lead to unexpected results, as it did in 2008. Also, equities are more priced for growth now than they were then (the S&P500's PE ratio was around 7.4 back in 1980, vs. 18.5 now) and there is more retail participation - even "apes", and far fewer barriers to panic selling!

The ride is guaranteed bumpy from here, and the opportunities will be great when there's blood in the streets and panic in the headlines.

blue_green_sparks

  • Bristles
  • ***
  • Posts: 282
  • FIRE'd 2018
Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #309 on: September 23, 2022, 02:34:12 PM »
Prof. Jeremy Siegel gets animated on Fed hikes, LOL.
https://www.youtube.com/watch?v=9Xnwh_9KV3o
He was calling high inflation a year ago.
https://www.youtube.com/watch?v=t3ygJbJjocI

habanero

  • Handlebar Stache
  • *****
  • Posts: 1090
Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #310 on: September 23, 2022, 05:07:07 PM »
Forecasting future interest rates out with a precision of one one-hundredth of a basis point. It's bold. I'll give them that.

There is a lot of wounded boldness out there. Central bankers are becming sort of a joke (I work in rates markets).

First they were unable to predict futre inflation and interest rates. Then when inflation showed up they, especially the Fed, thought they had the ability to look thorugh it - it  being transitory and all. The fact they they were unable to predict it did not diminish their faith in being able to predict what happened on the other side of what they were unable to predict in the first place.

Now they sort of all know they screwed up massively, but will never admit it in public. There has been a lot of hubris across the globe in central banker land. They employed a ton of smart folks with fancy models but at the end of the day they had no clue as to what was going on.


MustacheAndaHalf

  • Walrus Stache
  • *******
  • Posts: 5452
Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #311 on: September 23, 2022, 05:14:04 PM »
Prof. Jeremy Siegel gets animated on Fed hikes, LOL.
https://www.youtube.com/watch?v=9Xnwh_9KV3o
Professor Siegel claimed commodity prices coming down is the only thing that matters, which I view as anger clouding his judgement.  Fed Chair Powell views commodity prices as only part of inflation.  He says they are only part of the picture, and it's too early to tell if commodity price drops are sustained.

"commodity prices look like they may have peaked for now ... those developments, if sustained, could help ease the pressures on inflation".
https://www.youtube.com/watch?v=durR-4fCG2g&t=932s

Consider Russia, which could cut off energy to Europe.  That would immediately send commodity prices higher.  Would Professor Siegel then admit he's wrong?  But the Fed doesn't have the option of flip-flopping on events like that.  They need to make directional changes and be consistent.  A big part of the Fed's influence is their guidance, which causes Fed statements to be priced in to markets.  I think Professor Siegel is too focused on commodities, and too early in claiming inflation is dead.  If no uncertainty occurs, he may be right - but we won't know until later.

Professor Siegel wrote off wage increases as "catching up" with inflation.  How is that different with wage pressures fueling inflation?  As long as wages are going up at the pace of inflation, that fuels inflation, risking that it becomes entrenched.  I really think he's wrong on this point, but Fed Chair Powell just says that wage pressures are not moderating enough.  I believe a "wage price spiral" is the next phase of inflation, which Fed Chair Powell confirmed is still a risk.  I hope when Professor Siegel calms down, he'll admit a wage price spiral is a real risk, and not write it off as he did.

EscapeVelocity2020

  • Magnum Stache
  • ******
  • Posts: 4134
  • Age: 48
  • Location: Houston
    • EscapeVelocity2020
Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #312 on: September 28, 2022, 09:28:58 AM »
I might be off base here, but with the United Kingdom cutting taxes and now the Band of England pledging to buy 65B pounds ($69.4B) of long-dated gilts (i.e. QE), won't inflation continue to get worse over there? 

And if inflation is getting worse in a significant neighboring economy, won't that make US inflation worse?

ChpBstrd

  • Magnum Stache
  • ******
  • Posts: 4564
Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #313 on: September 28, 2022, 10:16:39 AM »
I might be off base here, but with the United Kingdom cutting taxes and now the Band of England pledging to buy 65B pounds ($69.4B) of long-dated gilts (i.e. QE), won't inflation continue to get worse over there? 

