Odd Lots - What Is Really Going On With Rent and Healthcare Inflation?

Episode Date: October 3, 2022

One of the biggest drivers of inflation is rent. Arguably, it's the whole ballgame right now. If rent growth stays firm, it's hard to see inflation getting back to the Federal Reserve's intended target anytime soon. If it rolls over, then maybe that will allow the Fed to breathe a little bit easier. But signals about the future direction of rents are mixed. While the government data is red hot, various private surveys do show some easing. On this episode, we speak with Omair Sharif, the founder of Inflation Insights, who walks us through rent prices and how the numbers are gathered. He also discusses a key change coming to the measured price of healthcare that will likely be a significant drag on inflation in the year ahead.See omnystudio.com/listener for privacy information.

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Saturdays and Sundays starting at 7 a.m. Eastern. Make us part of your weekend routine on Bloomberg Television, radio, and wherever you get your podcasts. Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Wisenthal. And I'm Tracy Allaway. Tracy, last month's inflation number. I mean, I guess it was just a disappointment, right? Because two months ago, it was this cool number, both on headline, core, like,

maybe the turn is finally here. And then last month, it was like, nope, straight back up again. How many words did you write about why people should be focused on month on month versus year on year? No, I still think that from an investor standpoint or just someone trying to understand the economy, clearly like the sequential numbers are more telling. I wasn't trained. Tracy, I resent the insinuation that you'd think I would write something. I would never insinuate anything. Okay, but you're right. Okay. So people were expecting inflation to start to slow down a little bit. And that's why there was lots of talk about why you should look at the sequential month-on-month data versus the year-on-year. But what we saw instead was basically any. way you slice the data, it looked disappointing. And were you going to defend month on month again? No, no, of course month. I was just going to say, ironically, the only measure that looked good was the completely

unslaced headline data because that was so far dragged out by that price. But the moment you did even the slightest bit of prodding under headline, it was like, oh, my God, raging hot. All right. Well, I think the big takeaway from that number, other than it being disappointing, was the fact that we really see some of these price increases starting to spread from things like food and energy and more towards services. And services, as everyone is now finding out, is a big, big part of the core index. And I guess everyone called this too. Like I think last year they're like, oh, we're going to have

this big shift to services. And yeah, sure goods prices will come down in bullwhip effects and inventories and all that. But now it's here. And it's like, oh, man, this could be here for a while and it's not slowing down yet. Yeah. And I think the big question is, how long does it take to feed into the index and how long does it take to kind of go away? And there are different data points, and there's been some discussion of this as well. There's private market data points, for instance, that show rents are starting to slow. So when does that feed into CPI? Right. So various online companies like a Zillow or something, they'll have a rent index. And this sort of gets to the question. Because first of all, the thing that one of the big upward drivers of inflation in the last report was rent.

Most people feel rent. It's like a very salient category. There are some categories that maybe are hidden. Rent is not one of them. Shelter is not one of them. But then, yes, there is this thing. So it's like, okay, we have these private measures that seem to be rolling over a little bit, but the numbers in the CPI keep going up. So is this a case where the CPI has just lagged? Like, is it bad data? Or is it people are misunderstanding the relationship between the official government numbers and what some of these private surveys are saying? Well, today we are going to be digging deep into those numbers, right? Absolutely. So let's get right to it. We have the all. ultimate guest for digging into inflation numbers. And he knows more about what these numbers

actually mean and how they're derived. I think you've talked to him several times and you're reporting on like the minutia. Like you when you did like mayonnaise reporting, it's like, okay, where is this and which index and how much of this is like soy oils versus condiments? Yeah. He knows everything. The way we measure inflation never ceases to amaze me. And there's just so much to say about the actual construction of the indices and things that people don't normally talk. about, but we probably should. Let's talk about them. We are going to be bringing back to the show, a past guest, Omer Sharif, is the president and founder of Inflation Insights, and he will answer all our questions about why some numbers are going up, maybe some hopefully that go down. So, Amera, thank you so

much for coming back on the show. Thanks for having back. What's going on? When's the numbers get to start turning down? This is, I thought inflation was transitory. I made a whole, like, you know, I was like on team transitory. Now I look ridiculous. Well, I think probably, the turn of this year is what I'm thinking is we're going to start to see the monthly rate, especially in the core, starts to really kind of come off. I mean, we've been kind of stuck around 0.5, 0.6, every month on the core pretty much for close to a year. We haven't got a long relief, but I think that relief is coming from a few different areas, hopefully in the next couple of months. Okay, I'm going to, it doesn't matter how long it takes, I'm going to claim victory for

