Inflation, The Fed, and Mark's Mystery

Episode Summary

Executive Summary: The episode centered on a strong May CPI report that showed headline inflation flat and core CPI up just 0.16%, reinforcing the view that underlying inflation is moving back toward the Fed’s 2% goal despite sticky shelter costs. The hosts also answered listener questions on why deflation is undesirable, discussed the role of OER, reviewed a small-business sentiment reading, and parsed the Fed’s latest dot plot, which now implies fewer cuts this year.

Main Topics: May CPI report: broad disinflation and a strong read (Priority: 5/5): The hosts said the inflation report was better than expected, with headline CPI flat and core CPI running at a pace consistent with progress toward target. Goods prices weakened broadly, services improved, and the report lacked the usual negative offset that had hurt prior releases. Shelter, OER, and the composition of inflation (Priority: 5/5): Shelter remained sticky at 0.4% m/m for both rent and owners’ equivalent rent, but the broader picture improved because non-shelter inflation cooled. The discussion also emphasized how OER complicates interpretation and why the Fed should rely on multiple measures. Why not target falling prices? (Priority: 4/5): In response to listener questions, the hosts explained why broad deflation is harmful: it encourages consumers to delay spending, pressures wages and employment, and can create a self-reinforcing downturn. They distinguished that from targeted declines in items like groceries or gasoline, which can be helpful. Fed policy, dot plot, and rate-cut timing (Priority: 5/5): The Fed held rates steady and signaled slower progress on inflation, while the median dot plot now points to only one 2024 cut. The hosts argued this may reflect the median shifting rather than a dramatic policy change, and that markets still price in roughly two cuts this year. Inflation psychology, sentiment, and 'greed inflation' (Priority: 3/5): The conversation touched on consumers’ lingering anger over past price spikes, corporate profit margins, and the possibility that competitive pressures are finally starting to restrain pricing. They noted high margins historically, but also growing price resistance in some categories. Stats game and ancillary data (Priority: 2/5): A brief stats game featured small-business sentiment and mortgage application activity, with the latter jumping sharply as rates eased. These served as supporting indicators that broader conditions remain stable or are improving.

Key Arguments: Core CPI at 0.16% m/m is strong evidence that underlying inflation is cooling and is roughly consistent with a 2% goal on the Fed’s preferred PCE measure. Shelter remains the main sticky component, but a lack of re-acceleration there plus weaker autos and insurance offset it. Broad deflation is undesirable because it can depress spending, wages, and employment and trigger a vicious cycle. It is reasonable to look at several inflation measures, not just one, because any single metric can be distorted by special factors like OER or temporary seasonal effects. The Fed’s reduced dot-plot rate-cut median may reflect a shifting median rather than a wholesale hawkish turn; markets still expect cuts later in 2024. Consumer and business sentiment remain oddly subdued relative to the improving data, likely because inflation scars and post-pandemic behavior have changed how people respond to surveys. Some inflation relief appears durable in goods and certain services, but one-off drops in travel-related categories may not persist.

Data Points: Headline CPI (month over month): 0.0% - May CPI was unchanged from April, versus consensus expectations of +0.1%. Headline CPI (year over year): 3.3% - Annual headline inflation eased from 3.4% due largely to lower energy prices. Core CPI (month over month): 0.16% - May core CPI came in below the podcast forecast of 0.26% and rounded to 0.2%. Core CPI (year over year): 3.4% - Core inflation eased from 3.6% the prior month. Core CPI, 3-month annualized: 3.3% - Near-term trend improved from 4.1% previously. CPI excluding shelter (year over year): 2.1% - Used to show underlying inflation is much closer to target when shelter is removed. Shelter CPI (month over month): 0.4% - Both actual rent and owners’ equivalent rent rose at the same monthly pace. Food at home (month over month): 0.0% - Grocery prices were flat in May after a small April decline. Food at home (year over year): 1.0% - Groceries remain subdued relative to the pandemic surge. Food away from home (month over month): 0.4% - Restaurant prices continued to rise faster than groceries. Food away from home (year over year): 4.0% - Dining out remains a pain point and above overall inflation. Energy prices (month over month): -2.0% - Lower energy prices helped pull down headline CPI. Gasoline prices (month over month): -3.6% - A key contributor to lower energy inflation in May. Auto insurance (month over month): -0.1% - A reversal from prior sharp increases that had been boosting core inflation. Used vehicle prices (month over month): -0.5% - Used car prices softened and are near flat year over year. New vehicle prices (month over month): +0.6% - New vehicles rose and partly offset used-vehicle weakness. Airfare (month over month): -4.0% - Travel-related prices fell sharply, likely a mix of seasonal and measurement effects. Super core services (month over month): 0.0% - First zero monthly change since August 2021, signaling easing service inflation. Super core services (year over year): 5.0% - Still elevated, though shorter-run averages are decelerating. NFIB Small Business Optimism Index: 90.5 - Improved for a second month but remains below its historical average of roughly 98. MBA mortgage applications composite index: +15.6% - Weekly increase driven by a nearly 30% jump in refinancing activity. Fed median 2024 core PCE forecast: 2.8% - Up from 2.6% at the prior meeting. Fed long-run fed funds rate forecast: 2.8% - Their equilibrium-rate estimate rose from 2.6% at the March meeting and 2.5% before that. Fed projected 2024 rate cuts (median dot plot): 1 quarter-point cut - Down from three cuts in December/March-era expectations.

Pivotal Quotes: "It was a great report. It was as good as anything we've seen since late 2023." — Matt Collier: Opening assessment of the May CPI release. "If people expect prices to go down, they wait. If they wait, that's a spiral that weighs on consumption." — Matt Collier: Explaining why broad deflation is harmful. "We should be a lot more optimistic about the U.S. economy." — Mark Zandi: During the discussion of sentiment versus hard data.

Implications: Inflation looks closer to normalizing, supporting a gradual Fed easing cycle later in 2024. Consumers may still feel scarred by past price spikes, but the data suggest the economy can sustain growth without renewed inflation pressure.