Hello, and welcome to another episode of the Odd Lots Podcast. I'm Joe Wisenthal and I'm Tracy Halloway. Tracy, do you remember I think it was probably like last June or last July, like over a year ago. Now, I think we're talking to Vitour Constantio, and I think you asked like one of the most important questions, like at the time and maybe still like that we've had on this podcast. I struggle to remember things that happened a month ago, um let alone twelve months ago. Everything is sort of
blurring into this one long stretch. But um, yeah, that's fair. What did I ask, Well, you asked him whether economists or anyone these days had a cogent theory of inflation. Do you remember that? And at the time, like you know, there wasn't much inflation going on. I think we're probably still in something resembling deflation or disinflation not long after the initial shock. But now, you know, fast forward to August and official inflation measurements are pretty elevated relative to
recent history. And I think that question and I think it's basic into us. No, although I don't want to quote him on that, that question of like whether economists understand inflation has probably never been is extremely top of mind these days totally, And I mean, I think I would agree with you on the no part. But of course there's a really big irony right now, which is right when the FED changed to the flexible average inflation targeting regime, after you know, more than a decade of
undershooting the two percent inflation target. As soon as they did that, now we seem to have possibly um transitory inflation, but like certainly more than they would have expected a year ago. And and yeah, like it just illustrates that no one seems to have a very good handle on
what exactly causes price increases or decreases. Right, So, even prior to the new framework, there's always been this idea that, okay, we'll use and this came up in our recent episode of Neil Cary of the Minneapolis Fed, that okay, we'll use inflation as our gauge, as our speed limit to know when we say hit maximum employment or full employment. That's true under the old FED, that's true under the
current Fed. Now we have elevated inflation, but it's like, oh, this doesn't really count because it's transitory and it's related to shipping, and we know that doesn't have anything to do with employment, but there's always probably gonna be a story to tell which sort of calls to mind whether these are sort of like useful things. Of course, no one predicted this sort of like very few people accurately predicted the timing and the degree of elevation of the
current inflation. So I think we're still sort of like back to square one. We don't know how long this will last. I don't even think there's a agreement of like what really would be transitory, of what would be worrisome, of what would spur the FED to act sooner than maybe markets effect, And so I think, um, that question that you asked Constancio several months ago remains really the
sort of the key thing right now. Yeah, alright, So today we're going to be talking about inflation and really what it is and how it's measured, and whether it's even possible to forecast it accurately or how we should be thinking about it right now, And we have literally the perfect guest. We're gonna be speaking with Omar Sharif.
He's currently uh the founder and president of a new shop that he's set up called appropriately enough for this episode Inflation Insights, but he has a long track record. He's prior to that a by side strategist at the asset management for Millennium. He's been an economist at various shops including a Soak, Gen, RBS, and so forth. So we're going to talk about whether there is a a cogent theory of ation and how to think about it right now. So Amara, thank you so much for joining us.
Thank you having me. Well, what's your answer to Tracy's question? Do do economists have a useful or cogent theory of inflation that that works in practice? I think the short answer to that is, now, you know, all you have to do is sort of look at the fact that there's a massive academic literature that's basically just devoted to forecasting inflation and you know, coming up with variou types of models to figure out what the inflation process is.
And there's an equally large literature talking about why we're so bad and forecasting inflation. So I don't know that there's a coaching theory. It seems to sort of change based on where we are kind of in the cycle, and there's different ways of approaching you know, how you want to forecast inflation. They're sort of the top down
modeling approach that a lot of academics use. And I think sort of what's more kind of in favor and out something that I started doing, you know, well over ten years ago, which was kind of more of the bottom up approach UM to forecasting inflation. But ultimately, I don't know that there's a coaching theory that really can explain the inflation process over you know, let's say the last several decades. UM. You sort of try to understand it based on where you are, I think in the cycle.
So what is it that makes inflation UM so difficult to grasp? Is it the idea of UM that you just pointed out that it basically depends on where you are in the cycle, and so your framework or the dynamics that are underpinning prices are are kind of changing constantly. Yeah, I think that's that's exactly what it is. It's just
it's a constantly evolving process UM. And you know, one way to think about it is that if we're trying to forecast it, and let's say we just want to think about where it's going to go over the course
of the next year. You know, there are all sorts of approaches you can take in terms of modeling, but some of the simplest approaches actually worked the which is simply to say that, you know, if I want to forecast inflation over the course of the next four quarters, I might just use the average of the last four quarters, and most often than not, that will actually perform better than trying to come up with some models that you know,
Phillips curve type models for example, because inflation persistence is actually a pretty big key I think in trying to understand the dynamics with an inflation um and that persistence is is it varies across time and and that is one of the keys really and trying to think about it is you know, if I if I were to tell you that the core CPI has been between one and a half to two and a half percent for the last twenty years, those types of models that are
what we call nightive models work quite well because if inflation has been around that for the last twenty years, pretty good odds that you know for the next year will be somewhere in that range. Uh. But that persistence varies in the short run. It varies, you know, even within a decade, and so trying to capture that kind of time varying nature of inflation for sistance is really
what everyone's striving to do. And that's why certain models perform, you know, really well in certain decades and they completely
collapse in the next decade. Well, so this gets to something that we um talked about in the beginning that whether we're talking about the FEDS new framework, and we should point out recording this auguste by the time people listen to this, it will have been the one year anniversary of Jackson Hole where they laid out and so we make it some new speeches on this, but where
