The Pomp Podcast - #1242 Darius Dale | Will Inflation Come Back Hot?

Episode Date: September 14, 2023

Darius Dale is the Founder & CEO of 42Macro. In this conversation we talk about inflation, what is going on with headline CPI, core CPI, confusing data, sticky inflation, should the Fed move the inflation target to 3%? ======================= Trust and Will has simplified the process of creating and managing your will or trust online. They leverage a data-driven, design-first approach and amazing customer support to help you protect your legacy from the comfort of your home starting at just $159. Sign up today for 10% off using https://trustandwill.com/pomp ======================= Pomp writes a daily letter to over 250,000+ investors about business, technology, and finance. He breaks down complex topics into easy-to-understand language while sharing opinions on various aspects of each industry. You can subscribe at https://pomp.substack.com/

What's up everyone? This is Anthony Pompliano. Many of you know me as Pomp. You're listening to the Pomp Podcast, which is my effort to find the most interesting people in the world and sit with them for hours while I ask questions in an effort to learn. So it would mean the world to me if you would subscribe to the show on your favorite audio platform, watch episodes on YouTube, and tell your friends and family about the podcast. My goal is to help millions learn from the world's most interesting people. So let's get into today's episode. Darius Dale is the founder and CEO of 42 Macro. In this conversation, we talk about inflation. What's going on with headline CPI, core CPI? Why is there seem to be confusing data?

Are we headed towards a sticky inflation world? And should the Fed move their target from 2% up to 3%? All of that and more covered in today's conversation. Here is an episode with Darius Dale. Today's episode is brought to you by Trust and Will. I've gone through a number of different changes in my life over the last few years. I got married, I had a kid, and I had to start thinking about how could I ensure that my wife and my child would be okay if anything ever happened to me. That's where trust, wills, and estate planning come into play. Now, most people, what they do is they get introduced to a friend, an uncle, or someone in their local community. It tends to be someone who's really expensive, a lawyer, an accountant, or somebody who does

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Plus, you'll get free shipping of all your estate planning documents. So go to trustandwill.com slash Pomp and make sure you get an estate plan in place. Whether it's for you or one of your loved ones, having a trust and or a will can literally be the difference between someone being taken care of and someone not. Go check them out today at trustandwill.com slash Pomp. Anthony Pompliano runs Pomp Investments. All views of him and the guests on his podcast are solely their opinions and do not reflect the opinions of Pomp Investments. You should not treat any opinion expressed by Pomp or his guests as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of his

personal opinion. This podcast is for informational purposes only. All right, guys. Bang, bang. I've got Darius with me. Darius, CPI numbers, they're coming in. People see headline falling, then going up. We see acceleration. What the heck is going on with CPI? Yeah, absolutely, man. It's great to be back. So I just thought I'd show a few charts to kind of help investors understand kind of what's happening with inflation dynamics. We could be in the midst of a phase transition with respect to the market sort of narrative and themes around inflation. So we'll start with this first chart here where we show headline CPI. It's now accelerating again, and it's primarily due to energy. So in these panels, in each of these charts where you see the blue bars, those are

the three-month annualized growth rates or inflation rates in this particular instance, and the red line shows the year-over-year rates of change. So the first panel, we show headline CPI, year-over-year rate of change, the red line popped up primarily due to easing base effects. But what's most concerning is that we had a big, massive spike in the three-month annualized inflation rate from roughly just around 2% to about 3.9%. So that's the highest number we've seen in quite a few months. And that number, obviously, was ticked up by food and energy. Food accelerated very modestly to 2.4% on a three-month annualized rate of change basis. But most importantly, we see this big pop in energy in that third panel there. You see,

we had basically been trending negative, compounding negative in energy inflation, really, since this time of last year. Now we just go, bang, this big pop of 25.4%. And that's something that looks like it may persist, given our volatility just on minimum signal on Brent crude oil. So when we see the headline number accelerating again, people sort of say, oh, wait a second. The core CPI seems to be decelerating, but maybe not on a month-to-month basis. What's going on with core versus the headline number? Yeah, absolutely. And this is why I said we may be in the midst of a phase transition because it's not entirely clear yet because we have this divergence between headline and core. So again, core CPI continued to

decelerate. We decelerated 2.4%. That's the lowest number we've seen really since going back to 2021 on a three month annualized rate of change basis. That deceleration was driven by a breakdown to deflation in core goods CPI. That's the second panel there to minus 1.9 percent. We saw core services CPI was pretty flat, right around 4 percent three month annualized. But we saw a pretty significant breakdown in shelter inflation from just over 5 percent to 4.4 percent on a three month annualized basis. So that's quite positive. And then lastly, that bottom panel there where we show super core CPI. So that's core services, ex-housing. This is one of Jay Powell's favorite metrics to track, particularly in the PCE deflator statistics. That number has

