Lousy Inflation and Life Lessons

Episode Summary

Executive Summary: The episode dissects the hot May CPI report, arguing inflation remains painfully high but is mostly driven by supply shocks: energy from Russia’s invasion of Ukraine, lingering pandemic supply-chain disruptions, and housing/rent pressures. The hosts reject corporate-greed and money-supply explanations as primary causes, then debate how long inflation may persist and what it means for Fed policy, markets, and recession risk.

Main Topics: May CPI and the inflation shock (Priority: 5/5): The hosts review the CPI’s unexpectedly hot month, noting broad-based price increases and emphasizing that energy and food were the biggest drivers of the headline number. Energy prices and the Russia-Ukraine war (Priority: 5/5): A large share of inflation is attributed directly and indirectly to higher oil, gasoline, diesel, natural gas, and freight costs caused by Russia’s invasion and related sanctions. Supply chains, reopening, and goods inflation (Priority: 4/5): They argue that pandemic-related bottlenecks, reopening demand, and inventory/transport constraints still explain much of goods inflation, though some easing is appearing in categories like lumber. Housing, rents, and demand-side pressures (Priority: 4/5): The discussion separates the inflation story from broad demand-pull dynamics, highlighting rent and shelter inflation as the clearest demand-related component because of housing shortages and strong rental demand. Competing explanations: corporate greed, money supply, wages (Priority: 5/5): The hosts test alternative narratives—gouging, monetary growth, and wage-price spirals—and largely dismiss them as primary explanations for current inflation. Fed policy, market repricing, and recession risk (Priority: 5/5): They debate whether the Fed should raise rates more aggressively after the CPI surprise, how market expectations shifted, and whether tighter financial conditions raise recession odds. Outlook and possible peak inflation (Priority: 4/5): Baseline view is that inflation should moderate as oil stabilizes, supply chains improve, and reopening effects fade, but the summer could still bring elevated readings.

Key Arguments: The headline CPI surge is largely a supply-side inflation shock, not a broad demand boom. Direct energy inflation explained a large chunk of the May CPI, and indirect energy effects likely added another meaningful share through freight, food, and airfares. Pandemic-era supply bottlenecks are easing only gradually; goods disinflation is expected, but not fast enough to offset energy and shelter. Rent inflation reflects a real demand-supply imbalance: strong rental demand plus decades of underbuilding and low vacancy rates. Corporate greed is not the main driver because profit margins are not rising sharply; if gouging were widespread, margins would be expanding. Money supply growth is not a sufficient explanation because velocity is low and post-crisis liquidity did not translate into sustained inflation. Wage growth is being pulled up by inflation rather than causing it; no clear wage-price spiral is evident yet. Markets reacted to the CPI by pricing a higher probability of faster Fed hikes and a higher terminal rate, reflecting concern about inflation expectations. A recession risk is meaningful because the yield curve is very flat and financial conditions have tightened materially.

Data Points: Headline CPI (non-seasonally adjusted): 8.6% y/y - Reported May CPI figure that made headlines as a new 40-year high in press accounts. Headline CPI (seasonally adjusted): 8.5% y/y - Hosts’ preferred comparison; slightly below March’s peak, suggesting inflation may have peaked earlier. Headline CPI monthly change: 1.0% m/m - May CPI rose more than expected, driven largely by energy and food. Core CPI monthly change: 0.6% m/m - Core inflation matched April and remained elevated even excluding food and energy. Core CPI (seasonally adjusted): 6.0% y/y - Underlying inflation remained very strong on an annual basis. Energy contribution to CPI y/y: 2.8 percentage points - Direct contribution of energy prices to May headline inflation. Energy contribution in April: 2.3 percentage points - Shows the increase in energy’s role from April to May. Supply-chain constrained component contribution: 1.5 percentage points - Includes new and used vehicles, bedding, furniture, apparel, electronics and other goods affected by logistics issues. Reopening component contribution: 0.4 percentage points - Captures items like food away from home, lodging away from home, and airfares. Inflation burden per household: $460.20 per month - Estimated additional monthly cost for the average household to buy the same basket of goods and services as a year ago. AAA national average gasoline price: $5.00 per gallon - Current U.S. average cited during the discussion of energy-driven inflation. Projected gasoline price: $5.50 per gallon - Wholesale gasoline prices point to further increases in retail gasoline over the next couple of weeks. WTI oil peak in Oct. 2021: $85 per barrel - Used to argue oil had already been rising before the war-driven surge. WTI oil low in mid-December: $70 per barrel - Referenced as the point where oil started to rise again. Wheat price: $1,085 per bushel - Spot price cited as still elevated and relevant to food inflation. Wheat price low over past year: $640 per bushel - Pre-invasion comparison point. Wheat price peak after Russia invasion: $1,285 per bushel - Shows the post-invasion spike in food commodity prices. Lumber price: below $600 per board foot - A signal that some goods/supply-chain inflation is easing from prior peaks. Lumber peak: $1,600 per board foot - Poster child for supply-chain inflation during the prior year. Two-year Treasury yield move: +20 bps in one day - Markets repriced sharply after the CPI release. 10-year minus 2-year Treasury spread: 9.8 bps - Extremely flat yield curve, often viewed as a recession warning sign. Consumer confidence index: 46.8 - Cited as a record-low/near record-low reading reflecting weak sentiment. 30-year fixed mortgage rate: 5.85% - Illustrates tighter financial conditions. High-yield corporate bond spread: 450 bps - Used to assess financial conditions; near but somewhat below long-run averages. Fed funds rate (current): 1.0% - Starting point for the policy discussion. Market-implied terminal rate: ~3.0% to 3.5% - Markets were pricing a faster tightening path after the CPI surprise. Current 1-year 5-year forward inflation expectation: ~2.7% - Viewed as still above the Fed’s target but not far from it. Recession odds over next 12 months: 40% (Chris), 45% (Ryan), ~33% (Mark) - Each speaker gave a subjective probability of recession. Recession odds over next 24 months: 60% (Chris), 75% (Ryan), just under 50% (Mark) - Shows elevated medium-term recession risk.

Pivotal Quotes: "It was miserable." — Ryan Sweet: Opening assessment of the May CPI report. "I would stress, though, if we're talking energy, prices were up before the invasion." — Chris Torides: Pushback on the idea that Russia’s invasion alone explains all energy inflation. "If it was corporate greed, you'd see profit margins really start to increase noticeably." — Mark Sandy: Argument against greed as the primary explanation for inflation.

Implications: Consumers face continued near-term pain from energy and food, while the Fed is likely to stay aggressive. Inflation should ease only gradually, and a flat yield curve plus tighter financial conditions keep recession risk elevated.