And if inflation is getting worse in a significant neighboring economy, won't that make US inflation worse?
Not necessarily. Collapses in the value of other currencies this year have made imports relatively cheaper for people in the U.S. Additionally, if demand in the UK collapses because prices are so high, then that's just more supply for US buyers. The dynamic where investors flee to US treasuries in times of turmoil tends to prop up the dollar and make things cheaper in the US just when we need it most. Conversely, the reverse happens to the rest of the world. Hence the saying that if the US sneezes, the rest of the world catches a cold.

Of course, this observation also reveals how badly monetary policy in the US has been handled, if despite all these disinflationary shock absorbers we still managed to hit 9% inflation. Imagine how bad it would be if this dynamic wasn't in place!
« Last Edit: September 28, 2022, 10:53:32 AM by ChpBstrd »

BicycleB

  • Magnum Stache
  • ******
  • Posts: 4296
  • Location: Land of Lincoln
  • Older than the internet, but not wiser... yet
Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #314 on: September 28, 2022, 06:59:30 PM »
I might be off base here, but with the United Kingdom cutting taxes and now the Band of England pledging to buy 65B pounds ($69.4B) of long-dated gilts (i.e. QE), won't inflation continue to get worse over there? 

And if inflation is getting worse in a significant neighboring economy, won't that make US inflation worse?
Not necessarily. Collapses in the value of other currencies this year have made imports relatively cheaper for people in the U.S. Additionally, if demand in the UK collapses because prices are so high, then that's just more supply for US buyers. The dynamic where investors flee to US treasuries in times of turmoil tends to prop up the dollar and make things cheaper in the US just when we need it most. Conversely, the reverse happens to the rest of the world. Hence the saying that if the US sneezes, the rest of the world catches a cold.

Of course, this observation also reveals how badly monetary policy in the US has been handled, if despite all these disinflationary shock absorbers we still managed to hit 9% inflation. Imagine how bad it would be if this dynamic wasn't in place!

That's what the rest of the world IS experiencing, I think. It seems we can export the difficulty by raising our rates. Won't surprise me if our recession is last and least, resulting in a relative advance of the US compared to the global economy.

MustacheAndaHalf

  • Walrus Stache
  • *******
  • Posts: 5452
Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #315 on: September 28, 2022, 07:15:56 PM »
I might be off base here, but with the United Kingdom cutting taxes and now the Band of England pledging to buy 65B pounds ($69.4B) of long-dated gilts (i.e. QE), won't inflation continue to get worse over there? 

And if inflation is getting worse in a significant neighboring economy, won't that make US inflation worse?
Not necessarily. Collapses in the value of other currencies this year have made imports relatively cheaper for people in the U.S. Additionally, if demand in the UK collapses because prices are so high, then that's just more supply for US buyers. The dynamic where investors flee to US treasuries in times of turmoil tends to prop up the dollar and make things cheaper in the US just when we need it most. Conversely, the reverse happens to the rest of the world. Hence the saying that if the US sneezes, the rest of the world catches a cold.

Of course, this observation also reveals how badly monetary policy in the US has been handled, if despite all these disinflationary shock absorbers we still managed to hit 9% inflation. Imagine how bad it would be if this dynamic wasn't in place!
That's what the rest of the world IS experiencing, I think. It seems we can export the difficulty by raising our rates. Won't surprise me if our recession is last and least, resulting in a relative advance of the US compared to the global economy.
I'm not that familiar with currency markets.  Can you expand on that?  I know strong USD helps in some ways, but I don't quite get how.

Also, if you come across data suggesting the US could be last and least, I'd be interested in that.

ChpBstrd

  • Magnum Stache
  • ******
  • Posts: 4564
Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #316 on: September 28, 2022, 08:02:53 PM »
The National Financial Conditions Index (NFCI) took a dip in July and August, but is now approaching zero again. This suggests tightening financial conditions and more stress in the debt markets.


Meanwhile M2 is still holding steady.


Initial claims are steady...


Durables are steady...


Things look fairly bleh, with no discernable trends in many of the metrics I'm watching. However, the yield curve inversion is getting deeper. On Friday, the 10-2 inversion hit -0.51%, which is deeper than it went in 2006, 2000, or 1989.


PCE gets released on Friday. My prediction is for PCE to be flat, due to precipitously falling commodities prices.
https://www.bea.gov/data/income-saving/personal-income

About those commodity prices: The past 30 days have seen the GSCI fall 16.3% and the CRB index fall almost 19%.
https://tradingeconomics.com/commodity/gsci
https://tradingeconomics.com/commodity/crb
This is to me a reaction to the 0.75% September rate hike, and reflects anticipation of a recession happening sooner than initially thought. You don't want to be long commodities when the recession hits, so there's a game of musical chairs going on.