they laid out the new framework last year. So whether it's the new framework, the Flexible Average Inflation Targeting Framework, or the old framework, I'm not even sure what that was, both are premised on this sort of like Phillips curve, thinking that there is some inherent trade off, that there is some inherent speed limit or maximum employment, and we'll know we'll get there not by some number of employment level,
but by inflation readings. And if the nature of inflation sort of changes all the time, maybe decade by decade or some other time interval. Is that going to be a folly for the FED to think that inflation or like, is there any reason to think that Philip's curve thinking or Philips curve framework will be a useful guide post for the FED? It's hard to say. I think that the thing is that the Feds, you know, their time horizons really if you think about it is essentially about
three years, right. We we get about three years of forecast from the FRET FED within the SCP, and so you know, if you're thinking about inflation changing over ten years or fifteen years, that's less of an issue for the FED. So that can the Phillips curve work accurately for them? And then a three to five year horizon sure, And and so you know there are times that it
has actually performed relatively well. So for example, kind of the late seventies when you ran aggressions sort of these you know, using output on employment gaps, Phillips curves actually turned out to to be kind of useful. But you know, the FED will always tell you that they have a
suite of models that they look at. They will look at everything from core inflation to you know, trim means and medium c P I S. So I don't know that they're as reliant on the Phillips curve as they used to be, and I think they've kind of spelled that out for us over the course of you know,
the last year. It's not clear that the Philip's curve really works, and I think Powell's kind of ditched that approach, and it's you know, it's kind of back to the old adage of saying, you know, we'll we'll know it when we see it, and we'll kind of wait for the whites of the eyes of inflation before we decide
to move on on policy. MHM. So you mentioned all the different inflation stats or figures that the FED can look at, and of course there are, I mean, there's probably dozens of different measures of inflation um that are
based on hundreds, if not thousands, of different baskets. I guess my question is how much does your interpretation or does one's interpretation or thinking around inflation actually depend on the measure that they're looking at, And how do people go about choosing which measure is most relevant m in a particular time. Well, I think, you know, we there's basically two main measures. Is the way that I really
look at it. You know, there's obviously the c p I and then there's the there's the Feens preferred measure that the core PC. Are there other measures that you can look at, absolutely, but typically they tend to be kind of variations on those two. So you know, the trim mean and and the median c p I and the median PC are just variations and different ways to
kind of approach those same baskets. And you know, maybe you're taking some of the volatility out from the top and the bottom, but you're really sticking with those two main baskets, which one you want to really focus on? You know, I think it depends. Um, if you're the Fed, they've already made that decision for us. You know, it kind of makes it easy. Um, we're gonna be focusing on the core PC if you're thinking about monetary policy.
But obviously for the markets, what matters is the c p I and what matters is the CPI because that's what it goes into pricing tips. So it sort of depends on who you are. You know, if you're the A, obviously you're going to be concerned and obviously the two are related about you know, roughly something like seventies seventy of the core PC is actually just passed through from the course cp I. So those to me are really the at least in the US, are the two main
metrics that you want to focus on. Well, let me ask you. You know, if economists, you know, don't have a great track record of forecasting inflation, they don't have great models um for it. So we have these things that Okay, if I talked to Tracy, I say, let's talk about inflation, and we want to know where inflation is. We'll look up some indicries on the terminal, might look up to c p I, course, CPI, core PC, etcetera.
Are the concepts of inflation indices themselves cogent? In other words, we're put we're aggregating all these different prices and trying to arrive at one number. And right now I think the number, you know, cp I, it's a little bit over five percent, maybe five point four percent, I don't remember exactly. That's down from a recent high. But is there some true information contained in that headline number or is it just a number that gets spit out when you go through the work of adding up all of
the thousands of prices that go into it. Yeah. Look, I mean at the end of the day, Um, all of this stuff is is a construct, right, and and there's certain things in there which I think do a great job of reflecting reality. And if we think about energy, that's a very simple one. You know, everybody knows what they're paying at the pumper for gasoline, and within the c p I, you know you're you're capturing these movements
and energy prices, those are pretty straightforward. The same thing is true when you think about you know, car prices. These are items that are pretty easy, easy to capture, and you know they do a pretty good job sort
of representing reality. Where you start to get we start to lose people, frankly, is when you kind of get into some of the sort of the price index theory and sort of the number theory where you start to talk about imputations and you know how to handle missing prices and you know, owner's equivalent RAN is a great example. There's been a debate about this for you know, pretty much the last forty fifty years about how should we really capture house prices? What is the role in an index?
And the CPI is very clear, we don't want to We don't want anything to do with house prices. Why, because we consider it to be an asset. We're trying to measure what you pay out of pocket as a consumer, And so these are the kinds of debates that I think, you know, when you're paying, when you're seeing you know, home prices go up, you care less about what satistations are arguing about when it comes to you know, imputation
and so on. You just know that if you want to buy a house, you've got to pay more than maybe you did last year. And so you tend to kind of lose the public when you're getting into those sorts of weeds in the inflation data. But I think for the most part, these indexes do a pretty good job of capturing what's going on in terms of the
pricing environment around US. UM. Can we spend a little bit of time on owners equivalent rent or o E ER, because as you mentioned, this is a source of big controversy. Anyone looking at the housing market, you know, over the past few decades will say that house prices have gone up, rents have gone up, um, certainly relative to one's income.