actually risen for the past couple of months on a three-month annualized basis, but it's still trending below its pre-COVID trend of 2.3%. So nothing to be worried about there. Got it. Now, on this next slide you have is sticky inflation. And you're going to have to explain a little bit in terms of the deceleration of median CPI, but also how the accelerating trimmed mean CPI and what the differences there are and why you think that this really is showing this, quote unquote, sticky inflation. Yeah. So let me take a step back and just kind of explain what I mean by sticky inflation, right? So go back to January of this year, when we co-authored with Bob Elliott over at Limited Funds, this theme, this transitory

Goldilocks theme, this sort of idea that, hey, the U.S. economy is likely to continue to show resilience. Recall that we've been in the resilient economy camp since back to last summer. But once we started observing real material immaculate disinflation, we put those two factors together, resilient economy plus immaculate disinflation together to form the transitory Goldilocks theme that's been underpinning the bull move that we've seen in asset markets, Bitcoin, stocks, et cetera, throughout the year to date. What sticky inflation is, is this expectation based on our research that we always knew that eventually the immaculate disinflation would run out and be stuck at a level that's inconsistent with 2% inflation in terms of the

Fed's price stability mandate. So it's my job as an investor, it's all of our jobs as an investor, and we're certainly going to do our best to help 42 Macro clients to get this on time. But we have to understand when we go from immaculate disinflation to sticky inflation, because that obviously has significant asset market implications in terms of unwinding one half of the stool, the theme that created a lot of the price action we've seen year to date. So in terms of this chart, focus on the top two panels. The first panel shows the Cleveland Fed's median CPI statistics. So that's just the median inflation rate of all the things in the CPI basket, of which there are about 4,400, sorry, roughly around 400 categories in CPI. So that 400 categories, they're now

compounding at 3.5% on a three-month annualized basis. That's the lowest number we've seen since going back to 2021. But what's concerning at the margins is when you look at the trend mean in CPI, but what we're doing is we're chopping off the upper eighth percentile and the bottom eighth percentile of the movement in that time series to form a kind of trend mean or more kind of narrow time series on inflation, if you will. And as you can see from that second panel, the blue bars, we actually ticked up in the most recent month to 2.9%. But what's actually more concerning is that we're kind of getting stuck around this kind of 3%-ish level, right? Like you go back to the pre-COVID trend, it was around 2.1 in terms of the mean that we observed in the

time series from the beginning of 2015 to 2019. And so the fact that we're kind of getting stuck at 3% is supportive of our view that we're going to have to eventually transition and really run out of immaculate disinflation at an awkward and opportune time. Now, this producer price inflation, unpack a little bit. What exactly is that? And then what's the impact? Yeah. So this is the prices that people who sell things to the consumers are observing in their own cost structures in terms of really what businesses are paying, just the inflation that businesses are feeling. In terms of final demand there, we're seeing producer price inflation, so basically headline PPI accelerated to 4.2% on a three-month annualized basis. That's the highest number we've

seen since going back to the first half of last year. So that's concerning at the margins. We saw a core PPI, I was kind of flattish, right around 1.7%. That's right around its pre-COVID trend, So not too concerning. But then when you subtract food, energy and trade services, trade services, which is effectively super core PPI, producer price inflation, we saw that number tick up to three point three percent. Again, the highest number we've seen in like six months. So, you know, we are starting to get information at the margins that inflation is starting to bottom out, potentially, potentially bottom out and accelerate. And I'm not really talking about headline because I don't think the Fed's reaction function has anything to do with headline inflation. But what's most concerning is that we're starting to see some of these leading underlying measures of inflation, you know, like super core PPI, trim mean CPI, median CPI, super core CPI, et cetera, start to show some resistance to continuing to exhibit that downside momentum. and that is concerning for asset markets because it means a couple things one you're probably going to have more dollar strength as a function of markets expecting more policy tightening out

of the fed and or higher for longer for longer and you're likely to have more bond market volatility as well and both of those things are headwinds for uh for global liquidity creation now one of my favorite things to talk about your last slide that you got here which is is the fed gonna have to actually go from a two percent target to a three percent target uh one very popular idea two years ago now it seems to be getting some steam you got some data here with uh this inflation model explain what you're seeing here yeah absolutely so i appreciate the the intro on this man because we put this model out at the beginning of last year uh and the conclusion was roughly the same in terms of hey we think we're going to see roughly 50 to 100 more core