in five years if inflation comes down. Great. Okay, well, maybe we can talk about one of the things that people expect, to start coming down, and it hasn't, at least according to last month's data, and that's used cars, car prices. And this was one of the big drivers of inflation actually, you know, going up over the past year or so. Why haven't prices come down? This is what everyone was expecting to happen. Yeah. So use car prices like a lot of things, you know, when prices are cool sale prices are going up, they adjust very quickly on the way up. When they are coming down, they take a little while to come down. And so what we've seen honestly all year long is that

wholesale prices are down very, very sharply. You want to look at Mannheim, Blackbook data and JD Power, which is source data actually for the BLS. All of these things are down, you know, 10, 11, 12 percent, depending on the index, over the last six, seven months. Retail, though, on the other hand, has been kind of roughly flat because a lot of sellers are not really pulling down their prices. But we are starting to see that change. And really over the last six to seven weeks, I would say that that is starting to adjust. So model years, you know, two-year-old models, three-year-old models. Those prices, retail prices are coming down.

You can see this in the Black Book Retail Index, for example, prices were down about two and a half percent in August. So all we're really waiting to see is that data translate into the CPI index for use cars. And I think, you know, September is a good point where that might enter, but I think October is probably the month we really want to focus on. September, there's a lot of adjustments that are happening in September. But September-October, I think, is when you really are going to start to see the retail stuff on these cars index start to come come off in the CPI.

And that's going to be a big boon in terms of, you know, getting that core weight, poor index slower. How do you actually go about, because this is your day-to-day business, how do you go about trying to measure that lag between, you know, what we see in the market and what we actually see showing up in the CPI data? First of all, you're looking at these market indices, you know, whether it's Mannheim or Blackbook. And you're essentially mapping them at the wholesale level against the retail.

price index for the CPI. Now, obviously, wholesale, you know, typically what you'll find is the strongest correlations will be with wholesale changes, feed in roughly about two months later into the CPI. Now, what's really interesting is like before the pandemic, this was pretty much a constant, roughly a two-month lag. So eight weeks later, whatever happened, wholesale typically showed up in the CPI. What the pandemic did was completely throw these lags off to the point where, you know, prices started moving at the wholesale level. And obviously, are going up and that immediately fed into retail. Like there was no lag whatsoever. And if it went at five, six percent of wholesale one month, guess what? The CPI was going at five, six percent of

use cars in next month. Now, what we're seeing now, I think, is a little bit of a reversion to that, you know, the old lag of about two, three months. And that's why I think, you know, we've seen wholesale come off the last several months and people are saying, well, wait a second, the CPI use cars indexes, you know, kind of unchanged or maybe up a little bit. So I think, think it's just the issues that the lags are kind of back to what they were. This is sort of like gasoline. You know, when gasoline prices go up at wholesale level, you feel it right away and you see it right away at the pump. When they go down, it's a very gradual decline, right? You're kind of pocketing that extra margin. And I think dealers are doing the same thing and have been for a while. But

I think that jig is up and should be over the next couple of months. So let's talk a little bit more about this. And, you know, I'm starting to like feel a little bit better about always being wrong on everything, because I just look at these measures, right? I look at trucking. I look at cars. I look at the AAA gasoline. It's like, look, all these lines are going down. They should show up. Can you talk a little bit about why these lags exists? What is the difference between some of these measured prices and the government prices? And do you have any theories or sort of explanations why past lags got disrupted and so that the gap between private survey measures of prices versus what showed up in government data did not have the same temporarious.

relationship as it used to pre-pendom. Who temporal is a good word. Thank you. Yes, I would talk about this with using, you know, let's go back to use cars. Yeah. One is, you know, that in terms of the pandemic, when it hit, what you had was basically a complete disruption in the used cars market. So it wasn't just that people demanded used cars because, let's say they were moving

in suburbs or whatever. The biggest shift was you had a natural seller in the used cars market, rental car companies, who became a net buyer of used to vehicles. And we really haven't seen that before. And what they did was they scooped up all the zero to three-year models that they could to sort of replenish their stock. You know, things came back a lot stronger obviously in 21 that people thought. So take a company like Avis, they had about 450,000 vehicles in their fleet in 2019.