So why is it that it seems difficult for the inflation indices to capture that, is it just is it just that they've made a conscious decision not to include it or to include it in this very specific way, or is it something else? So we actually used to include it, um so so prior to the CPI, for example, um they took what was called the asset approach, and so that included, uh, you know, the price of a house, included everything related to your mortgage, interest costs, your property taxes,
and so on. And even though from about the late fifties to about three they they did it in this manner, they knew from really the early sixties that this was not the right approach and this was just a conceptual issue with the cp I. All this had to do was was to say, what we're really doing here is we're capturing an investment piece of the house, and we're also we really want to capture is just the consumption
aspect of it. And so they knew for you know, twenty plus years um that even though they were doing in this manner, this was not what they wanted to actually be doing in terms of the CPI. And finally around the late seventies they started doing more detailed work on how to get around, you know, eliminating the investment piece of it and focusing just on sort of the
shelter part of it UM. And they made that change in three and you know, another part of the reason for making that change was, you know, as you recall, interest rates were kind of all over the map in the late seventies and the early eighties, and that introduced a tremendous amount of volatility in the CPI to the point where it sort of became, I don't want to say useless, but so volatile that it was really hard to get any kind of sense of what was going
on with underlying inflation. And you had everything tied to it, you know, cost of living adjustments UM, wage negotiations were tied to it. And one year it was up you know, ten eleven, the next year might be back down to three. So it was sort of losing its significance, and so this decision was made to work on trying to implement this owner's equivalent rent index, which finally came into playe UM.
So that is a consensual issue. It's it's just underlies sort of what the CPI is really meant to do. The second part of this, I think, is that you know, when you look at for example, Zello core logic and you're seeing rents up, where you're seeing case Shiller saying house prices are one of the you don't see it in the CPI indexes. To that magnitude is because it is there's just very little turnover in the CPI sample.
So every month, only about ten to fift pent the sample actually represents new renters, and so what you see in list prices um you know that might be moving very quickly when market conditions are changing, that shows up over the course of about twelve to eighteen months in the CPI because you just don't have that same kind of turnover that you see in these indexes that look at just for example, listed rents. So part of its conceptual issue, but the other part is just the methodology
and the way that the sample works. You're just never going to have the magnitude of the changes that you see in all these sort of you know, private private
sector indexes. So like if we're talking about something like buying apples or buying milk or buying gasoline, everybody buys those things every day or every week all the time with rant, not only do very few people actually signed a new lease every every month, but also many of the new leases that people actually sign or with their current landlord, and so they probably uh don't get the full market rent because those are those don't adjust as fast. And so you know, looking at this, Okay, this is
one of the big questions right now. We know that headline inflation has come down a little bit. Used cars seem to have stopped going up. That's a big factor. But everyone's like, okay, ore is coming, ohr is coming. We see the market rent some places like Zillo and so forth, those are shooting up. Why don't you give us what you know? Sort of you just explained the theory.
What are you actually seeing in practice when you look at the data and how much is rent and other attempts that the CPI or that these in disease used to capture shelter. How much upward pressure are they going to put on the measures in the months and years ahead. Yeah, so we you know, we have seen both of these measures, both rent and now we are actually bottom out over the course of the last several months, and you're starting
to see price increases. Is in the major metro areas, and so even you know, places like New York, Los Angeles, Chicago, San Francisco, which are still down pretty sharply year over year, it looks like on a monthly basis they've they've finally
kind of begun to stabilize a little bit. And you know, it's important to kind of understand when you talk about the c p I that a lot of these rent indicries, what really matters is where these you know, so called Class A cities, which are you know, the big ones with populations over two and a half million, what they're doing because the weights on these cities um is incredibly large. So if you looked at just three of them, New York, Los Angeles, Chicago, that is of the entire rent inducts
from just those three metro areas. So where they go matters quite a lot for the overall index. But we are starting to see these places stabilize and move up. But I think there's something to keep in mind here about you know, this whole story about shelters commenting and O we are is going to go up and so on. Number One, people again are looking at these private market rent data and they're seeing seven percent eight percent growth.
We've never seen anything like that in the c p I. I'm hard pressed to think, you know, we'll see anything like that over Let's say that the course of the next year, um will rent go up, yes, but you know, don't forget before the pandemic we were running around three and a half percent. We're about two and a half
percent right now, and rent and we are combined. So you know, even if you move up a full percentage point over the course of the next year, you'll be kind of right back where you started in early two thousand and twenty. But let's assume for a moment that you know, we move up to four and a half percent, so another two percentage points from where we are today. What that basically means is you're looking at overall core
inflation rising by roughly about another eighty basis points. You know, rents got about a weight, you go up two percentage points. That's about eighty bits on on the core cp I. Now that sounds like a lot, but you mentioned used cars earlier. They're adding over a hundred and thirty basis points to the core CPI right now in the year. Your basis that it's almost certainly going to come off.
So even if we are goes up and rent goes up, you know, a couple of percentage points over the course of let's say, the next year eighteen months, that's almost certainly going to be offset to a great extent by you know, a lot of these things that we're seeing now that we you know, continue to think of transitory. That's going to upset a lot of the upward pressure you're gonna get from from shelter, I think, over the
course of the next eighteen months. So it's kind of important to keep that in perspective because again, four and a half percent is really where we've peaked in the past, and even if we get a bit higher than that, you know, year a year on use cars is not going to stick. You know, that's going to potentially more
than offset what we see out of shelter. So since we're talking about the current environment in terms of inflation, maybe it's worth asking, you know, when you hear the term transitory inflation, what does it actually mean to you?