pc inflation on a trend basis throughout this decade and so how this model what this model is designed to do is sort of score the change in a series of indicators that have all been proven to be correlated or co-integrated with the underlying trend in Core PCE. And in terms of the mean or the weighted trend in that change in that model, it's effectively saying, hey, look, Core PCE was 1.6% in the previous decade. At best, it's now trending at 2.5%. And on the high end of that estimate range, just right around 3.2%. And so, you know, we continue to have a strong, steadfast belief that we're going to continue to experience higher rates of trend inflation, underlying trend

inflation over the long, medium to long term in this particular decade. Avi said his implications for Fed policy, they talked about it at Jackson Hole about, you know, two is, you know, we're going to stick it two, stick it two. And we just said, that's all hogwash. If the unemployment rate's high enough, they're going to go from two to three because two is essentially an arbitrary number to begin with. In fact, a fun fact, the reason all these global major central banks actually target 2% inflation in terms of their price stability mandate is actually goes back like 20 or 30 years when the Royal Reserve Bank of New Zealand just decided 2%. And they came out and since then and said, well, we just picked a number two sounded like not too much and not too

little. And all the rest of the world's central banks are anchored on this kind of borderline phony 2% number, which obviously is incongruent with the evolution of the economy, according to our secular inflation model. And so as it relates to our second and one final conclusion I'll make as it relates to asset markets in terms of the meaning of term I look for asset markets. If the model is correct, what it ultimately means is that we are decelerating to something that looks like two-ish percent inflation, and we're going to re-accelerate from 2% inflation in subsequent quarters, right? It's one thing to get inflation back down to two, which is obviously what the Fed's targeting and their forecasts imply that, you know, kind of by the end of 2025,

really at the end of next year, but first half of 2025. But the reality is, if you don't stay at two, then you've not accomplished your goal. If we bounce off two and go back to three or go back to four, this model would say we're going to go back to 2.5, 3.2% in terms of core PCE on a trend basis, then they have not accomplished their goal. And so ultimately, rather than fail, we think that institution, the Federal Reserve, and perhaps other central banks around the world are going to ultimately have to pivot and fold so they can continue to finance these burgeoning sovereign debts. Now, last question for you, Federal Reserve, obviously, you know, they're getting trigger happy. Everyone is starting to price in the fact that they're not going to raise rates

anymore. Maybe they'll start to cut rates next summer. But there is this fear of the resurgence of inflation. We also have recently seen data come out that suggests that the American consumer now has three straight years of their wages actually declining. What do we do here? Like, what's the Fed's play? Do they simply hold their nose and say, look, we got to stop? or do you think that there is room and really kind of knockout punch to this potential resurging of inflation? And you think that they should go ahead, continue to raise rates and make sure that doesn't come back? Well, the probability that inflation resurges is higher in a scenario where the Fed is not responding to it, right? Like the Fed has effectively signaled to us market

participants that they don't want to go much beyond the current level of interest rates. Now they're sort of playing the waiting game, right? Well, history shows that the waiting game is not an effective strategy, right? Like the waiting game is an effective strategy, which I believe many Federal Reserve policymakers still believe, you know, kind of behind closed doors, which is that if inflation was indeed transitory, then let's not kill and break the economy unnecessarily. Let's just wait and wait and wait and wait and ultimately get back down to two. But again, go back to our second inflation model we just discussed. It ain't going back to two. And if it goes back to two, it's going to bounce off two and reaccelerate. And that's the, you know,

when you think about this from a multi-year perspective and ultimately the policy response saw this. To me, that's the biggest risk to asset markets. And ultimately, I think they're going to capitulate and pivot anyway. We're in a fourth turning. We got CBO budget projections as debts and deficits, as far as the eye can see, in terms of trillion, $2 trillion deficits. Someone's got to buy these bonds. They're either going to financially repress commercial banks into buying this stuff, or the Fed's going to change its inflation target, which will allow it to flex its interest rate policy a little bit more, and ultimately flex its balance sheet a little bit more in response to economic and market downturns.

Where can we send people to find you on the internet or find out more about 42 Macro? Hey, I'm like Coach Prime, baby. I ain't hard to find, man. Come find me at 42macro.com. You know me at 42 Macro Weather on Twitter. You know, we like to put out a lot of good content to help educate the audience, but obviously our bread and butter is helping, you know, institutional professional investors and, you know, high net worth individuals, you know, kind of construct portfolios in

the context of some of our systematic macro, you know, signals. I appreciate you. The only thing that you missed is you ain't hit us earlier last year with We Coming, but you're here i appreciate it maybe we'll do it again in the future appreciate you brother