That got down to about $290,000 by, you know, the summer of 2021, right when demand was moving. So they could replenish them for manufacturers. they ended up going to the used cars market. So what you found was price increases in the zero to three year bucket, which is all billed by. Those prices skyrocketed. If you're a dealer trying to buy a car, you can't find these vehicles. Now you need to go out by four or five, six euros.

So all across that age curve, prices spanked. And it wasn't, you know, I think the issue is just the magnitude was so large that you couldn't really wait to price them out on retail. Right. So you're paying way, way more than you were used to paying. You had to pass it on quickly. and so I think we saw those labs disrupted for that particular case. Now on the way down, wholesale is getting a lot cheaper.

You can still sell it for a bit more on the retail side. So again, just like gasoline, you kind of pocket the margins as long as you can on the way down. And I think that's what you're seeing. The other item I would actually mention where honestly I am pretty stumped as to what's going on is really furniture prices. You know, we have seen you talk about, you know, trucking rates going. down, import prices of furniture, going down, inventories have jumped. Yeah. All the big box retailers are telling you, you know, Walmart and Tartney, we've got too much

of this stuff that we're discounting heavily. And yet the CPI is going up about 1% every single month. And there, you know, typically you start to see the stuff come through pretty quickly. I've honestly been waiting since March or April for furniture to really slide and it just continues to sort of defy expectations. So there I don't have as good of an answer in terms of what's happening, but we know all the signs are pointing to the fact that they should be dropping. And the industry will tell you that. I mean, you read any furniture industry trade publication like I started doing when I was wrong on furniture for a while.

You know, Furniture Today magazine will tell you, hey, they're preparing for recession. They've got too much stuff. They're discounting. Orders are declining. And yet, the CPI is not showing it. I will say one other thing to think about is some of these samples in the same. CPI are not that large. Furniture, if you're talking about bedroom furniture, they may only have a couple of hundred quotes in the entire sample versus, you know, thousands for something like rent

or, you know, a thousand for airfare. So the smaller sample, the larger, you know, the chance that you'll have some errors, you might miss some of the price changes in a particular amount. So that It could also impact the lags that occur in the security. So, I mean, it is true on the whole that goods inflation has been going down. So I think it fell from like 10.7% last year to 7.1% last August. And meanwhile, services, as we mentioned, is starting to pick up. And services, correct me if I'm wrong, but I think it's something like triple the weight in the core index, something like that. Can you walk us through like, A, why do services get that much weighting and B, how significant is it for the core index that it's now going up?

Yeah. So, I mean, the bulk of that weighting is shelter. It's rent and its owner's equivalent rent. You know, in the core CPI, 40% of the entire core is just rent and OVR combined. And so within services, you know, the bulk of the weight is coming from shelter. So that's really what's driving that overweighting, if you will, to services relative to goods. The fact that it is going up so dramatically, you know, that's obviously been an issue for the core. I would really say probably since early spring when shelter really started to accelerate. Now, you know, one thing I want to mention is that we, I think the shelter story, honestly, is something that most people knew was going to happen coming into this year.

You mentioned some of these private market indices like apartment lists and Zillow and so on. They were showing these huge gains and rents, you know, late last year, last spring, last summer. So we knew that this was likely going to enter in the CPI this year. The question was always about magnitude. So whether it was going to be up 6% this year or 7%, which looks like we're headed for that 7% number. So to me, like that's not really a surprise on the services side. I think most people who track this stuff closely realized, hey, rents are going to be up a lot this year, probably somewhere in the 6, 7% range.

It's the other part of services, the non-shelter services stuff that I think is the more interesting part of the story. And there, what you'll find is a lot of people talking about how wages are driving those services up, you know, how all of these other costs in the non-shelter services, those are the sticky elements of inflation. And until that stuff starts to roll down, you know, it's going to be really hard to get core inflation down. I would actually sort of counter that a little bit by arguing that a lot of what you've been seeing, and this has been true since really last probably, I would say, fall, is we've had a lot

of oscillation in that non-shelter service component. And that's mostly because of sort of the economy reopening and closing and kind of fits its first. So summer of 21, if you remember, airfare started to jump very significantly, people started traveling a bit again. So a lot of what was driving services in that point was actually things like Air Affairs and Hotels. It wasn't medical care services. It wasn't recreation services.