Because we've had um at least one feed official come on and talk about how they sort of regret using the term transitory inflation, and other people have said you know, maybe it would have been better if the FED was talking about narrow inflation versus more broader inflation, or um manageable inflation versus unmanageable inflation. So what does that term actually mean to you? Transitory inflation? So to me, it's just about, you know, how long that rate of change
continues to sort of accelerate. So you know, use cards going up yar over a year from zero basically, which is where they were pre pandemic too. Now the question is how long can we sort of not just how long will that persists, but can it continually go up at sort of the rates we've seen over over the last six months. That's kind of the way I think
about it. That's I think the way that share Powell has sort of explained inflation as well, is it's this process of can we see continually this rate of growth sort of accelerate year after year after year, And that's what we're sort of looking at for these components, but obviously much more sort of in the short term. But I do think there's a couple of ways to think
about this transitory question. And if you're trying to figure out is is the inflation I'm saying that transitory or is it gonna continue will spread out to other components. There's I think a few ways to kind of think about that um. One, for example, is just simply look at the dispersion within the cp I, so you know what share of components are seeing price increases today versus price decreases, And also you know what does that look
like on a weighted average basis versus history. So you could have a lot of components, for example, rising, but if combined the weight of those components is not that that high, it really may not matter for kind of
the longer term inflation picture. Another thing that I like to look at is momentum within the core cp I. So here what I want to look at is, you know, what is the share of components that are either accelerating or de cel a rating within the corese c p I. And here you can sort of you know, normally you would look at, for example, the twelve month change in the year of a year rate of specific components and see if that's picking up steam or losing steam, and
that once you wait those those sort of changes gives you a sense of kind of the underlying momentum that's really sort of driving the you know, the aggregate core number.
And then one final thing, which I think is pretty important right now, especially since we're sort of comparing everything to kind of the pre pandemic time, is you've got to kind of keep a close eye on where the price level is today for certain components versus not just where it was let's say in but where would you expect it to be today, you know, given the pre pandemic trend. So are we overshooting that or are we undershooting that? And I think a good example here is
something like air fares. Right there's still about ten percent above excuse me below their fable, but they're more like pent below where you would expect them to be if they had just continued on their pre pandemic trend. So that kind of tells you, you know, things normalize. That's an area where you might start to see some upward
pressure come, as in airfares. And on the flip side, hotel rates are running about eight percent above where you'd expect them to be right now, and so that's the place where you might get a little bit of get back. And if you don't, then then you you know, potentially start to get a little bit concerned that this might
stick a bit longer than you would have expected. Big picture, I mean, we you know, we we fixate on a few of these so called reopening categories, and used cars we know the story there, and rental cars we know the story there. And with airplanes and hotels we understand some of this also. You know, we talk a lot about certain goods related that relate to shipping and logistics,
which we know is supply chains jammed. When you look at some of these measures, like you do the breadth of the inflation, general inflation momentum and so forth, what are you seeing right now? Is their process happening. It appears to be broadening out, and momentum is gathering steam or or is it something else? You know, let's let's we go back to its kind of the FATS preferred measure of the PC. The San Francisco FAT actually does a nice job keeping track of some of these dispersion
measures and so on. And what you look at now is that about roughly, you know, if you sort of look at all the components in the PC, about eight percent of them currently are showing price games. And you know that sounds like a pretty big number. That most of the most of you know, the components arising, but in fact it's it's only a couple of percentage points more than what we were seeing sort of you know,
pre pandemic. So it doesn't it's not clear to me that we've seen a big broadening out of of price pressures. We've seen, as you mentioned, just really concentrated increases in pressures in some components. So I'm still very much in the camp that you know, as we sort of get through the spring of two, we're essentially going to see a lot of slow down I think in the core and much more I think in the core PC for example.
Like I wouldn't be surprised if by the middle of twenty two we're talking about core PC being closer to around two whereas the core CPI potentially is is still you know, punching along and around two and a half percent. And one thing I just want to mention is, you know, you talked a little bit about some of these macro stories with you know, chip shortages and so on. You know, these are important, right we we we we like to
have narratives to try to explain something. But one of the things with when you are really in the weeds of this inflation data. Is that as important as those narratives are to kind of understand the picture, most people don't really pay attention to the fact that a lot of price movements that you tend to see have nothing to do with the macro story or a micro story. It's literally just about the way the methodology works in
the index. It's about the seasonality of the index. You know, it's about changes in the way we actually compute and construct the data, and it has less to do with you know, these broader stories that we're trying to explain. We're trying to use explain the inflation number. Sometimes it's just about understanding how this thing is built and sort of really getting into the weeds of, you know, understanding the parts that sort of make up the sum. And
that good example is motor vehicle insurance. This is an index that you know a lot of people don't pay attention to. Last month was down about two and a half percent, you know, a little bit less than a full tenth off the core CPI, which is a lot when the core is around point three only and it has nothing to do with a big story. You know,
UM insurers are not cutting your your rates. It just has to do with the way the seasonality is working out this year for this particular index, and it's going to be a very similar story when the next point comes out insurance motor vehicle insurance should be down around two and a half three percent. Again, do you just to the seasonal factor. So, no big story, but if you understand the seasonality and understand how this thing is constructed,
it gives you an edge in terms of forecasting. Uh, this number just to play Devil's advocate for a second. So um, when it comes to those macro stories that you just mentioned, one of the things that Joe and I have been discussing a lot over the past year or so is this idea of the bullwidth effect and that you end up seeing a massive amount of volatility
in orders and stockpiling because of the uncertain environment. So you know, you get a shortage one month and then everyone ramps up their orders because they don't want to be caught short again, and suddenly they're oversupplied and you get these sort of intense um price increases and decreases. So I guess my question is, like, is that a risk to inflation Actually proving transitory. Is that something that could start to come into play. Yeah, that's a that's
a good point. It's it's possible. But I think you know, where you would see that obviously would be a ramping up in in the inventory numbers for some of the you know, the places where we're seeing where we are seeing shortages now, where we are seeing orders pick up steam, you know, I mean, honestly, to some extent to your point,
we're kind of seeing this. We use cars now, so wholesale prices have been coming off the last couple of months, and again where you really want to look as on the inventory side, so when you look at use cars, when you look at the wholesale piece of that, we're only about a couple of days below a normal level of inventory for wholesale used vehicles, and on the retail
side is actually pretty similar as well. So you know, we were catching up on the inventory side and getting to something that actually really resembles normality in the wholesale used vehicle market. And you know, low and Behold you were down about three or four and wholesale prices over the last couple of months. So I think, sort of to your point, I think where we are starting to see some of that happen in some of these components.
