Why the Fed Is Seeing Disinflation in the Wrong Places

Summary

This script discusses the limitations of the Consumer Price Index (CPI) as an accurate measure of inflation, with a significant portion based on homeowners' estimates of their rental equivalents. It explores alternative metrics like business contacts, product sector prices, and service sector components. Economic data, including upcoming jobs reports and Fed Chair Powell's commentary, are anticipated, potentially revealing a more hawkish stance than expected. The accuracy of non-farm payroll numbers is questioned, with the household survey and workweek data suggesting a weakening labor market, potentially signaling an impending recession.

Takeaways

• 😕 The consumer price index (CPI) is a flawed statistic, with 27% of the index based on a survey of homeowners' opinions about home prices and rental values.
• 😐 The service sector component of CPI is considered unreliable as it relies heavily on imputed pricing, rather than observable prices.
• 😏 David Rosenberg suggests focusing on the prices of tangible goods, which can be more reliably measured, rather than relying on imputed service sector prices.
• 🤔 The Federal Reserve is increasingly shifting its focus towards anecdotal evidence from business contacts, rather than solely relying on government data.
• 😳 Recent Beige Book reports suggest that the corporate sector is experiencing diminished pricing power and reduced ability to pass on cost increases.
• 🧐 While the headline non-farm payroll numbers may appear strong, the household survey and the contraction in full-time jobs paint a different picture of the labor market.
• ⚠️ The divergence between the non-farm payroll headlines and the workweek, which is already at recessionary levels, suggests that the labor market may not be as robust as it seems.
• 🔍 David Rosenberg expects Fed Chair Jerome Powell to sound hawkish in his upcoming remarks, despite market expectations for rate cuts.
• 💭 The market has already walked back its expectations for rate cuts, aligning more closely with the Fed's December commentary.
• 🤨 Rosenberg believes that the recession is likely staring the economy in the face, despite the current consensus narrative of a robust economy.

Q & A

What is the main issue raised regarding the Consumer Price Index (CPI)?

The main issue raised is that the CPI is flawed because 27% of the index is based on a survey asking homeowners how much they think they could rent their homes for, which is known as the "owner's equivalent rent" component.

According to David Rosenberg, what inflation series should be paid attention to instead of the CPI?

David Rosenberg suggests paying attention to the prices of tangible products that you can "see, touch, and feel" instead of relying on imputed prices in the service sector, which he considers unreliable components of the CPI and the PCE deflator.

What is David Rosenberg's perspective on the upcoming Federal Reserve Chairman Jay Powell's commentary?

David Rosenberg expects Chairman Powell to sound pretty hawkish in his commentary, possibly more hawkish than what the market is currently pricing in. He believes Powell will try to walk back some of the more dovish expectations from the December meeting.

How does David Rosenberg view the nonfarm payrolls data?

David Rosenberg is skeptical of the nonfarm payrolls data, as he believes that a significant portion of the growth in nonfarm payrolls last year came from a model adjustment (the "plus factor") rather than the actual survey. He suggests looking at the household survey and the contraction in full-time jobs over the past six months as a better indicator of the labor market's health.

What does David Rosenberg point out regarding the workweek data?

David Rosenberg highlights that the workweek data is already back at recession levels, which contradicts the narrative of a robust labor market based solely on the nonfarm payrolls headline numbers.

What is David Rosenberg's overall assessment of the current economic situation?

Based on his analysis of the labor market data and other indicators, David Rosenberg believes that a recession is "probably staring us in the face," contradicting the consensus narrative of a robust economy.

Why does David Rosenberg suggest focusing on product prices rather than service prices?

David Rosenberg suggests focusing on product prices because they are the prices that can be seen, touched, and felt, and are therefore more reliable than the imputed service prices in the CPI and PCE deflator, which he considers to be unreliable guesswork.

What does David Rosenberg expect to happen with product prices in the next year?

David Rosenberg expects product prices to be in a deflationary momentum over the next year, based on his assessment of diminished pricing power in the corporate sector and the ability to pass on cost increases.

How does David Rosenberg view the Fed's focus on the service sector?

David Rosenberg expresses concern that the Fed is overly focused on the service sector, which he considers to be the most unreliable component of the CPI and PCE deflator due to the imputed pricing and guesswork involved.

What is David Rosenberg's stance on being an economist?

David Rosenberg has a lighthearted perspective on being an economist, saying that "it's always a great time to be an economist" and that economists need to "fasten your seatbelt and stay at our desks 24/7" to keep up with the ever-changing economic landscape.

Outlines

00:00

🧐 Critique on the Consumer Price Index (CPI) and Alternative Inflation Metrics

The speaker expresses skepticism towards the reliability of the Consumer Price Index (CPI) as an accurate measure of inflation, particularly due to the significant weightage given to homeowners' assessments of their home prices and rental values. The speaker suggests focusing on alternative inflation metrics that capture tangible product prices, which are more reliable than imputed service sector prices used in the CPI and Personal Consumption Expenditures (PCE) deflator. The speaker advocates for closely monitoring pricing power trends in the corporate sector and deflationary momentum in goods prices as more trustworthy indicators of inflationary pressures.