You know, it was really personal care services. It was these sort of reopening categories, if you well. Then you had, you know, I think Delta was later that year. Prices for those categories fell. The non-shelter services inflation actually decelerated very sharply. So basically what you've seen up until really pretty, pretty recently is just this quarter to quarter oscillation that's been going on in the

non-shelter services index really just reflecting kind of the economy reopening and then slowing down. And we've got that same dynamic this spring by the way when airfare spiked and now they've been down the last few months and so the non-shelter stuff is kind of moderating a little bit again.

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Listen to new episodes every other Monday. Follow leaders with Francine Lacroix wherever you get your podcasts. So let's talk a little bit more on rent specifically for two reasons. A, because it is such a big part of core CPI, Also, it's one of the most like people feel it and people complain. Certainly in New York, everyone is aware of just like how brutal the rent market is, but also elsewhere. You mentioned that we sort of had reason to think that this number was coming in part because the private surveys were flagging this several of, like maybe even a year ago, the Zillows and all this.

So that raises one big question, which is like, is the data stale? And at a time when people are worried about, oh, are we going to create, is the Fed going to create a recession? Is it being too aggressive in light of, you know, is it whatever? Is it operating on old data that's not as timely as what the private sector surveys are showing? Is the public data stale? So I wouldn't necessarily say it's scale. I would just say that it measures something different than what these private sector indices are measured. So most of these private sector indices are measuring new leases. So when you think about moving into a new apartment, you sign a brand new lease, that's what they are capturing. They're capturing that change in the rent for that unit with a new tenant versus whatever it

rented for the last tenant. And that's true of most of these apartment lists and less so on. And so it's really just one segment of the market that those private measures are capturing. The CPI is capturing the entire rental market. So it's not just people who are looking for new apartments or signing new leases. It's also people who are renewing their lease. And it's also people who were currently renting and still all in the same lease they were, you know, five, six, seven, eight months ago. So they want to capture the entire market versus just a slice of the market. So in that sense, I don't think it's stale. Now, that said, you know, when you think about is a Fed operating on old day, we do know that

it lacks, right? Before this very reason, it doesn't capture, the BLS doesn't capture turning points in the market as well as these private sector measures. from, right? If something is changing in the marketplace, those new lease, the way those new leases are changing is going to be a much better indicator of what's happening than the CPI one. That's true. But it's not as if the Fed, number one, doesn't watch the other private sector measures. It's not that, you know, they don't understand the lags. I mean, if I understand the lags in the rent and other people do, I promise you the folks that the Fed do as well. So I don't think that they are, you know, sitting here working on these sort of lagging indicators.

if you will, because they are capturing a huge amount of data to look at what's happening in the shelter. And they also kind of see where shelters likely head. These private sector measures have started to roll over the last, you know, depending which one you want to look at, four to seven months, they've been slowing down quite a bit. So another thing related to housing and the cost of shelter, which again, it seems important because of the weight and just how much it how important it is for the public. We have seen a clear slowdown in anything related to home buying and home purchasing. And of course, that isn't, I don't believe, is they captured directly? Historically speaking, is there a relationship or a stable relationship between activity in the

home purchase market, the price of a house, the price of a monthly mortgage, which is shot up if you're just, if you're buying a house today versus a year ago, and then what feeds through into rent prices? Can I just say that was going to be my next question. Tracy, We've been working together so long. We always do this. We keep asking the same questions, but can I just tag on to that? So one thing I've heard is there are some people who say that like interest rates going up could end up increasing the pressures on rent because more people decide they're not going to buy houses. Right. They're going to stay where they are or keep renting an apartment, things like that. Yeah. So on that latter point, yes, that's very impossible. You know, if it's getting too expensive to get a mortgage or you can't find a house to buy, you renew your lease. or you know, are moving into a new apartment, that certainly can actually push rents up in the short term until supply does eventually catch up. But yeah, that's very possible. We've seen that happened before. In terms of the idea of, you know, the housing market and her purchase activity,

it really is kind of what you're talking about, which is the knock-on effect on the rental market. That's really the way it's going to feed through into the rent index because, you know, contrary to popular relief, like house prices don't play any role whatsoever in the same. CPI at all. Even the owner's equivalent rent index, you know, it's not intended to measure house prices. It basically is using the contract rent data that they capture and sort of, you know, rejiggering it a little bit to come up with OBR. But no house price goes into the index whatsoever. The mortgage interest stuff, you know, it used to actually be in the CPI prior to 1983 because it just, it was a very different methodology back then. And so when,