So I'm thinking, you know, I kind of want to zoom out a little bit and talk about the relationship between some of your work and you know, how investors use it. You've been on the cell side, You've been on the BI side, now you have your own shop. As Tracy and I have talked about the past episodes, inflation gets people going. It gets consumers going emotionally, but it also gets traders and investors going, and people are
very strong views about the FED and so forth. I'm curious about like receptiveness to your way of thinking, because you obviously clearly take this bottoms up approach where it looked not only at individual categories, but individual category construction. How do like, you know, traders investors who want to use this, are they receptive to it? Are they do they get you know, are they angry at the ideas like, oh, you know, this is all the FED money printing, etcetera.
Which is kind of seems to be the opposite of how you think about these questions. What do you talk a little bit more about your work and how how investors use it? I think, but the most part, people are incredibly receptive to it. I mean, when I started doing this, um, I don't know of many shops or many individuals who were taking this kind of bottom approach and sort of doing you know, detailed analysis of the
components and index construction and so on. And I think people are especially periods like this, they want to understand what is moving the print, Is it a one off print, is there you know, was there something driving it this month that could be more persistent? And how do I
think about that for the following month. Because if you're an investor and you're you know, in the tips market, or you're you're, you know, interested in the fixings, one month obviously influences everything, and so you really want to understand what is what's going on kind of beneath the hood of the data. So I think people are incredibly receptive.
And you know, in terms of getting pushed back from folks who are like, hey, this is just the FEDS money printing, there's there's always element of that, but I find that those are the folks who were, you know, potentially removed from actually trading or managing money. Um, you know, the folks who are managing the money. They are into the weeds of it. And you know, it's funny because, as I mentioned, when I was on the cell side,
when I did this, very few people did it. Now, being on the buy side of the last two years, I was a consumer of all the cell side research, so I got all the research from the banks on
inflation and how they forecast it and so on. And it's it's funny to me because now a lot of people take this bottom of approach on on the cell side as well, some more so than others, but it's kind of the way everyone on the cell side is doing it now because I think there's a value add in understanding the weeds of you know, what's driving shelter inflation and what's driving apparel prices and so on, because it really does give you a window into where the
kind of headline numbers going and importantly, is it going to stick or is it just you know, kind of a one off. So in a bottom up approach like the one, you just describe what role, if any, does
monetary policy actually play. And you know, I'm thinking of that famous Milton Friedman quote about inflation is always in everywhere a monetary phenomenon like is that incorporated anywhere in the type of work that you do, or is it irrelevant the way when you're when you're doing the sort of approach, it is almost by design, it's a very short term approach. You know, I'm not going to sit here and say, hey, I'm in a forecast inflation for the next five years, um doing this approach because it's
it's just not designed to do anything like that. When you're doing something like this, it's much more looking at let's say the twelve next, twelve to eighteen months UM. And really, if you think about policy in the lags, you know, to some extent, you know, maybe it's impacting, uh, some of these components in that time frame, let's say, especially housing, but in the twelve eighteen months, it doesn't play that big of a role. And honestly, if you
even think about the way that these indexes work. The San Francisco Found a couple of years ago had a great paper where they applied kind of the Phillips curve methodology to individual components of the PC and what they found was a roughly sixty percent of these components or what they would term a cyclical and essentially, you know,
policy can't really impact them. So stuff like medical care, for example, whatever you're doing with policy is probably not really going to impact physicians prices um or you know, hospital prices, and so six the index just doesn't really react to policy. And even that does, you know, it's going to be a bit of time. That's twelve to eighteen months, And this approach is pretty narrowly focused on
kind of you know, just that kind of window. So I would say that if it does, it's kind of hard to really it's hard to really incorporated into this sort of a framework when you're thinking about forecasting. Should we sort of established that there isn't that much of a sort of cogent theory of an inflation from sort of like pure macro standpoint. What is your pitch then? Is it just that you're going to help explain what you a little bit more about your pitch to potential
clients to help them understand what's going on. Like what is it that you say it's like, okay, you do at your new shop appropriately enough called inflation insights? What is like the basic sales pitch of what you can bring to the table. Sure, so you know, for for me, my target audience, is mostly um, you know institutional clients, right, Um, the folks who actually are are trading tips and who are trading to fix things. Um, So in that respect that the pitch is really sort of uh. I would
say there's kind of three main elements. One is the actual forecast. You know, for me, luckily, I've been doing this long enough where I've got a reputation, I've got a hit track record in history that I can present to clients and say, look what I'm trying to build. Here is the best in class forecasts, Um that you will get on the c P I S N s A Index, which is what matters for tips, and kind of here's my my history of that, and that's you know, the goal for is to have that be the best
in class moving forward. The second is just the detailed analysis making sure that everyone understands what's going on. And the timeliness I think also matters quite a lot. So you know, the stuff that I put out typically will be well in advance of anything you're gonna get from
the south side, and it will give you an opportunity. Um, you know, if you agree with my view, for example, that it will give you opportunity to actually traded in the market before the CPI comes out, whereas right now a lot of seal side research, you know, it's coming out forty eight hours before the number prints, and that's really not much of an edge, but it's the detail analysis, the timeliness, and then finally, you know, I would say I'm probably on the horn with the BLS, if not daily,
you know, at least once a week. Even though I've been doing this for a long time. It is honestly just a constant kind of learning process. I mean, there's there's about two eleven indicators that go into the cp I. There's over seven thousand basic item in area indexes that you could look at, and so it's just kind of
a constant learning process. And it's you know, for me, I've always had this likely good rapport with with the folks there, who I think are incredibly helpful in terms of learning about the components and so on, And that's sort of the kind of I think, you know, the kind of knowledge you're not really going to be able to get most other places. So now I have to ask how specific you can actually get when it comes to the inflation baskets. So this is a really weird question.