This is how recessions can postpone themselves for a year or more: Heightened risk of holding commodities futures or inventories puts downward pressure on commodity prices, which lowers producer prices, which lowers consumer prices, and which lowers the necessity of more large rate hikes. July and August already saw negative PPI growth (i.e. producer price deflation) thanks to commodities.
https://fred.stlouisfed.org/series/PPIACO
Also, economic uncertainty and/or rate hikes tend to increase the flow of investment dollars into US treasuries, propping up the dollar, and further lowering the price of imports for U.S. consumers.

Then, as we all know, lower prices lead to more consumption, which leads to economic growth and low unemployment. These feedback cycles are being missed by the people shouting that we're already in a recession, or that we will be in recession by the end of 2023. There are reasons why we usually go a year or two after yield curve inversion, before actually experiencing recession. Interest rates actually plateaued and then were cut just before the 2020, 2008, 2001, and 1990 recessions, in response to the sort of falling price signals we're seeing now.

The FOMC is taking flak from pundits like Jeremy Siegel, who argue that the disinflation in each of the past 2 months is the recession warning we should be watching, not trailing-12-month numbers that mostly reflect price changes that happened long ago. These same pundits will be calling the recession and demanding rate cuts at the first sign of a blip in initial claims - or trouble in any market. That day will come, but for now it looks to me like we're in the burn-up phase prior to recession.

If commodities and producer prices fall again in September, I think we might be looking at a 0.5% rate hike in November, an outcome the FFR futures market thinks is 12% more likely than it was a week ago (now assigned 42% odds).

BicycleB

  • Magnum Stache
  • ******
  • Posts: 4296
  • Location: Land of Lincoln
  • Older than the internet, but not wiser... yet
Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #317 on: September 28, 2022, 09:29:12 PM »
I might be off base here, but with the United Kingdom cutting taxes and now the Band of England pledging to buy 65B pounds ($69.4B) of long-dated gilts (i.e. QE), won't inflation continue to get worse over there? 

And if inflation is getting worse in a significant neighboring economy, won't that make US inflation worse?
Not necessarily. Collapses in the value of other currencies this year have made imports relatively cheaper for people in the U.S. Additionally, if demand in the UK collapses because prices are so high, then that's just more supply for US buyers. The dynamic where investors flee to US treasuries in times of turmoil tends to prop up the dollar and make things cheaper in the US just when we need it most. Conversely, the reverse happens to the rest of the world. Hence the saying that if the US sneezes, the rest of the world catches a cold.

Of course, this observation also reveals how badly monetary policy in the US has been handled, if despite all these disinflationary shock absorbers we still managed to hit 9% inflation. Imagine how bad it would be if this dynamic wasn't in place!
That's what the rest of the world IS experiencing, I think. It seems we can export the difficulty by raising our rates. Won't surprise me if our recession is last and least, resulting in a relative advance of the US compared to the global economy.
I'm not that familiar with currency markets.  Can you expand on that?  I know strong USD helps in some ways, but I don't quite get how.

Also, if you come across data suggesting the US could be last and least, I'd be interested in that.

I don't have data*; am following up on the logic we've already stated.

You've explained how us raising rates causes inflation elsewhere, even while the resulting lower prices from our viewpoint help us delay our recession. If they're suffering increased inflation while ours is moderating, it seems that they are suffering an economic headwind while we are getting a tailwind. I therefore imagine that their recessions will start sooner than ours. Similarly, while their pain softens our recession, causing inflows to us of cheap imports and (I assume) extra capital, it seems like their recessions would be worsened by the high cost of imports that they experience, plus their outflow of capital. So I figure their recessions will be worse as well as sooner. "Last and least" summarizes the presumed effect. Perhaps there would be exceptions even if the trend mostly as I describe, though if we're the driver, perhaps it would be literally true.

*Strictly speaking, I noticed anecdotally a couple months ago that when US raised interest rates, the dollar got stronger against multiple currencies. I was in Medellín Colombia and my friends there felt that the plunge in the Colombian peso (COP) vs the USD was due to the then-recent election of Colombia's new President, perceived to be a negative economic influence. I compared the % change with other currencies, found USD had strengthened against multiple others (EUR, GBP) by the same 10% as COP, and concluded the reason was US interest rates, not Colombian policy. But I don't have recent or comprehensive data, it's just a supportive anecdote.

