Monetary Policy and Multiple Models

Episode Summary

Executive Summary: The podcast centers on near-term market signals and the inflation outlook. The hosts discuss sharp moves in lumber, copper, Treasury yields, and jobless claims, then debate when the Fed will first hike rates. The core disagreement is whether inflation will settle near 2%-2.25% or run higher for longer, driven by demand, labor costs, and housing/rent pressures.

Main Topics: Inflation outlook and forecasts (Priority: 5/5): The hosts revisit their earlier five-year inflation forecasts and debate whether inflation settles near the Fed’s target or trends higher due to labor, housing, and expectation effects. Fed policy timing and dot plot shift (Priority: 5/5): They analyze the June FOMC dot plot, noting a larger shift toward earlier rate hikes, but questioning whether the Fed is still too slow versus market pricing. Commodity price correction (Priority: 4/5): Lumber and copper are used as real-time inflation gauges; both have pulled back sharply, suggesting speculative froth is easing even though prices remain elevated. Treasury yield moves and term premium (Priority: 4/5): The 10-year Treasury yield’s volatility is discussed in terms of Fed communication, term premium, inflation expectations, and possible technical factors like Treasury cash balances. Labor market and jobless claims (Priority: 4/5): Initial claims, job openings, and participation are discussed as indicators of labor-market healing and future wage pressure, with some data distortions noted. Housing, rents, and shelter inflation (Priority: 4/5): They connect tight housing supply, rising rents, and shelter costs to future inflation, especially in CPI, while noting supply shortages and affordability constraints. How to model inflation (Priority: 5/5): The hosts compare approaches: ensemble methods, demand-pull/cost-push frameworks, sector splits between goods and services, and the importance of productivity growth.

Key Arguments: Inflation is difficult to forecast with any single model, so an ensemble or sector-based approach is more reliable than a single theory. Near-term inflation is being driven by demand outpacing supply, plus speculation in commodities; those pressures can reverse quickly. The Fed can likely prevent sustained inflation well above its target by tightening policy and using communication tools. The labor market will tighten further as job openings are absorbed, raising wage growth and service inflation pressure. Productivity growth may improve and offset some wage pressure, supporting a lower long-run inflation outcome. Rents and shelter inflation are a major risk to the inflation outlook, especially in CPI, because housing markets remain very tight. Treasury yields may be temporarily distorted by technical factors such as the Treasury General Account drawdown, not just fundamentals. The dot plot shift toward earlier hikes suggests the Fed is moving closer to market expectations, but communication remains inconsistent.

Data Points: Lumber price: $900 per thousand board feet - Chris cites a sharp decline from the recent peak as evidence that commodity inflation can unwind quickly. Lumber peak: $1,700 - Approximate high reached just a month earlier before the correction. Lumber decline from peak: 47% - The fall in lumber prices was used as a headline sign of easing commodity pressure. Copper price: $4.15 per pound - Used as a broader inflation gauge; down from recent highs but still elevated. Copper peak: $4.70–$4.75 per pound - Approximate recent high before the pullback. 2023 first rate hike dots: 13 FOMC members - Ryan highlights the shift in the June dot plot toward a first hike in 2023. 2022 first rate hike dots: 7 FOMC members - Members still expecting a first hike in 2022 after the June meeting. 10-year Treasury yield: 1.48% to 1.44% - The yield moved sharply after the FOMC meeting and ended lower, reflecting market whipsawing. Treasury General Account drawdown: $150 billion in 10 days - Discussed as a technical factor that could depress Treasury yields by reducing issuance. Initial jobless claims: 412,000 - Claims rose from the prior week and were attributed partly to state-level and seasonal distortions. Prior week jobless claims: 375,000 - Baseline used to frame the week-over-week increase. Job openings (JOLTS): 9.3 million - Used to support the view that labor demand remains extremely strong. Existing home sales forecast: 5.6 million - Ryan’s expectation for next week’s report, below consensus. New home sales forecast: 860,000 - Ryan’s expectation for next week’s report, also below consensus. Core PCE inflation long-run forecast: 2.0% to 2.25% (baseline) - Chris’s view and the official Moody’s baseline discussed in the inflation section. Ryan’s long-run core PCE forecast: 1.75% to 2.0% - Ryan remains at the low end of the long-run inflation range. Mark’s long-run core PCE forecast: 2.25% to 2.5% - Mark argues risks are tilted to higher inflation even if the baseline remains near target. Medical care CPI inflation: lowest on record / very weak - Mentioned as one factor suppressing measured inflation. Housing vacancy rate: 35-year low - Cited to support the argument that rental and shelter inflation may stay firm.

Pivotal Quotes: "The best model of inflation is actually a naive model, right? You just, if you want to know next year's inflation, your best estimate over time is to look at what inflation was last year." — Chris: He explains why no single inflation model is fully reliable and why he favors an ensemble approach. "I think inflation expectations are, you know, they're right where the Fed wants them to be, but we're not past this transitory period of inflation." — Ryan: Ryan argues inflation may temporarily spike but later fall back toward a low long-run range. "The risks are definitively to higher rates of inflation, that the probability distribution is skewed towards higher inflation, not lower inflation." — Mark: Mark closes by emphasizing that even if the baseline is near target, upside inflation risks dominate.

Implications: Listeners should expect continued debate over whether inflation is temporary or durable. The Fed may tighten sooner, but housing, wages, and expectations could keep inflation above target longer than the low-case forecast suggests.