But I went on like a massive tangent a couple of weeks ago because there was a restaurant in North Carolina that that a guy was quoted as saying that he was spending two hundred dollars more per week in mayonnaise because of inflation, and so of course everyone started calculating like, well, how much mayonnaise is this restaurant actually buying based on CPI, And then I started going on Bloomberg and looking at the components and c p I, and it turns out mayonnaise comes under the salad dressing
um and spreads basket. And so I guess I'm just curious, like, how in the weeds do you go? And can you give me like a quick, uh quick read on what's going on with with salad dressings? Yeah, so I don't know if I can pull up the salad dressing forecast just now, but you know I would stick. When you get to kind of that level, Um, you have to make choices, right, I mean, like I said, there's there's
over seven thousand I had to marry indexes. Uh, there's over two sort of broad components in the c p I. Most likely when you can kind of get something like food, which has dozens of indexes, you kind of have to make a choice in terms of how far are you
going to drill down. So I might follow all of these, you know, I've got them in my spreadsheets and so on, but when it kind of comes to forecasting, you're probably gonna want to stick, for example, with looking at the broader too, which is the food at home index, which kind of encompasses the entire grocery basket and the food away from home with restaurant prices and there with within
food at home. You know, you would if you want to drill down, you would break break it down into some of these components, so cereals, you know, the various types of meats, eggs, food, vegetables and so on. But it doesn't mean that you're necessarily going to go in and you know, forecast uncooked beef steaks for example, right, I mean you could, you could, but it would take you a month or longer to just come up with a simple forecast. I mean I used to spend probably
two days just doing the food forecast. So you have to kind of make some choices about the timeliness of your forecast and how uh, into the weeds you're going to be able to go in order to produce something that's actually you know, actionable. So this reminds me of
something I wanted to ask you. Um So, when I was in my Mayo analysis adventure, one of the things I was trying to do because I couldn't find an inflation pick up in the official CPI basket, but I tried to look at um an Amazon tracking website to see if prices had gone up on Amazon. So I'm curious, do you ever look at alternate data in order to make your forecast? Yea, So there's a couple of things, UM I do for certain components that where I will look at you know, uh, non BLS data sets to
try to get a sense of what's going on. And one of those, for example, is just airfares. Air Fares is only worth you know, a little bit less on one percent of the core, but it's it's basically been the bane of my existence and forecasting for the last you know, fifteen years, because it's incredibly convoluted the way
that it's done. But um, you know, at the end of the day, what they're really pricing is you know, they're going to the websites of you know, Delta American Southwest so on UM, and they're pricing flights out, so you can try and come up with an index yourself where you just you know, go onto these websites and try to say, hey, what's the flight, um, you know, from your to l A going to cost me or new or to Miami or whatever. And so you can sort of look at those sorts of data to try
to help you forecast, um the airfare sundas. You can look at you know, Black Book and JD Power and so on to get a sense of what use card prices might do. And then there's of course the Billion Prices project there. I think you just have to be a little bit careful because a lot of what they are capturing is much more UM has much more to do with goods prices and much less to do with services prices. But for goods prices, you know, that does
a pretty decent job from time to time. So there are other things that you can certainly look at gas Buddy, which is actually now being used directly in the c p I UM. So they've gone from having you know, one thousand quotes on gasoline each month to having millions of quotes because essentially they've crowdsourced the data is something else that you can also look at. So there definitely are alternative data sets that you can try to to work into into your forecast. I just want to say, Tracy,
you you stole the question right. That was literally the next thing I was gonna ask you. No, no, no, that was great, You asked it. Great. But I just weirdly continue to be perfect blade length. You know, I'm bigger picture, or I guess sort of like medium term.