Keywords

💡CPI

CPI stands for Consumer Price Index, which is a measure of inflation that tracks the average change in prices paid by consumers for goods and services. The video highlights the flaws in the CPI, particularly the 27% weight given to homeowner rent estimates, which the speaker sees as an unreliable and frustrating component. The CPI is a key economic indicator that the Federal Reserve monitors closely when making monetary policy decisions.

💡Inflation

Inflation refers to the sustained increase in the general price level of goods and services over time. The video discusses various measures of inflation, such as the CPI and the PCE deflator, and how these metrics may or may not accurately capture the true inflationary pressures in the economy. The speaker suggests that the Fed may be relying too heavily on imputed service sector prices, which are less reliable than observable product prices.

💡Disinflation

Disinflation is the process of inflation decreasing or slowing down. The speaker mentions that much of the disinflation observed has been in the goods sector, where prices are more reliable and can be 'seen, touched, and felt.' This contrasts with the service sector, where prices are often imputed or estimated, which the speaker sees as less reliable.

💡Federal Reserve (Fed)

The Federal Reserve is the central banking system of the United States, responsible for conducting monetary policy and maintaining price stability. The video discusses the Fed's focus on different inflation measures, such as the CPI and the PCE deflator, and how the Fed may be shifting its attention to business contacts and observable product prices. The speaker speculates on how hawkish or dovish the Fed Chair, Jay Powell, may sound in upcoming commentary.

💡Nonfarm Payrolls

Nonfarm payrolls is a key economic indicator that measures the number of paid workers in the U.S. economy, excluding farm workers and certain other employees. The video questions the reliability of this metric, suggesting that it may not accurately reflect the true state of the labor market. The speaker points out divergences between nonfarm payrolls and other labor market indicators, such as the workweek and household survey data.

💡Recession

A recession is a period of significant economic decline, typically characterized by a contraction in economic activity, rising unemployment, and declining business and consumer confidence. The speaker suggests that the data, particularly the contraction in full-time jobs and the decline in the workweek, may be indicative of an impending recession, despite the seemingly robust nonfarm payroll numbers.

💡Monetary Policy

Monetary policy refers to the actions and decisions taken by a central bank, such as the Federal Reserve, to influence the supply of money and credit in the economy. The video discusses how the Fed's assessment of various inflation measures and economic data may impact its monetary policy decisions, such as raising or lowering interest rates or adjusting the pace of asset purchases or sales.

💡Imputed Prices

Imputed prices refer to estimated or inferred prices for goods or services that are not directly observed or traded in the market. The video raises concerns about the reliability of imputed service sector prices used in inflation measures like the CPI and the PCE deflator. The speaker suggests focusing on observable product prices, which are more reliable and can be 'seen, touched, and felt.'

💡Deflation

Deflation is a sustained decrease in the general price level of goods and services over time, which is the opposite of inflation. The speaker suggests that observable product prices are actually exhibiting deflationary momentum, meaning prices are declining. This contrasts with the service sector, where prices are often imputed and may not accurately reflect the true inflationary or deflationary pressures.

💡Labor Market

The labor market refers to the supply and demand for workers in an economy. The video discusses various labor market indicators, such as nonfarm payrolls, the household survey, and the workweek, and how they may be painting different pictures of the true health of the labor market. The speaker suggests that the labor market data may be indicative of an impending recession, despite the seemingly robust nonfarm payroll numbers.

Highlights

The CPI is considered a flawed statistic, with 27% of the index being based on a survey asking homeowners how much they think they can rent their homes for, known as the "owner's equivalent rent".

The overall trend in inflation is expected to remain intact, despite the flaws in the CPI calculation.

The speaker suggests paying attention to inflation series other than the CPI, such as the one proposed by David Rosenberg at Merrill Lynch, which involves "slicing and dicing" inflation data.

The Federal Reserve is increasingly shifting its focus from government data to what business contacts are telling them, according to Governor Waller.

The speaker suggests looking at the prices of tangible goods instead of relying on imputed service sector prices in the CPI and PCE deflator, as the latter are considered guesswork.

The speaker expects the service sector, which the Federal Reserve is most focused on, to be the most unreliable component of the CPI and PCE deflator.

The speaker anticipates that Federal Reserve Chairman Jay Powell will sound hawkish in his upcoming commentary, despite the economic data supporting a pause in rate hikes.

The speaker expresses concern that the nonfarm payrolls data, which the Federal Reserve heavily relies on, may not accurately reflect the true state of the labor market.

The speaker suggests looking at the household survey and the contraction in full-time jobs over the past six months as indicators of a potential recession, rather than solely relying on the nonfarm payrolls data.

