This morning’s January CPI release gave markets dozy with visions of rate cuts and other sugar plums a reality check. Up 0.3% over December, 3.1% over last January, the release tossed buckets of cold water on an overheated market.
Multi-metaphor-worthy or not, it’s happening. Financology readers are not surprised; we’ve long been aware of the near-universally-ignored link between asset price inflation and consumer price inflation, and with regard to the latter, just days ago warned It’s Baaack ….
Why isn’t this more widely known? One reason is that the time lags are widely variable. Asset prices can rise for years while consumer price inflation remains quiescent. Or the effects can be noticeable within a few months. The link is mechanical and certain but the time lag is a function of less certain psychology. People decide to exercise purchasing power stored in assets when they decide.
The main reason people don’t see it though is that they don’t want to. While inflation is evident in asset prices we want to believe it’s prosperity. Inflating asset prices are fun. It feels like getting rich.
Until it spills over into consumer prices, after a lag that is complicated to suss out.
The markets give clues though. From the point of view of consumer price inflation, asset markets act like storage tanks. The fuller the tanks the shorter the lags. After a decade of mostly tank filling, this latest cycle has shown a lot of lags are happening within a few months. The 2020-2021 monetary inflation affected asset prices immediately, with the bulk of the consumer price response coming in 2021-2022. The 2022 asset price deflation was echoed in 2023 consumer price disinflation.
As night follows day, the 2023 asset price inflation has now begun to appear in 2024 consumer price inflation. Media chalk it up to higher than expected housing and food prices. But those are only effects noticed by skin deep observation. As we pointed out at the time, genuine analysis would reveal that the cause is that the Fed effed up with its rate cut talk. Now it’s having to walk it back.
The markets’ response is the silver lining. If asset prices come down sufficiently and soon enough, some of that inflation in the pipeline and headed towards consumer prices could be neutralized before it fully blooms. As I’ve been saying since the days of iTulip, asset prices will come back down or consumer prices rise to meet them. Or some messy combination of both.
And as I’ve repeatedly asserted over these months of Fed-pivot-talk-fueled market rallies, the media have it backwards. The grounds for kiting asset prices on rate cut anticipation are faulty. Markets will have to sell off before cuts can be justified.