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...