The speaker highlights the divergence between the nonfarm payroll headlines and the workweek data, with the latter already at recession levels, suggesting a more concerning state of the labor market than the consensus narrative.

The speaker emphasizes the importance of digging beneath the surface of commonly cited economic indicators, such as nonfarm payrolls, to gain a more accurate understanding of the underlying economic conditions.

The overall message is that policymakers and analysts should look beyond headline numbers and imputed data, and instead focus on tangible, reliable indicators to better assess the true state of the economy.

The speaker advocates for a more nuanced and critical examination of economic data, particularly those related to inflation and employment, to avoid being misled by flawed or incomplete statistics.

The discussion highlights the ongoing debate and uncertainty surrounding the interpretation of economic indicators and the appropriate policy responses, underscoring the complexity of economic analysis and decision-making.

The transcript provides valuable insights into the limitations of widely used economic metrics and the importance of considering alternative data sources and methodologies to better understand and respond to economic conditions.

Transcripts

We've talked about it like almost forever, about how flawed a statistic

the CPI is when 27% of the index is one question to a sample of homeowners,

which is how much do you think your home price,

how much you think you can rent your home, your unit for?

And so, you know, that's the owner's equivalent.

Rent in particular is an ongoing source of frustration for people like me.

But I do think that the overall trend is going to be intact.

David, you were on the high ground on this to review this quickly with a lack

of time because Paul wants to get in. There was a guy named Farrell at Merrill

Lynch a few years ago, and he had this young Turk name, Rosenberg, who owns the

slicing and dicing of inflation. If you don't like CPI, what inflation

series? David Rosenberg, should we pay attention

to? Well, you know, what's interesting is

that, you know, in December, I think it was Governor Waller had said that the

Fed was increasingly shifting its focus from, you know, the government data

towards what business contacts were telling them.

And, you know, we're going to get the base book tomorrow.

And the last couple of base books have said decisively that the corporate

sector is seeing diminished pricing power.

The ability to pass on cost increases has gone down materially.

So I think you have to I mean, so much of the CPI, even the PC deflator are

imputed guesswork. They're imputed pricing in the service

sector. So I'd say turn your attention to the

things you can see, touch and feel in the product sector.

And when people say to me, well, but, you know, all the disinflation has been

in the goods sector. Well, those are the prices you can

actually have reliability on as opposed to imputed services.

My big concern is that it's the service sector that the Fed is most focused on

and that is the most unreliable components you have within the CPI PC

deflator. So I say look at the prices of the

things you can see, touch and feel, and they're actually in a deflationary

momentum. And I expect that that will persist over

the next year. So, David, this is a good week to be an

economist. Lots of economic data coming out this

week, including we're going to hear from Fed Chairman Jay Powell.

Do you expect the chairman to I don't know, try to walk back a little bit some

of the December commentary. It seems like the economic data is

supporting just kind of waiting here on rate cuts.

Well, firstly, it's always a great time to be an economist.

It's no exception. We just have to fasten your seatbelt and

stay at our desks. 24 seven.

Look, the Fed has already walked back that business in December.

And, you know, the markets leapt on some, you know, comment that I think

Mary Dailey made about that maybe March would be the date.

And of course, then the futures price in, you know, six rate cuts, not three.

The Fed has successfully calibrated the market back to where was in December.

I expect that. I think he's going to be pretty hawkish.

And everybody has lined up hawkish relative to where they were in December.

And the question is going to be, will these sound more or less hawkish than

what's priced in right now? My big concern, actually, and this is

coming from a bond bull and who would be ordinarily a dove on the Fed.

I think he's going to sound pretty hawkish tomorrow.

Hmm. How about the.

I mean, we're going to get some data here, I think, in a big data week here.

You got the payrolls on Friday. I mean, that's kind of one of the issues

for this market is the labor market's been very strong here.

Well, look, if you bow down to the holy grail of nonfarm payrolls, that's what

you would believe. And of course, that's all the Fed

focuses on is nonfarm payrolls. And I've almost given up trying to

forecast the number because last year, last year, half of the growth in

non-farm payrolls didn't even come from the survey.

It came from the down model where we used to call it the plus factor.

But frankly, if you looked at the household survey and especially the

contraction in full time jobs over the past six months, yeah, I mean, we're

replacing part full time jobs with part time jobs.

There's been practically no growth in the household survey over the course of

the past half year, though. So certainly be thinking this recession

is probably staring us in the face. The other thing I would just mention is

this. Look at the look at the divergence

between the non-farm payroll headlines and the workweek.

The workweek is already back at recession levels.

So I know I hear this all the time, the employment numbers, the robust economy.

But actually, you know, when you dig beneath the veneer, even of the beloved

payroll survey and you look at the hours worked, it's telling you something a

little more insidious of what's happened in the labor market than what the

current consensus narrative is.