In my mind, other Colombian anecdotes I noticed support your theory and my extension of it. Colombian inflation has been higher than USA's, for example. But again, nothing comprehensive.
« Last Edit: September 28, 2022, 09:37:02 PM by BicycleB »

ChpBstrd

  • Magnum Stache
  • ******
  • Posts: 4564
There's no FOMC meeting in October, which makes it the perfect time for the bear market rally we're seeing now, just like August was. However, the next release of CPI data is looming and could burst the bear rally, just like what happened in August when we saw Core CPI expand despite falling commodities. CPI and Core CPI for September will be released on Thursday morning, October 13. The question is whether history will repeat, and disappointment over still-high CPI and Core CPI will end the latest rally.

Commodities - a key cost driver for everything - have been falling for three months straight:

S&P GSCI month-to-month change in average of daily price levels:
Jul '22: -12.44%
Aug '22: -1.25%
Sept '22: -5.58%

3-month cumulative GSCI loss:

-18.36%

It would be a weird world in which such massive commodity price drops did not translate into lower inflation, and surprisingly low inflation numbers are what the people plowing into stocks this week are betting on. Yet, producers are still catching up in terms of passing on cost increases to consumers and wage increases to workers. That's what we saw in the higher than expected August Core CPI numbers, and the trend could continue into September. PPI growth has turned negative with the commodities correction, but it seems unlikely to me that corporations will decide to take the losses from the commodities spike. Reported margins for S&P500 companies took a dip in Q2 2022 due to the sudden cost increases, and I think we'll see them try to claw back those inflation-driven margin losses, and to position themselves more favorably if high inflation continues.
https://www.yardeni.com/pub/sp500margin.pdf
We often comment about how the Federal Reserve was behind the curve on inflation, but corporations are even further behind. The PPI was 15% higher in August than 12 months before, but prices measured by Core CPI increased at less than half that rate.

So I see it as a tug-of-war between falling commodities and price hikes by corporations trying to protect their margins.

Soon-to-be-embarassing prediction:
September Core CPI: 5.8%
September CPI: 8.1%


BicycleB

  • Magnum Stache
  • ******
  • Posts: 4296
  • Location: Land of Lincoln
  • Older than the internet, but not wiser... yet
@ChpBstrd, may I mention my great admiration for your thoughtful approach and persistent posting? Being right is difficult, but right or wrong, your thoughts are illuminating.

What confuses me is questions like "When do people absorb news and change their value estimates based on it?" It seems like a variable that change results from logical to illogical in a moment.

In my own baffled mind the long term questions are hard to be sure of, and investors seem to keep swinging their views by 5% to 10% of S&P prices in a few weeks based on reactions to various changing tea leaves (even though the tea leaves are real data). I'm not sure the tea leaves are reliably telling us much yet, but then since the swings in value later from a good or bad outcome are probably more than 10%, maybe the swings are still rational for people who hope they're using the tea leaves to get ahead of a bigger swing. Kudos for at least taking a very reasonable crack at this.

ChpBstrd

  • Magnum Stache
  • ******
  • Posts: 4564
Let's explore the bull case for stocks, because the risk of sitting too long on the sidelines is equal to or greater than the risk of jumping in too soon.

First, inflation is forecast to plummet in the next several months:
https://www.forecasts.org/economic-indicator/inflation.htm
This would reduce pressure on the FOMC and encourage them to start tapering down their rate hikes to 0.25% by early 2023, and to cease rate hikes soon thereafter.

