Progress on (half of) inflation

Good morning. Shares in card network operators Mastercard and Visa were hit hard yesterday when US President Donald Trump expressed enthusiasm for a bill taking aim at card interchange (or “swipe”) fees. Unlike Trump’s terrible card rate cap idea, there is actually a debate to be had about interchange fees. If you have views, send them along: [email protected].

Inflation is getting a little better, probably

Core consumer price index inflation was 2.6 per cent in December, on an annual basis. That is 0.4 per cent lower than the last time we got a remotely reliable CPI reading, back in September. This is welcome news. Given that fiscal and monetary easing are on the way, the financial system is highly leveraged, and asset prices are very high indeed, falling inflation is required to keep the whole show on the road.

As usual, the details are more ambiguous than the headline number. Below is a chart of services inflation less energy and housing (housing is a lagging number in the CPI index, for reasons that are complex and by now wearyingly familiar) and of goods inflation less food and energy. Because these are month-over-month changes annualised, there is a gap for October and November, due to the October number going missing in the US government shutdown:

There is still some blurriness in the December number. Because not every spending category is measured in every area every month, some shutdown distortions remain. But I think the broad story is legible.

All the deflationary work is being done by goods. This suggests tariff inflation is fading as “liberation day” fades into the rear-view mirror — though some analysts worry companies have been “eating” the tariffs, and this might stop in the new year, when price increases are often put through.

The “supercore” services number looks stickier. This makes people jumpy, inasmuch as services prices are associated with wage pressure, and a feedback loop between wages and prices is the thing that keeps economists up at night (wage growth, by most measures, has been stable all year at about 4 per cent). Several analysts have noted the December services number might be anomalously low. Andy Schneider of BNP Paribas points out December is often a soft month for services. Omair Sharif of Inflation Insights said services inflation would have been meaningfully higher were it not for a very large decline in wireless plan prices.

In sum: goods inflation seems under control, and we are just waiting for further confirmation of that signal. Services inflation is well above target and doesn’t seem to be improving much. Until it does, we can’t declare the battle is over.

Maybe the market doesn’t care about Fed independence because it is already gone?

Yesterday I wrote about several reasons the market doesn’t seem to care about Trump’s attacks on the Federal Reserve. But there is one important school of thought on this that I didn’t discuss: the view that Trump can’t kill the central bank’s independence because it’s already dead.

The argument is that out-of-control government deficits and debt eventually require debt monetisation through money printing or financial repression — that is, though ending the structural separation of monetary and fiscal policy. The economist Tyler Cowen recently laid out the argument, when asked about Trump’s attacks on chair Jay Powell:

It was terrible what Trump did. Fortunately most of the markets did not react very much but gold and silver went crazy. To me that's a sign that the dollar is no longer a safe haven and Trump . . . is just not reliable. That is very bad, but I don’t think it’s going to change inflation or interest rates very much . . . because we already wrecked the independence of the Fed…

The basic problem is our debt and deficits are so high we will monetise them, to some extent, and have higher inflation — because we prefer that over high taxes, no matter what we might say. So Fed independence is taken away through that mechanism.

A longtime advocate of this view is Société Générale’s Albert Edwards, who summed it up to me as follows:

What else are governments going to do? Fiscal dominance is here. We are headed back to quantitative easing and yield curve control. Cyclically there may be reasons for bond yields to come down, but on a secular basis we are headed up.

He noted that while the US is tied with China in deficits to GDP, the US pays a far larger slice of GDP as interest than other large economies. His chart:

No one doubts there is some level of US indebtedness at which bond investors will rebel, or interest payments will become unsustainable, or both. The debate is how close we are to that point.

One might argue that, if we were close to the decisive moment, markets would have picked up on it and driven the long end of the yield curve up. Robin Brooks of Brookings disagrees. He points out the very long end of the curve did rise sharply between 2020 and 2023. Currency debasement happens by fits and starts, and the past few years have been nothing but a pause in the process. He illustrates this point with the below chart of implied 10-year inflation 20 years from now (“10y20y forward yields”) in developed economies, showing a massive synchronous swing upwards in yields:

Brooks also argues (somewhat in tension with his first point) that bond yields and break-even inflation measures are bad predictors, which won’t price in the coming inflation “until it’s staring them in the face”. He illustrated this with a chart of the correlation between a measure of forward inflation expectations and the price of oil:

“Oil price swings are transitory and shouldn’t correlate with medium-term inflation expectations,” Brooks writes, “But they do, because break-even inflation is famously backward-looking and myopic.”

But even accepting that bond markets are short-sighted, the question about how much debt is too much stands. The debasement crew all cite the rising value of gold and silver as proof that fiscal dominance is being priced in. But precious metal prices can’t see the future either. They don’t have a stronger historical relationship with inflation than oil does.

I agree there comes a point in a sovereign debt cycle where central bank independence becomes irrelevant. I’m just not convinced we’re near that point yet.

One good read

Venezuela, as seen from Midland.

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