when rates were moving higher and the cost of servicing your mortgage moved up, that price actually was reflected in the CPI back in the day. But in 1983, there was a lot of different problems with it, and they ended up switching out to this new method of rental equivalence in 1983. So now that doesn't really play much of role, again, other than the knock on effect on the rental market in what's happening in-house. Is that how Volcker defeated inflation by removing mortgage rates from CPI? It's like, oh, we want to raise rates to fight inflation. Oh, but our current measure of inflation includes mortgages, we better to change the rules because otherwise our rate regime won't help us at all. So, it's a little weird. So actually, in that instance, because of

the rate increases, mortgage interest costs in the CPI skyrocketed. Yeah. And actually we're pushing inflation higher. So even though he was boosting rates at the same time, you would think, okay, higher rates, you should lower inflation. In fact, inflation was moving higher partly because mortgage interest costs were so much higher. And there was a lot of problems. And there was a lot of problems with the idea of mortgage interest costs. I mean, they knew about mortgage interest costs and the problems with sort of putting it into the cost of limiting index. A lot of what you, you know, a lot of issues that people have with the CPI, whether it's rents or other indexes, is really about the concept of how you design it, how you think about what you should be

capturing. And that fundamentally gets back to the idea of, you know, what is the purpose of the CPI and is intended to be a cost of living index. And, you know, the, you know, they knew back, I think it was in the 70s, they had papers at the BLS saying, look, we need to get away from this mortgage interest costs because it doesn't really fit the way that we're supposed to construct a CPI. You know, you could do a whole separate episode on that, but I think the short version is, in 1983, in 1983, they decided to say, hey, we've been talking about this rental equivalence method for many years now, and we think it's the right way to do. And by the way, I will just say very recently, National Academy of Sciences basically put out a report that said

you know, here are our recommendations for improving the CPI in the coming years. And they talked about looking at, you know, these private measures of rent as potentially trying to incorporate them into the CPI. But they said up until then, the best measure that we have is really the rental equivalence method that we use today. Let me ask a slightly less provocative question other than how we measure or don't measure mortgage interest in CPI. So historically, one of the reasons we focus on rents is because people feel them. They're a big component of the core index, but also because rents and wages tend to be tightly linked. And I think there's concern that as rent inflation accelerates, are we going to see that knock-on effect into wages? What are you seeing there?

Yeah. As you said, it is a pretty tight fit. I mean, basically, I would say labor income and rent growth are pretty tightly correlated. You know, again, I think, as rents have gone up, they correlated well with this improvement in wage growth. One of the interesting sort of tip-its is that a lot of, even though rents are rising, a lot of people who are re-uping their leases are actually, or sign new leases in, you know, sort of more professionally managed apartment buildings, so more of your large multifamily unit buildings, are actually showing that their incomes have increased pretty significantly over the last two years. So even though we talk about, you know, the idea of a lot of people getting priced out because rents are rising so sharply, people who are

signing new leases and having to provide the paperwork from their bank statements or their employment information are showing that incomes have actually also increased pretty significantly. And so I think, you know, as you start to see wage growth decelerate a little bit, which is already starting to happen at the margins, you know, people who manage these apartments sort of, they get this kind of real-time flow of what labor income looks like. And I, I, I, I think that's partly also why you ought to see rents start to decelerate is because they're not raising rent to 6% when these labor income only go again. Let's say it's 3%. Where did you get?

Where's that data from that the people, that the cohort that is signing new leases is actually seeing wage gains that are keeping up with rent? Yeah. So that comes from real page. And that's another large sort of private market provider of everything from rent data to all sorts of information on multi-family buildings. And so they've been tracking this and sort of publishing, you know, stories on those for the last, I think, about 18 months or so. Just this idea that even though rents are moving higher, people are able to afford those rates because their incomes are rising alongside those rent deals as well. So one other question on rent before we go off it. And again, it sort of connects to broader housing questions. A lot of people, I think, in the last couple of years, when rates were low, bought houses as investment property.

and maybe don't want to sell right now, in part because there aren't a lot of buyers who are excited about the sticker shock of what a monthly mortgage now cost them. Could this bring more rental supply to market? In your view, it's like, well, I can't sell it, so I'll rent it. And could that have a dampening effect on rents? Yeah, very possibly. I mean, most indices don't trap single family rentals. The only one that I'm aware of that does is either Zill or logic. It's one of those two has a single family rent index where they do track.

what rents are specifically for that sort of, you know, for that type of rental. And yeah, obviously, if you can't sell it and you want it as best investment property, it makes quite a lot of sense given that, you know, demand is still pretty robust for rentals. Vacancy rates have only barely started to edge higher from the lows that we saw, you know, even six months ago. Yeah. So there's still quite a lot of demand out there.

