Inflation is so over

Today the bond market is convinced that there will be no more Fed rate hikes. Yet the Fed insists that inflation has not fallen by enough, so that warrants continued monetary restraint; some governors even argue that further rate hikes might be necessary, even as evidence of economic weakness builds. Chalk this up to one more example of how the bond market is usually smarter than the Fed. Fed mistakes like this have been the proximate cause of every recession in my lifetime. This is yet one more reason why individuals—and especially committees like the FOMC—are never as smart as they should be. By extension, bureaucrats are rarely smarter than the collective wisdom of those they are supposed to oversee. Which is why at heart I'm a Libertarian—government should be limited as much as possible.

Simple logic says that if inflation is clearly decelerating, no further rate hikes are necessary. When you apply the brakes when approaching a red light, you don't take the pressure off until after you've stopped—you start easing up before you come to a stop. The evidence in the charts that follow make a strong case for rate cuts starting NOW, because inflation has already declined by enough.

Chart #1

Chart #1 compares the year over year change in the CPI (red) to the 6-mo. annualized change (blue). When inflation dynamics change, that show up first using a shorter time frame. Compared to a year ago, prices are up about 5%, but over the past six months, the CPI is rising at only a 3.3% rate. In the current disinflationary environment, it is essential to look at the rate of change in prices over a shorter time frame— one year is too long.

Chart #2

Chart #2 compares the 6-mo. annualized change in the CPI to the same change in the ex-shelter version of the CPI (shelter costs account for about one-third of the total CPI). Over the past six months, CPI less shelter is up at a mere 1% annualized rate.

Chart #3

Chart #3 shows the 1- and 3-month annualized rate of change in Owner's Equivalent Rent, the main component of shelter costs in the CPI. By either measure, shelter inflation has peaked and is beginning to decline, but only very recently.

Chart #4

Chart #4 shows that it takes housing prices (blue line) about 18 months to feed into the shelter component of the CPI (red line). Housing prices have been falling for the past year, and only just now is the shelter component of the CPI beginning to reflect that. That means there's a lot more disinflation in the CPI shelter pipeline that will come from declining shelter costs.

If the Fed doesn't ease up on the monetary brakes soon, we could be seeing some deflation before too long.

Chart #5

Chart #5 shows inflation at the producer level (the first part of the inflation pipeline) over the last year and the last 6 months. Inflation by this measure has collapsed to a mere 0.6% over the past six months!

Chart #6

Chart #7

Charts #6 and #7 are the most important charts that hardly anyone is looking at these days. What they show is that our recent surge in inflation was caused by a surge in deficit spending from 2020 through 2021. As much as $6 trillion of Covid "emergency" spending was effectively monetized, as it accumulated in the nation's savings and deposit accounts (M2). Once people started to spend the money, beginning in early 2022, inflation took off. A ton of extra money was printed, and about a year later, inflation started to rise. Now that the extra money is disappearing, inflation is slowing significantly.

The best news here is that the third round of deficit spending that began last summer, and has now pushed the 12-month deficit from $1 trillion to almost $2 trillion, has not been monetized at all. This all but ensures that inflation is on its way out. The fires of inflation have been extinguished; only embers remain, and they are already flickering out.

How long before the FOMC realizes all this?