The CME futures market and the Fed's dot plot are forecasting a peak federal funds rate upper bound of 4.5% or 4.75% next Spring.
https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html
https://www.financialexpress.com/investing-abroad/featured-stories/us-fed-dot-plot-september-2022-with-target-level-for-the-federal-funds-rate/2686380/

I've already established that the 10y treasury yield routinely inverts against overnight rates in times of market stress. So the forecasted peak of 4.5% in the FFR might occur at the same time as 10 year yields of 4% - or lower. Against that backdrop, the S&P500's current earnings yield of 5.26% - and growing at 5-6% per year after the recession - provides a historically typical risk premium.
https://forum.mrmoneymustache.com/investor-alley/inflation-interest-rates-share-your-data-sources-models-and-assumptions/msg3059511/#msg3059511
https://www.multpl.com/s-p-500-pe-ratio/table/by-year

Meanwhile the 5 year inflation breakeven rate is down to 2.26% and still falling.
https://fred.stlouisfed.org/series/T5YIE/

Markets entered this tightening cycle months ahead of the Fed. The correction started in January, even though the first small rate hike didn't happen until March. This is atypical. Before the pandemic, the stock market peaked an average of 10 months AFTER the yield curve inversion, and this time stocks peaked about six months BEFORE.
https://www.isabelnet.com/10y-2y-yield-curve-inversion-vs-sp-500-peaks/

If stock investors are now ~12-16 months ahead of the usual cycle / cadence, then it is possible we've already hit bottom and stocks could rally through the recession in anticipation of future rate cuts. The rallies of the last two days could represent the bottom of the V.

But how healthy is the consumer?

Unemployment is 3.7%, near all-time lows.
https://fred.stlouisfed.org/series/UNRATE

Household debt service payments as a percentage of disposable personal income is at all-time-record lows. I.e. there has never been a more affordable time to be holding a mortgage, a car loan, a HELOC, etc. Consumers are less stretched than ever before.
https://fred.stlouisfed.org/series/TDSP

And that's why delinquency rates on credit cards and bank loans are also near record lows:
https://fred.stlouisfed.org/series/DRCCLACBS
https://fred.stlouisfed.org/series/DRCCLACBS

Wells Fargo recently estimated consumers are still sitting on up to $2.1T in "excess savings" from stimmie checks and foregone spending during the pandemic etc:
https://finance.yahoo.com/news/consumers-still-have-13-trillion-in-extra-spending-power-morning-brief-100026042.html

Consumers' 3.5% personal savings rate is near the lows that occurred in 2006-2007...
https://fred.stlouisfed.org/series/PSAVERT

...and they are plowing those savings into both durable and non-durable goods at an unusually fast pace, perhaps to avoid future price hikes.
https://fred.stlouisfed.org/graph/?g=Urjb

Credit card balances just hit pre-pandemic levels in nominal terms:
https://fred.stlouisfed.org/series/QBPBSTASLNINDVCRD

Overall, consumers look like they still have at least six months of shop-till-you-drop spending ahead, and we are likely to hear analysts talking about a record xmas shopping season.

The almost all-good consumer data seems to be in contrast with the projections for rapidly falling inflation and a Fed "pivot". Is that because the inflation forecasts and markets are applying theoretical wishful thinking that ignores the health of consumers, or is it because the forecasters and markets are anticipating that "something breaks" between now and next Spring.

For example, maybe Eurozone & UK households are not in such good shape, with lower savings to draw upon, higher inflation than the US, currency devaluation, skyrocketing utility bills, and their recession will quickly drag the US down too. Can US 30 year mortgages really go up 4% in 18 months and not cause another meltdown in housing prices?

As another example, how long do we really have before a couple of emerging market countries - or a southern European country - go into debt crisis?
Those falling commodities prices generally come out of their pockets, and the skyrocketing dollar increases the real cost of their debts.

However, if such a crisis comes, it will only further depress the 10 year treasury yield which is used to anchor the discount rate which is the basis of stock valuation. So maybe our worst-case fears can be interpreted as reasons for the rate hikes to end, the 10y treasury to fall from here, and for stock prices to go up in the meantime. That's how stocks could rally through the recession or coming crisis.

MustacheAndaHalf

  • Walrus Stache
  • *******
  • Posts: 5452
First, inflation is forecast to plummet in the next several months:
https://www.forecasts.org/economic-indicator/inflation.htm
This would reduce pressure on the FOMC and encourage them to start tapering down their rate hikes to 0.25% by early 2023, and to cease rate hikes soon thereafter.
They are full of shit.  Error bars of 0.13 for December 2022 inflation?  They lack humility when they screw up - no admission of it on their website, I notice.  Luckily, I know about something called "The Wayback Machine", which fetches web pages and stores them for posterity.

https://web.archive.org/web/20220120073029/https://www.forecasts.org/economic-indicator/inflation.htm
Back in Jan 2022, they also predicted inflation would fall rapidly to 5.00% in June 2022.  They used error bars of 0.13 to show their false precision, and were off by by 1.6x as inflation came in over 8%.  If they can't even get the first digit right, they should not be pretending their predictions have 0.13 precision.

