Canberra and CPI

Episode Summary

Executive Summary: The episode centers on the surprising January CPI surge, debating whether inflation has peaked and how much is pandemic-driven versus persistent. The hosts argue inflation should cool as supply chains heal, but worry about energy, rents, and wage-price dynamics. They also discuss Fed policy, quantitative tightening, and why rising rates may still not be tight enough.

Main Topics: January CPI shock and inflation breadth (Priority: 5/5): January CPI rose far more than expected, with broadening price pressures beyond energy. The group parses why core inflation remains elevated and how updated CPI weights affected the reading. Is inflation peaking or persisting? (Priority: 5/5): The hosts argue inflation likely peaked in January or February, with month-to-month measures already rolling over, but acknowledge risks from energy, rents, and wages. Fed policy path and market expectations (Priority: 5/5): They debate whether the Fed should hike 25 or 50 bps in March, how markets are pricing hikes, and whether the Fed needs to tighten financial conditions more forcefully. Quantitative tightening and the bond market (Priority: 4/5): The discussion covers how balance-sheet runoff (QT) could affect long-term rates, term premium, and the transition from QE to tighter policy. Long-term Treasury yield outlook (Priority: 4/5): The team examines why the 10-year yield has moved higher, whether it should track nominal GDP growth, and why term premiums and inflation expectations remain puzzlingly low. Sentiment and consumer pain from inflation (Priority: 4/5): They connect higher inflation to worsening consumer and small business sentiment, emphasizing household budget strain and the corrosive effect of price increases.

Key Arguments: Inflation pressures are broadening, not just energy, and core CPI at 6% year over year is historically high. January may represent the inflation peak, but February could still be the worst month before moderation begins. Updated CPI weights mattered because 2020 pandemic spending shifted weight toward goods and away from services, boosting measured inflation. The pandemic, especially Delta-era supply chain disruptions, is seen as the main driver of the inflation surge. Energy, rent, and potential wage-price feedback loops are the biggest risks to the disinflation narrative. The Fed likely starts with a 25 bp hike in March, but market pricing and inflation risks leave room for faster tightening. Financial conditions are not tight enough yet; rate hikes and QT may need to push asset prices and credit conditions more materially. Long-run Treasury yields may still need to rise because term premium and real rates remain negative relative to normal conditions.

Data Points: CPI month-over-month (January): 0.6% - January consumer price index increased versus a 0.4% consensus expectation. CPI year-over-year (January): 7.5% - Headline inflation rose from 7.0% to 7.5%. Core CPI year-over-year (January): 6.0% - Excluding food and energy, core inflation remained at the highest level since the early 1980s. Monthly household inflation cost increase: $276 per month - Approximate added monthly spending for a typical household versus a year earlier. Fed hike odds in March: 63.7% - Market-implied probability discussed for a 50 bp move versus a 25 bp move. Negative-yielding bonds outstanding: $8 trillion - Global bonds still carrying negative yields despite rising rates. Share of global non-sovereign debt with negative yield: 12% - The portion of outstanding global non-government bonds yielding below zero. Trimmed mean CPI year-over-year: 5.4% - A measure excluding top and bottom inflation outliers. Median CPI year-over-year: 4.25% - Underlying inflation measure discussed as still elevated. Sticky CPI year-over-year: 4.25% - Inflation components that adjust slowly remained firm. University of Michigan consumer sentiment: 61.7 - Weak consumer sentiment reading tied to inflation and market declines. NFIB small business optimism: 97.1 - Small business sentiment also softened. 10-year Treasury yield: ~2.0% - Benchmark long-term yield rose sharply and was used to discuss future rate expectations. Fed funds target forecast: 2.5% by mid-2024 - Baseline policy path described by the hosts. 10-year Treasury forecast: 4.0% by mid-2024 - Baseline long-run yield forecast used in the discussion. Fed balance-sheet runoff: $100 billion per month - Potential monthly quantitative tightening pace discussed. Fed balance sheet size: ~$9 trillion - Current approximate balance-sheet size mentioned in the QT discussion. Normalized balance sheet target: ~$4.5 trillion - Rough long-run size the hosts discussed as a benchmark.

Pivotal Quotes: "I think we're at the peak. If it doesn't peak in February, that wasn't seven and a half wasn't the peak in January, February will be the worst." — Mark Zandi: Mark argues inflation is likely near its top, though he allows February could still be the worst monthly reading. "The longer inflation remains high and persistent ... the more I worry that wages start and prices start to feed on each other." — Mark Zandi: He identifies a wage-price spiral as his main medium-term inflation risk. "I think it's going to be less than that, right? ... I think you'd average ... the rates on bonds, for example." — Ryan Sweet: Ryan pushes back on the idea that the 10-year Treasury yield must eventually match nominal potential GDP growth.

Implications: Listeners should expect persistent inflation volatility, a likely near-term Fed tightening cycle, and continued pressure on households and markets. Bond yields may keep rising, but the pace will depend on whether inflation cools without triggering recession.