You know, you present, as you said a little bit ago, when you look at some of the broader metrics, you don't necessarily see a sustained upward move in inflation that there isn't necessarily this kind of momentum that even if rent were to go above um grow at a pace that's well above historical averages, they might be offset. What would make you worried or what would make you think, Okay, this is going to be a type of elevated inflation
that persists. And maybe monetary policy doesn't really affect inflation at least in the medium term, but inflation could certainly affect monetary policy if the FED gets spooped or so forth. So I assume that's important information for investors. What would you be looking for saying through the rest of this year or early next year to say, oh, this is going to be higher and more persistent than I would
have gived. Yeah. So one of the things that's you know, kind of come up in the last print or two, um, that I'm going to be keeping a pretty close eye on going forward, is this, you know, idea of whether some of the pickup we've seen recently in wages begins to pass through more persistently into the inflation data. And you know, we saw this actually last month in the
food away from Home index. Um. You know, there was a pretty big increase in what are called you know, limited service restaurants so fast food, and it was for
for that index was was a huge huge jump. And we know that wages are going up in lena leisure and hospitality for example, and so the idea that some of this might be feeding through, for example, into hotel rates or limited service restaurants and things like that, those are areas where potentially you start to say, okay, you know, we've keep seeing wages move up at these sorts of rates if this is what, if this really is that kind of a path through, then this is potentially something
that is more persistent that will last into next year. And it's not going to be something you know, sort of a one off shock like let's say, you know, oil price shock or something of that nature. You know,
this is something that is potentially more persistent. And I have to say, I think even with something like use cars, we know they're starting to come off, I am a little bit wary of just kind of having a repeat of what we had, which is, you know, last summer we had a huge jumping used car prices, it completely tailed off, they declined throughout the fall and winter until we had another huge burst over the last several months.
And whether that's you know, mostly a function of sort of the demand side or the supplies I'm definitely more on the supply side part of that story. But you know, it's we still have kind of to deal with this idea of the delta variant and what's what is that going to do to activity going forward? What's that going to do for the demand for use cars and new vehicles you know later into this year and into next year. I don't know that anyone's got a good answer for that.
But that is something that I think kind of remains or upward risk on the in the inflation story. Is you know, we sort of see a repeat of some of these um some of these upward pressures from from you know, something like the delta variant going forward, but more persistently, it would definitely be some of this wage passed through into some of these components that I mentioned earlier.
So on a related note, is there you know, in your very long career analyzing inflation, is there any particular component that has just remained an absolute mystery to you? And that is sort of like I guess, immune to the bottom up analytical approach, like something that really flaw
makes you Yeah, I think apparel. Apparel is the is one where in you know, years of doing this, I've literally just never found anything that works at forecasting apparel other than you know, one of the approaches I mentioned earlier, which is just this naive approach of saying, Okay, you know, looking at these things on an unadjusted basis, you get a sense for a sort of seasonal patterns, and uh, you know, let's say apparel every March tends to decline
by about two tents. You're going to be probably um, doing a decent job if you put in you know, a drop of two tents, because there's very little to go on when it comes to two apparel prices. You know, I've tried using everything from import prices, um two you know, different data sets, retail sales and so on, and there's just nothing that is gives you a good lead into what apparel is doing. And that's been you know, that's been another tough one to do. UM, not as difficult
as as air fares. Air fares at least you know what they're doing, UM, you just can't replicate it exactly. But Apparel's yeah, apparel is one that has just really you sort of just have to lick the patterns and and honestly, it's it's it's much more about kind of looking at these patterns and thinking about, you know, to what extent you're following the same trajectory as you did
in the past for something like apparel. So one of the sources of like constant controversy and you know CPI inflation, truth thors and so forth always like to talk about it is like the so called hedonic adjustments, and they're always like, oh, this is not you know, we all
we've all heard the conspiracy theories right now. For example, though, if if everyone is complaining about the service they get at restaurants because of the so called worker shortage, people are complaining about the service they get at hotels, and we know, for example that hotels in some cases have degraded service or not picking up towels is often or whatever it is. Are these sorts of things captured to
the BLS. I mean, as you said, you talk to them all the time and you're trying to learn their approach. Are they trying to capture these types of things such that maybe the experience at a restaurant or a hotel isn't what it was in no, so hedonic adjustments are just applied um two goods. So yeah, and so you know, if if I'm sure you kind of remember this whole you know, wireless thing in Martial two seventeen. Yeah, so
things like that is where you see hedonics. Apparel is one where you see hedonics um and it so it really is just limited to goods. And also when you think about hedonic adjustments, for the most part, I think it's about only about four or five percent of the c p I is actually subject to those sorts of kind of quality adjustments. Um, you know, other indexes are subject to other types of adjustments, but they tend to
be much smaller. So for example, with rent, you know, rent, there's something called an age bias adjustment because you're let's say, let's say you've got an apartment and you happen to make it into the BLS survey and in January they come to you and they say, you know, what do
you pay for rent? You give them a number. They come back to you in July six months later, and of course you let's say you've got your least your rent hasn't changed, but your apartment six months older, and so they apply what's called an age bias adjustment to to your apartment. It doesn't really change, you know, very much. But those are the other sort of types of adjustments that the BLS will make. But for hedonics, it's it's just not a big fraction of the index that is
really kind of getting that kind of a treatment. And it's really only you know, it only really comes to light when you have these huge moves like you did with wireless a couple of years ago. Those sorts of quality adjustments. UM. You know, they get a lot of press, but they don't really remind people what happened. I remember the wirelessing happening, but I don't remember what it was. Can you just remind me? Yeah, I think we went to um, we went to unlimited wireless plans, and I
