From his Dr. Ed's Blog, February 3:
Inflation I: Prices Paid vs Prices Received
In recent Zoom calls with accounts, I am spending more time discussing the outlook for inflation. For investors, this may very well be among the most important, if not the most important, issue to get right in 2021 and beyond. If inflation looks likely to remain subdued, then we can “keep walking because there is nothing to see here, folks.” If inflation looks likely to make a modest comeback, then overweighting inflation hedges in portfolios would make sense. In recent months, there has certainly been some comeback-like action in the prices of assets that might benefit from higher inflation. If inflation were to make a big comeback, bond yields would soar. That could cause a credit crunch, a recession, and a bear market. I am inclined to keep walking.
Nevertheless, by popular demand, I will be returning on a regular basis to see what I can see on the inflation front.
I am counting on four deflationary forces to keep a lid on inflation. They are Détente (a.k.a. Globalization), Disruption (a.k.a. Technological Disruption), Demography (as in aging populations), and Debt (as in too much propping up zombie companies). I discussed the “4Ds” in my 2020 Fed Watching book (here is the excerpt). These forces are on one side of the tug of war over inflation. On the other side are the world’s economic policymakers. They’ve responded to the Great Virus Crisis with massive fiscal and monetary stimulus. In other words, they embraced Modern Monetary Theory. They certainly haven’t let this crisis go to waste! Let’s see what we can see in the latest price indicators:
(1) Regional prices. Five of the 12 Fed district banks conduct monthly business surveys. In addition to compiling business activity indexes, all five report prices-paid and prices-received indexes (Fig. 1). All 10 price indexes have recovered from their early-pandemic lows a year ago through January of this year. The average of the five regional prices-paid indexes is up from last year’s low of -3.6 during April to 48.4 during January, the highest since July 2018 (Fig. 2). The average of the prices-received indexes rose from -9.4 to 21.1 over this same period.
The prices-paid indexes tend to be more volatile than the prices-received indexes. That’s because the former tend to be correlated with the inflation rate of the intermediate goods Producer Price Index, or PPI (on a y/y basis), while the latter tend to be correlated with the inflation rate for the goods Consumer Price Index, or CPI (Fig. 3 and Fig. 4). Intermediate goods producer prices tend to be more volatile than consumer goods prices because they are more highly correlated with commodity prices. The spread between the averages of the regional prices-paid and prices-received indexes is highly correlated with the spread between the inflation rates of the intermediate goods PPI and the goods CPI (Fig. 5).
So what do we see? Since the start of the data in 2005, the regional price indexes have been this high before at least four times. Over that same period, the core PCED (personal consumption expenditures deflator), which is the Fed’s preferred measure of consumer price inflation, hovered just above 2.0% from 2005 through most of 2008, and has remained below 2.0% from 2009 through 2020 every month with the exception of only 14 months.
(2) M-PMI prices. January’s national survey of purchasing managers in manufacturing was released on Monday. This M-PMI survey also includes a price index, but only for prices paid. It is highly correlated with the average of the regional prices-paid indexes (Fig. 6). The M-PMI prices-paid index rebounded from last year’s low of 35.3 during April to 82.1 last month, the highest reading since April 2011. Again, this index is more reflective of commodity-related costs at the intermediate PPI level than consumer goods prices. It has been this high before a few times since 2005 without leading to a pickup in CPI inflation.
Inflation II: Commodity Prices, the Dollar, and Import Prices....
....MUCH MORE