So it makes sense to do that at this stage. And, yeah, hopefully that can help bring at least that one segment of, of rent of the rental market down. And by the way, that is also captured in the CPI, right? The CPI isn't, when you're talking about rents, it's not just apartments. They also do capture single-family rentals in that entire sample as well. You can get the news whenever you want it with Bloomberg News Now. I'm Amy Morris.

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So you're always getting the latest stories and developments. Get the reporting and the context from Bloomberg's 3,000 journalists and analysts we're all over the world. Listen to the latest from Bloomberg News Now on Apple, Spotify, or anywhere you listen. So we've been talking a lot about rents, which have been pushing services up higher, but are at the point you've been making, are expected to start to decrease sometime soon, or at least the rate of acceleration will start slowing down. Talk to us about another big change that you see potentially on the horizon that has to do with health care. Yeah. So this is another one that I think is, it's coming very soon. It's going to help everyone looking for that transitory inflation story to, you know, kind of pop up again.

We hope I can get. Yeah. So, you know, right, as I mentioned, the biggest part of the core CPI 40%. The second biggest component is medical care. That's worth just about 11% of the things. core. And for the last year, medical care has been rising at about, you know, roughly 0.5% each month, which means it's been adding about five basis points to the core change every single month. That's been very steady. It's kind of like clockwork pretty much all of last year. Starting in October, that index is going to turn negative. And it's going to turn negative in most months over the course of the next year. And so what was a pretty common, constant source of a boost to the core every single month is actually going to turn into a relatively decent drag on the core. And, you know, it's not because medical care is getting cheaper or so

on. This is actually just one of these works in the methodology that you kind of have to be aware of. And it comes very specifically from the health insurance index within the broader medical care gauge. Well, what's the, so what is that change that's coming? Why is it, what? What is going to switch from pushing up to being a drag? Yeah. So the story is basically that, first of all, health insurance is updated once a year, typically in October. It used to be September.

Last year was October. This year will be in the October report again. But this data lags by almost about a year. So the BLS takes this data, and this is from an official source, the National Association of Insurance Commissioners. So this is sort of, you know, they put out a big report on how much in premiums has been collected, how much is being paid out, and how much is retained by the insurer. So this is kind of the holy grail of this data set. Unfortunately, it doesn't come out until about 10 months after into the

year. And so what we're really capturing this October is going to be activity that happened in 2021. And so what's going to happen here is that if you think about 2020 and during the pandemic, people, you know, put off things like elective surgeries. They didn't go to the doctor because people didn't want to be, you know, in waiting rooms with other people who might have COVID, right? So there just wasn't a lot of utilization of healthcare services in 2020. Premium income continued to increase, but the benefits paid out actually declined. The way the CPI captures health insurance is by looking at the change in these retained earnings for insurers from one year to the next.

And very quickly, the reason they do this is because it's really hard to price health insurance from one month to the next because policies are changing. all the time, right? What a policy will cover will be, could be changing quarterly, monthly, you know, each year, the risk factors that go into the policy can change. So when the VLS is pricing any good or service, they want apples to apples from one month to the next. And if something changes, they want a quality adjusted. But in health care, and health insurance, they found that's just way, way too hard to do. So the roundabout way of this indirect way of capturing the price to you, the consumer of health insurance, is basically,

Basically, what does it cost the business to offer you health insurance? If their cost of administering health services or health insurance is rising, you'll probably see that in your premiums. And so the way they capture this by looking at these retained earnings and how they're changing from one year to the next. So during the pandemic, premiums kept rising. However, benefits paid out to people went down quite substantially because of COVID and the lack of utilization of healthcare.