think it's February March in two seventeen. So you know, when we switched over from let's say you paid however much, however much your bill was for a certain amount for your phone. When we went to unlimited plans and you had, you know, instead of having you know, time gigs and you maybe you had thirty or whatever it was, they had to find a way to price that out. And that's where kind of the hedonic regressions came in, was to say, you know, how much is this extra speed worth,
or how much is this extra memory worth? Um? How much is extra data plan worth to the consumer. And once they came up with those measurements, they applied them and what it ended up leading to was about a seven percent decline in the wireless index in a one month,
which is a record decline. And it's subtracted about almost close to a tent just a bit over a tent off of the monthly changing the core CPI, and you know, that's a huge, huge number, got a lot of attention, and so people start talking about hedonics again, and you know that's where you know, the so called sort of inflation truths come in. It's like, well, this is just this arbitrary adjustment that they're making and so on. But you know, this is the kind of stuff that goes
on in a pretty regular basis. Typically you just don't see those kinds of moves. But for the most part, these things are are pretty standard and not just for by the way, not just for the BLS, but almost for every statistical agency that does a cp I. At the end of the day, the c p I is you always want a price between you know, one month and the prior month the same good, and if it's changing in quality, you have to try to control all for that quality. So these adjustments are happening, you know
Canadian cp I and your status so on. So it's a pretty sort of time tested methodology that everyone uses in all kinds of m consumer price and nexes. So I just have one last question and it's sort of big picture. But you know, in the very beginning you talked about, Okay, different regimes, different times, different relationships might work. Philip's curve thinking sometimes seems to be robust, sometimes not
so much. One of the things in the post crisis period is people are asking, well, is this like a new regime, like as this is the economy now just going to be fundamentally different, maybe because of some sort
of change to international trade or something like that. Is that something that you're on the lookout for or thinking that maybe like even post virus, maybe we'll get something resembling normalization, but that's something structurally might be a different economy than we had pre crisis, thus forcing you know, thus causing a sort of different way to think about
what might uh manifest inflation. Yes, I think let me preface this by saying, you know, for the most part, economists are really terrible at picking up like turning points and you know, paradigm shifts and things of that nature, which is why there's such a large literature on how to forecast inflation. But yeah, I think one of the things that you know, at least I'm on the lookout
for it, and I think others are as well. Is to think about the idea of how all this sort of disturbce and supply chains is potentially going to lead to, let's say, on shoring. You know, we're talking about building more semiconductor factories here in the US. We're talking about having sort of you know, more of you know, manufacturing in the US, And you know, what does that mean for for inflation going forward? So that's that's potentially a big paradigm shift that I think we need to be
on the lookout for. But is that going to be a six, twelve, eighteen month thing. Uh, you know, I'm pretty skeptical of that. To meet that is a much broader, much sort of you know, longer tenure type of topic um to think about, and you know, probably not something that you're really going to be able to capture kind of doing a bottom up type forecast. Omar Sharif, thank you so much for coming on odd lots really appreciate it. Thank you appreciate it. Thanks O Mary. That was fantastic.
Thanks Sorry, I really like that was great. I really like talking to Amara. I feel like, at least right now, it really feels like if you're not doing some sort of bottoms up analysis where you're actually looking at the component. There's probably like no hope to understanding what's going on
with inflation. Yeah, totally, especially since so much of it seems to be driven by the reopening like not just the reopening categories, but literally one or two or maybe three reopening categories like a big chunk down to use
car prices, air affairs, um and hotels. I think. Yeah. Uh. I also thought it was super interesting that, you know, it's like that he sort of pushed back a little bit about the so called like stories we tell about even those categories, and so even though like, okay, we can talk about semi conductors are shipping containers, but that actually, per his view, you have to go even deeper and just like really get to know index construction and really
no methodology and seasonality and to actually sort of do it. Is not enough to just be able to like sort of like tell some like bigger stories about the categories that are really moving. Yeah. I'm very curious about the seasonality portion of it. And I guess, like if everything is so seasonal and predictable, why do people still get
it wrong occasionally? I guess it goes back to what we started um the episode talking about, which is this idea that you know, despite decades and decades of studying inflation, it does feel like economists certainly struggle to look at it as a whole. It's also interesting, Uh, by the way, I really liked your question about mayonnaise inflation or the
sailor addressing category. But it is interesting that there were like these categories that he like, you know, he he expressed sort of like confidence about his ability to make a forecast and then other runs. And I think he said like air fairs, and you wouldn't necessarily think of with air fares, because again, it seems like the numbers are kind of transparent or there's like dozens of websites that track airfairs. But it's interesting that they're like these
categories that like, you just can't quite crack. I have a great book idea, So what if you, um, what if you went through the like two hundred CPI components and like for each one kind of told the story of the industry and how prices are actually made and how the BLS incorporates them. Yeah, best seller New York Times. No, I think it's interesting. I've read a book one through every ingredient of twinkies, and and that was that was fascinating.
There's something like a hundred ingredients in there. You could do the same for CPI. No, Actually, on ironical, maybe what about a a coffee table book like each picture is like sort of like a really glossy photo, beautiful photo of like mayonnaise picture or something like that, and then a page on the left talking about how the prices derived. Yeah, okay, literary agents and publishers hit us up, We're ready to write it. Reach out. Let's leave it there.
All right, let's leave it there. This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway and I'm Joe wisn't thought you could follow me on Twitter at the Stalwart. Follow our guest Omar Sharif. His handle is at f Cast of the Month. Follow our producer Laura Carlson.
She's at Laura M. Carlson. Follow the Bloomberg head of podcast Francesca Levi at francesco Today, and check out all of our podcasts at Bloomberg under the handle at podcasts. Thanks for listening to