Wednesday, January 12, 2022

Way Too Complacent about Inflation and Rates

This morning the BLS reported that the CPI increased by 0.5% and the core CPI increased by 0.6% in December. On a year-over-year basis prices are up 7.0% and 5.5% for headline and core, respectively. The data came in somewhat higher than expected, yet both stock and bond prices rallied figuring that inflation has peaked and will gradually retreat througout the year, especially with the Fed signalling three or four rate hikes over the balance of the year.

I agree that we are roughly at the peak in the year-over-year inflation rate, but where I disagree is that inflation will likely running between 4-5% on a year-over-year basis in December. Why? The runrate for both owner's equivalent rent and tenant paid rent is currently 5% and that will likely increase to above 6% compared to the recent year-over-year rates of 3.8% for OER and 3.3% for tenant paid rent. Similarly medical services which increased at a mere 2.5% YOY is now increasing at at 3.6% rate and likely to go much higher given the labor shortages in that sector. Underneath all of this is that average hourly wages increased at 4.7% YOY in December, but the current runrate is more likely in the 6%-7% range. 

What this means is that sometime midyear, the Fed will wake up and instead of increasing rates at a measure 25 bps a quarter, there will be a surprise 50 bps increase. That, to say the least, will shock the markets.

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