So what you saw was a huge spike in retained earnings. And what that meant for the CPI was that in October of 2021, which reflected this 2020 data, health insurance jumped by 2% in the month of October, which means that basically, since you only updated once a year, it's effectively going to print right around 2% every single month like clockwork until the next update. Fast forward to 2021. people started going back and taking care of these elective surgeries and utilizing health care much, much more than they did 2020. Premiums didn't really change too dramatically.

So now you have a mismatch again where way more utilization of health care than you had in 2020 and 21. And so those retained earnings dropped on a year-over-year basis. So what's going to happen now when you update it is that you're going to have a very large track. So health insurance, which has been 2% a month pretty much for the last year, is very likely to print in October report around minus 4%. Wow. You know, on the surface, you say, well, plus 2 to minus 4, that doesn't really sound like a lot. But if you kind of put it into context, it actually is kind of dramatic because, number one,

in the month of October itself, that alone is worth almost a seven basis point swing on just the core CPU. So if you're forecasting, let's say the core, maybe you get a 0.4 in October, you're probably looking at something that's more like a point three instead just because of this move in health insurance. And that's kind of the difference between a 5% annualized rate and, you know, something that's more like a 3.5% in a plus rate. So that's a pretty big gap. The other issue is here on a year-by-year basis, health insurance currently is about 25% year-per-year because of a steady, you know, 2% march every month. When the next report comes down in September, which is sort of the last hurrah before it, you know,

turns negative, we'll probably hit about 28% year we year. Once this minus four comes in in October and it stays there for the bulk of the year, by September of 2023, health insurance, I suspect will go from plus 28 to about minus 40 year over year. That swing is worth almost about 80 basis points on the core CPI. So you have an index that's worth just over 1% of the entire core CPI, that by itself will subtract almost a full percentage point for inflation for another next year. That's major match. This is so crazy to me because the whole point of like measuring this stuff and then monetary

policy is like countercyclical. And this huge component, as you just described it, has no, there's no actual like economically cyclical impulse part of it. Well, this was actually going to be my next question. And Omer, that was absolutely fascinating. And the thing about qualitative adjustments was something that I only, like, really discovered this year. So I didn't know the BLS, you know, if they're looking at the cost of a refrigerator, for instance, will take into account technological advances on the cost of the refrigerator if it now comes with, I don't know,

Wi-Fi connectivity or something. Blockchain-enabled fridge. And they will factor that into the CPI. But, I mean, this gets to one of the major criticisms of the indices themselves. you can kind of see what they're trying to do. So it's difficult to measure qualitative improvements in things like health care insurance. But on the other hand, it does lead people to look at these things and go, well, what are we actually measuring here?

And isn't it weird that the cost of living, you know, as measured by the CPI, which includes rent, health care, food, energy, whatever, can change just because of like the way this one thing is measured, retained earnings versus. the way we measure goods and things like that. What do you say to that criticism? It's fair to make those sorts of criticisms. I guess I would say a couple. One is that, you know, this is never a static process

in terms of the methodology. So the BLS is always trying to improve upon whatever is that they're doing. A good example of this is something like new vehicles. Just in April of this year, in fact, they introduced a brand new methodology for capturing the price of new vehicles. So before they used to go to dealers, figure out what was selling, you know, try to capture those prices.

Now they're using a massive data set from JD Power, which captures, you know, essentially real live transactions that are occurring. So they've updated that quite significantly to really reflect kind of the conditions on the ground for people who are providing new cars. So there's always, there's always this sort of, you know, goal to improve upon the methodology. So that's, that's number one. Number two is, you know, you kind of do the best you can with what you're given. And by that, I mean that a lot of these things are subject to things like budget constraints. You know, when we talk about rent, for example, the BLS, if you survey a unit, let's say in January, and you say, hey, how much you're paying in rent, you come back to that unit, you don't come back to it in February or March or April,

you come back to it in July, six months later. Part of the rationale is because, you know, rents don't change a lot in terms of the contract. So six months. seem like in an adequate amount of time. But the two other reasons are one respondent burden, right? If I'm knocking on your door every single month asking what your rent is, you might be less willing to participate in the survey. But the other is also, there's a budget, budgetary constraint involved in terms of, you know, sending people out into the field to capture a lot of these data sets. So that all of these things sort of constrain what, you know, the BLS can ultimately produce. In this particular instance for health insurance, you know, I can sort of understand a bit

more of the criticism, but the issue here is really the data is just lagged 10 months. We can't do anything about that. I mean, the data that they are getting is from the National Association of Insurance to issues. And if you think about capturing all of the premium information, all of the claims that are paid by all of these health insurers, you know, it just takes up for the last year, it just takes a while to put those numbers together. So this is just something where the BLS just has to wait on the data that they're capturing. Again, that data set is effectively like the Bible for health insurance data, right? And so in this instance, they can't do anything.

