Monday, December 26, 2016

Inflation expectations

CPI rent inflation has spent 2016 slowly climbing from 3% toward 4%.  In the meantime, Zillow's rent measure has cooled off.

Is this a signal that CPI rent inflation might cool off as well?  CPI core inflation outside of rent is already on its way down to 1%.  If rent inflation joins it, then core inflation would start moving down away from the Fed's target levels.

This certainly isn't due to overbuilding.  Housing starts have leveled off in the past year at levels typical of recessions.  This seems like a potential sign of declining demand.

Source
On the other hand, inflation expectations have been rising since August.  Will inflation expectations turn back down as a result of the recent rate hike?  That's my expectation.  The question is how much will economic activity turn down?  How much will this effect homebuilding?  How quickly would the Fed reverse course if, say, 10 year treasuries fall back toward 2%?

I am fairly sanguine about the potential for a deep contraction now, but on the other hand, the answer to that last question plainly seems to be, "not very", in which case I do worry that the downsides here are bad.

I think the long term play these days is to be long on homebuilding with a long bond position as a hedge.  But, I wish there was better visibility about the short term.  A post-inauguration announcement about weakening some of the more damaging aspects of Dodd-Frank would be great.  In some ways, the direction it looks like things are going is somewhat positive - better than I had expected.  But, it's not so great that tactical positions are so dependent on political developments, even if that is necessary to a certain extent.

2 comments:

  1. The danger is this: the Fed will be reluctant to roll back its rate increases and has promised three more, and even more reluctant to return to quantitative easing, let alone helicopter drops.

    So there is danger. I suppose there is some hope the Fed will cut back its mysterious reverse repo program.

    The good news is the Bank of Japan and the People's Bank of China are embracing stimulus.

    The bad news, as David Beckworth points out, is that about 40% of the global central banking system is essentially tied to Fed policy.

    I think another year of very slow growth is on tap, but the risks are on the downside.

    One possible upside: Trump will bring in larger fiscal deficits, and the Fed will be a little bit cowed into letting inflation run a little bit higher as the right-wing will not be screaming about inflation with Trump in office and growth going on.

    ReplyDelete
  2. The danger is this: the Fed will be reluctant to roll back its rate increases and has promised three more, and even more reluctant to return to quantitative easing, let alone helicopter drops.

    So there is danger. I suppose there is some hope the Fed will cut back its mysterious reverse repo program.

    The good news is the Bank of Japan and the People's Bank of China are embracing stimulus.

    The bad news, as David Beckworth points out, is that about 40% of the global central banking system is essentially tied to Fed policy.

    I think another year of very slow growth is on tap, but the risks are on the downside.

    One possible upside: Trump will bring in larger fiscal deficits, and the Fed will be a little bit cowed into letting inflation run a little bit higher as the right-wing will not be screaming about inflation with Trump in office and growth going on.

    ReplyDelete