Crude and inflation

Probably the most interesting story of the day yesterday was the large unexpected draw in US crude inventories.  (The final presidential debate does not qualify.  At this juncture it's like driving slowly and staring at a particularly grisly highway accident.   Quit rubbernecking and move along!)  This in turn propelled prompt crude to its highest closing price since the end of June.

What's interesting is that crude is finally positive on a year on year basis for the first time in more than two years.  Although it is not the only determinant of headline CPI (energy only represents 7% of the basket, after all), as you can see it plays a pretty important role in shaping the trend of the overall consumer price index.


What's also interesting is the looming base effects.  Readers will no doubt recall the swan dive that oil took in the months either side of the new year, which is obviously one of the reasons that headline CPI was so low at that juncture.  While this obviously didn't stop the FOMC from raising rates last December, the follow-on clearly had an impact on their thinking and walking back rate hikes in 2016.
Well, the year on year rise in crude oil looks nailed on to be at least 30% or so by the beginning of 2017, and could be substantially more.  The chart below tracks the prospective y/y rise in WTI based on 3 scenarios: oil going to 35 in a year, oil staying at 48 (its ending level in September) in a year, and oil rising to 60 in a year, assuming a linear path to the eventual target.

How much that impacts headline CPI in the US (and Europe!) will of course depend on the behaviour of non-energy prices, which comprise the majority of the basket.  Still, a significant uptick seems reasonable, and it does make one wonder if the FOMC will be more amenable to moving rates with headline closer to 3% than 1%.  (The implications for the ECB are also interesting; they clearly know this base effect is in the pipeline; could that explain the apparent reticence to extend the 80 bio per month QE size?)

One final interesting point touches on Yellen's recent argument that economic actors are not monoliths that are easily represented by the median, as well as the level of dissatisfaction felt by  many today.     The chart below shows average hourly earnings, personal income (which includes wages and salaries, investment returns, benefits, government transfers, interest income, etc.), and the CPI rent index, all scaled to 100 at the end of 1999.


As you can see, so far this century the price of rentals has outstripped average hourly earnings...and that doesn't even account for the fact that average weekly hours worked has fallen over the same period.   Yes, aggregate personal income growth has surpassed that of rents, but as we know that measure includes income that is not evenly distributed.  Obviously, the Fed has tried to set policy in a way that improves wage growth, but as the US is not (yet) a command economy, wages are still set in many cases by the global marketplace.  Small wonder that a significant portion of the electorate is angry!   Is there time to get this guy on the presidential ballot?



Interestingly, this gentleman has endorsed Donald Trump for president, which seems ironic given that Trump is a property developer/owner.   Maybe Trump just doesn't set the rent too damn high...



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abee crombie
admin
October 20, 2016 at 9:13 AM ×

The base effects also have real implications for Tips too, if in not mistaken, which is based on actaul cpi.

Are u suggesting that draghi wont renew qe. I guess that would be viwed as positive for banks but gotta think euro will try to rally hard, which will be counter productive (though right outta boj playbook)...interesting.

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jdc32
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October 20, 2016 at 11:42 AM ×

I'm not sure your data/charts on crude are correct.... both Brent and WTI have had positive year on year prints back in August?

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Macro Man
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October 20, 2016 at 11:54 AM ×

This is using month end data on the chart. Crude did go positive y/y intramonth in August before lapsing back to negative by month end.

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jdc32
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October 20, 2016 at 12:16 PM ×

got it, thx

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wcw
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October 20, 2016 at 2:20 PM ×

I've got average hourly earnings up versus CPI rent. Not great, not awful.

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Macro Man
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October 20, 2016 at 2:24 PM ×

Mine is the rent of primary residence. I think your might include hotels, etc.

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washedup
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October 20, 2016 at 2:28 PM ×

@wcw - the relevant series would be to construct an altogether different series, perhaps disposable income ex rent, and look at the median of that - bottomline, the aggregation involved in average hourly earnings glosses away inequality effects, leaving the impression of a populace thats more upbeat and likely to spend than it actually is.

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checkmate
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October 20, 2016 at 3:56 PM ×

Unrelated. Ftse leader piece of s... Royal Bank of Scotland. Say's it all really.

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wcw
admin
October 20, 2016 at 5:04 PM ×

@MM, it might at a low weight, but I think the significant difference is including owners equivalent rent at a high weight. The primary residence series excludes it and so I guess better isolates rents in low-homeownership areas.

@washedup, in aggregate Disp PI less PCE Housing looks okay, median wages to CPI rent looks okay.

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Anonymous
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October 20, 2016 at 7:39 PM ×

Anyone got a handle on the contiued euro & USD move? I thought we might see a little pullback post ecb presser. Might be some pain out there soon.

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Leftback
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October 20, 2016 at 8:07 PM ×

Interesting. We have often discussed the relationship between oil and inflation here. If Yellen really wanted to goose US CPI she could just call Blankfein and ask to activate the J Aron unit again to manipulate the price of crude while their high yield traders make a sh*tload going long on energy junk bonds. [oooh, you don't think she did this in the winter?? They wouldn't, would they?? When the history of this period is written we will find out they did all this kind of stuff - and worse].

In any case, we are clearly set for a "transitory" spike in the CPI (thanks, Dame Janet) because of the base effect you describe above, and TIPs seem to have been anticipating this for some time, TIP being one of the year's better performers.

So the crude squeeze has injected some inflation, possibly a lot in the short-term, but with the futures rolling to the December contract and the Saudi bond sale safely launched we may well have seen the end of the latest batch of market manipulation via options contracts, and LB anticipates a gradual return toward price dynamics dictated by supply/demand.

Let's review some fundamentals: US rig counts are rising slowly but consistently once again, production appears to be rising globally, and price action in most other commodities is soft, revealing a slowing global economy. All these factors are consistent with a lower oil price by the end of the year. Other factors in play: a firmer dollar is negative for crude; in addition, speculative longs are close to or at record high levels and late arrivals will bail quickly when price turns.

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Bruce in Tennessee
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October 20, 2016 at 9:19 PM ×

Once again, weakness in equities at the end of the day...

..Sure looks trendy to me.

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12yo HFM
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October 20, 2016 at 10:08 PM ×

Once again, weakness in equities at the end of the day...
Not if you 'hedged' in Dax & Nasdaq ;)

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sydneypunter
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October 21, 2016 at 2:28 AM ×

Hmm. Oil did go down after Saudis got that bond issue out of the way... good call

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