Now I hear you say "What about Russia's invasion of Ukraine?"  Okay, fair enough, let's look after that war, to see their updated predictions in April of this year, a full month after the invasion.
https://web.archive.org/web/20220411094057/https://www.forecasts.org/economic-indicator/inflation.htm

This time, June was 7% ... and July had rapidly falling inflation to 5.94%.  They predicted August inflation of 5.73%, again off by several percent.  These people have been wrong by a wide margin repeatedly, and refuse to change their prediction.  They always predict inflation will fall rapidly.  And when they're wrong repeatedly, they keep providing the same wrong predictions.

It's one thing to be very wrong about predictions, but it's another level of arrogence to apply narrow errors bars after being so wrong repeatedly.  Their prediction is wrong, but their false precision is even worse.  Also note the lack of contrition on their website - I had to catch them being full of shit, since they do not show their past failed predictions prominently.

EscapeVelocity2020

  • Magnum Stache
  • ******
  • Posts: 4134
  • Age: 48
  • Location: Houston
    • EscapeVelocity2020
I appreciate you trying to hold both the bull and bear cases up for scrutiny @ChpBstrd but you do seem to hold a bias toward the bullish cases.  I am long US equities, so I'd like for you to be right and I also have no idea what will happen when and if 'something breaks' and the Fed is forced to either cut or raise rates (or, most likely, return to QE).  Maybe we do get a giant rally...  along with giant inflation.

I don't see much evidence for the Fed to be believable on their CPI forecasts (as MustacheAndaHalf so eloquently discussed).  Any time there is but a whiff of hope, markets go bonkers and commodities follow.  Still plenty of dry powder to drive risk assets up and inflation along with it.  I don't know why fears of Recession continue to subside, when pretty much everywhere in the world is catching financial contagion.  It's a race to the bottom out there!  Maybe the US can pull the global economy through this, but it'd be a helluva big accomplishment that I just can't imaging Jerome Powell is capable of.  His credibility is thinning every time he opens his mouth...

To break the back of inflation, there is going to need to be higher rates.  Maybe not Taylor Rule rates, but the Fed needs to hold the line that they are willing to go there.

PDXTabs

  • Magnum Stache
  • ******
  • Posts: 4907
  • Age: 39
  • Location: Vancouver, WA, USA
First, inflation is forecast to plummet in the next several months:
https://www.forecasts.org/economic-indicator/inflation.htm
This would reduce pressure on the FOMC and encourage them to start tapering down their rate hikes to 0.25% by early 2023, and to cease rate hikes soon thereafter.

I like your "consumer is still strong and still spending" take but I didn't bother quoting it here. I will point out that the St Louis Fed Inflation Nowcast is higher than the forecast.org numbers:
https://www.clevelandfed.org/our-research/indicators-and-data/inflation-nowcasting.aspx

And a core PCE in the 5% range could still lead to a 7% Fed funds rate.

But I'm long world equities so what do I know.

ChpBstrd

  • Magnum Stache
  • ******
  • Posts: 4564
First, inflation is forecast to plummet in the next several months:
https://www.forecasts.org/economic-indicator/inflation.htm
This would reduce pressure on the FOMC and encourage them to start tapering down their rate hikes to 0.25% by early 2023, and to cease rate hikes soon thereafter.

I like your "consumer is still strong and still spending" take but I didn't bother quoting it here. I will point out that the St Louis Fed Inflation Nowcast is higher than the forecast.org numbers:
https://www.clevelandfed.org/our-research/indicators-and-data/inflation-nowcasting.aspx

And a core PCE in the 5% range could still lead to a 7% Fed funds rate.

But I'm long world equities so what do I know.

I made up my September CPI estimate before I encountered some of these sources for forecasting, but it looks like all our September estimates are in a tight range except for the outlier, econforecasting.com.