They just have to wait until that's produced. So I think in some instances, like I get the criticism. I just think you've got to understand that they're working within a number of different constraints. And, you know, sort of take that into account when you're thinking about criticizing them for particular approaches. in terms of, you know, how they constructed it next. Omer, can we do a live event with you one day where people throw out a CPI category and then you like on the fly explain it? No, I seriously, people would love to explain how it's constructed because we could, we could just talk forever on every category. I found this conversation.

Seriously, can we do that someday? Yeah, there's, you know, there's 243 individual components in the CPI. I love it. I think I've got most of them down so we could probably do that. Other fats and oils, including peanut butter. Yeah. I didn't say we could do the PPI. Oh, that's true. Wow, you actually knew that was a PPI code versus the CPI.

That's very impressive. Yeah, because I think we've talked about it in the past with that one. One final thing I just wanted to mention on this health insurance stuff is that, you know, part of the reason why I think it is pretty important is because this data set, the official report is coming out. I think in about a week. I tend to use a separate source, which is, you know, captures quite well. basically my feeling is that folks who are either treating inflation or who just generate follow inflation are pretty unaware of this change that's coming. So this is going to be something that is at the margin going to help the Fed month over month for the next year, along with,

I think, the coming decline of use cars. So really, Q4 potentially is shaping up to see some lower core inflation prints from not just used cards, but also. I'm going to spike the football at the end of QFar. Omer Sharif, thank you so much for coming on. Fascinating conversation. Always love chatting with you. Always learned something. And we'll have to have you back again soon. Thank you. Take care, Omer. Thanks, Omer. That was great. I love talking to Omer. I always learned so much. Sending to said, the fact that he gave me, you know, he throws these little like bits of red meat for team transitory. I just actually like learning about this. I had no idea how they captured health church. That's so interesting to me. Yeah. So I think I have maybe three major takeaways from that.

Like, one, it's just crazy how much of the market and our daily lives are linked to the construction of this one index. And how, well, I mean, it's multiple indexes, but PPI, CPI, and how it works. Like, think about all the payments, Treasury Link, securities, things like that that are linked to CPI. And so much of it depends on the individual construction. And then the second takeaway, you know, what he was saying about the time lags and how COVID kind of messed those up, I think is a really good way of looking at why there's. there's been so much confusion over inflation. Yeah. And then thirdly, this is something that I'd heard before,

but the resource constraints on the BLS in terms of assembling some of this data and trying to adjust it, I think that is maybe an underappreciated factor over the past couple years. Well, and especially like some of these, some of the stickier prices within goods that like, of course these should come down, right?

Because we have every big box retailer saying, we have tons of inventory. The housing market slowed down. So it's like all kinds of reasons to think, yeah, we should be seeing some deflation and furniture. It's not happening. But then he says, oh, maybe they only contract a couple hundred in the survey. Well, right. If your survey respondents are like the big box stores that have pricing power or still have pricing power for a while, then it'll be sticky.

No, there's so many. And we should at some point do an episode on when they changed the rules of inflation because it is like it's crazy to think that like 40 years ago, if they raised rates, that mathematically raised measured inflation because interest in mortgages was included in the CPI, which is also like kind of maybe intuitive to a lot of people. Well, it's one of those things. Like you can see why they would do it. But on the other hand, it also seems odd if you think that CPI is supposed to measure the cost of living. Fascinating stuff.

Yeah. We could talk about this for a long time. Okay. Shall we leave it there? Let's leave it there. This has been another episode of the Oddlots podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloy.

And I'm Joe Wisenthall. You can follow me on Twitter at The Stallwart. Follow our guest, Omer Sharif. He's at F-Cast of the Month. Follow our producer, Carmen Rodriguez, at Carmen Armin. And check out all of our podcasts at Bloomberg under the handle at podcasts. Thanks for listening. This is Tom Keane, inviting you to join us for the Bloomberg Surveillance Podcast.

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