Me: 8.1%
Current Fixings Market*: 8.1%
Cleveland Fed Nowcast: 8.2%
econforecasting.com: 8.68%

*https://www.marketwatch.com/story/cpi-fixings-traders-nudge-up-expectations-after-opec-agreement-now-see-annual-headline-inflation-rate-of-75-for-october-2022-10-05?mod=mw_latestnews

With expectations as narrow as they are, and with the market consensus probably best represented by the fixings market and nowcast, there could be a big move on 10/13 if inflation is even slightly outside the 8.1/8.2% range. If past months are any guide, these big moves - usually in response to inflation disappointments - take a couple of days to reach full effect. Thus there may be an opportunity for someone to go long or short at the open next Thursday morning when they receive the data and have a contingency plan for either outcome.  A game plan for a small speculation might look like:

If CPI > 8.3% or CoreCPI > 6.8%, short the market
If CPI < 8% or CoreCPI < 6.4%, go long the market

Of course, in the big picture a rapid decrease in inflation will signal the onset of recession and the devastation of corporate earnings. But traders assume a recession is too far away to affect the value of stocks today. The soft-landing signal is for inflation to fall a bit faster than forecasted, because that implies the FOMC could reverse course before a recession starts, cut rates and do QE through the recession, never hit a very high terminal rate, and have a short shallow recession if it counts as a recession at all.

Monday and Tuesday's sharp upward market moves prove there is a lot of optimistic money still on the sidelines awaiting a signal to jump back in, or to hold out a little bit longer. Maybe Australia only raising rates 0.25% was mistaken for such a signal, but we can at least see that we're nowhere near peak pessimism. Bottoms look like headlines fretting over job losses, bankruptcies, financial crises, whether capitalism has a future, etc. and I'm not seeing that.

KateFIRE

  • 5 O'Clock Shadow
  • *
  • Posts: 65
Just want to say that I enjoy reading your thoughts @ChpBstrd. I especially liked your explanation of how stocks can move up into a recession as lower commodity prices provide relief.

Reynold

  • Bristles
  • ***
  • Posts: 314
[snip]
Commodities - a key cost driver for everything - have been falling for three months straight:

S&P GSCI month-to-month change in average of daily price levels:
Jul '22: -12.44%
Aug '22: -1.25%
Sept '22: -5.58%

3-month cumulative GSCI loss:

-18.36%

It would be a weird world in which such massive commodity price drops did not translate into lower inflation, and surprisingly low inflation numbers are what the people plowing into stocks this week are betting on.

I don't think nearly as much of the U.S. economy is dependent on commodity prices as it was during the last big bout of inflation, in the 1970s.  The U.S. economy has been getting "lighter", i.e. less weight of physical stuff per dollar of GDP, for decades as heavy, low margin commodity manufacturing has been outsourced to other countries, and we make more high value added items or services where raw materials are a fairly small fraction of the value. 

I think that is one reason for the Fed continually underestimating future inflation and the interest rates needed to fight it, as MustacheAndaHalf says above.  I know I got a good laugh back in the late spring (?) when inflation passed 8% and Powell was saying it would be back down to 2% by raising interest rates to maybe 3%, that didn't exactly happen last time inflation was this high.  I've also read that changes in the way inflation is measured means it is actually closer to those double digit rates of the late 1970s than we realize, and they didn't come close to killing that with interest rates of 4-5%. 

I'm friends with people with both low incomes and high incomes.  All of them are "worried" about inflation, but none of them plan any significant belt tightening, because one way or another they all came out of the pandemic in pretty good financial shape.  They know there are plenty of jobs if they want them (some of the low income folks don't even want them, they are fine with government benefits and odd jobs on the side).  I don't actually expect that situation to change much even with Fed tightening, because so many people have dropped out of the job market.  In addition to many people moving retirement up some during the pandemic, I saw statistics that 1/3 of all working age men are not in the job market.  Not employed, and not looking. 

Therefore, I predict CPI will still be above 6%, very likely above 8%, at the end of 2022, the U.S. economy will still be doing fairly well, and the Fed will, to their eternal surprise, still be trying to catch up.  Some time early in 2023 a recession may be achieved that lowers inflation, but it is going to be rather different from the last ones employment wise.  I also predict the S&P P/E ratio will never drop below 15 before it goes back up, there is too much investment money sloshing around that will want to buy on dips, it has worked for decades now. 

I also think things are going to get rough for developing countries, as commodity prices drop while their borrowing rates, often denominated in dollars, go up and they pay more for the developed world's products.  Things will also get tough for Europe because of the energy situation they put themselves in with dependency on Russia, green energy is volatile and expensive, and despite their grand plans they aren't close to going fossil fuel free.