VIPS

• In theory if you net out the volatility typically associated with items such as milk and gasoline prices, you get a more reliable gauge of price movements.
• “The CPI is based on a survey of what households are buying; the PCE is based on surveys of what businesses are selling.”
• The government’s de facto ‘price fixing’ of medical care costs has kept a lid on PCE relative to CPI.
• Come the next slowdown, the Fed can hold interest rates lower for even longer than ever before with a higher target based on a still-arbitrary measure

Can something be arbitrary and at the same time deeply damaging? Pursuing a strategy based on personal preference rather than reason can indeed inflict deep wounds if carried on for too long. Such is the case with the Federal Reserve’s preferred inflation metric, the “core PCE.”

Technically speaking, core personal consumption expenditures (PCE) exclude food and energy prices to arrive at the underlying inflation paid by households for goods and services. In theory if you net out the volatility typically associated with items such as milk and gasoline prices, you get a more reliable gauge of price movements.

Economists tell themselves that such reasoning is sound but try that same logic with the average consumer with a straight face. Because it’s their paycheck that will be decimated. In the space of five years, every dollar of their pay will be reduced to 90 cents. How is this in the public interest?!

Clearly Alan Greenspan was right when he said that the ideal inflation rate for households was zero.

As to the ‘arbitrary,’ ever since the Fed adopted its core PCE inflation target of 2%, it has stuck to it like super glue. The rationalization behind the target, however, has been shattered in recent years, a victim of prima facie evidence that outs the weakness of the core PCE compared to other measures of inflation.

Starting with the easiest comparison, how does the core PCE differ from the core consumer price index (CPI)?  Since 2000, core CPI has averaged 2% vs. core PCE’s rate of 1.6%. What explains this discrepancy? According the Cleveland Fed’s research: “Both indexes calculate the price level by pricing a basket of goods. If the price of the basket goes up, the price index goes up.” Simple, right?

But the “baskets” aren’t the same. Each has different weights on some very important cost-of-living factors, particularly housing and medical care. Also, as per the Cleveland Fed, “The CPI is based on a survey of what households are buying; the PCE is based on surveys of what businesses are selling.”  The greatest discrepancy between the CPI and PCE stems from healthcare and housing’s different weightings in each index.

The CPI has a 40% housing weight vs. just 23% in PCE. In PCE, medical care is 20% of the index compared to just 9% in CPI. Housing is the simpler of the two to explain. Persistent 3-4% annual rent gains speak to its outsized impact on the CPI relative to PCE.

As for healthcare, the CPI only covers out of pocket expenses on those goods and services bought. PCE includes these but also those expenses paid by a 3rd party, such as employer-provided health insurance, Medicare and Medicaid. Anyone who has spoken to a doctor should know that reimbursement rates have been on a perpetual spiral downwards.

The government’s de facto ‘price fixing’ of medical care costs has kept a lid on PCE relative to CPI.It’s also put the ‘arbitrary’ in the Fed’s senseless insistence on the importance of hitting a 2% target of a flawed metric.

Happily, all of this talk is meaningless as even the core PCE is at the cusp of piercing the 2% ceiling. As you can see in this neat table, tepid gains of as little as 0.14 percent a month would put the Fed officials on target by July. Any faster pace gets them there that much sooner. MoM run rate Month Core PCE hits 2%  0.14-0.15  Jul 0.16  Jun 0.17-0.24 May 0.25  Apr

With all of this as a preamble, you now know why Fed officials have raised their voices in concert to ask one question: “Shall we play a range?” It may appear that talk of aiming for a target inflation range of between 1.5%-2.5% gives the Fed leeway to raise interest rates to a greater degree to fend off burgeoning price pressures.

But how does the mirror image of this logic look? Come the next slowdown, the Fed can hold interest rates lower for even longer than ever before with a higher target based on a still-arbitrary measure. In other words, let’s make matters worse by raising the ceiling under the guise of even more sound econometric theory.

VIPs

• Despite the tough rate hike talk, a wholly different scene is being set, one that allows the Fed even more leeway in the event inflation retreats anew.
• So, this inflation scare is no head fake? Well, look again. Future New Orders are moving in the exact opposite direction, meaning there’s precious little faith on manufacturers’ part that the need to continue building stocks will be necessary.
• The fuel to this fire came in the form of tariff and trade war fear disruption which triggered a short-run spike in New Orders

With the NFL draft drama behind us, let’s look forward to the coming season with a bit of pigskin history. In 1919, Green Bay Packers’ founder Curly Lambeau solicited funds for uniforms from his employer, the Indian Packing Company. Within two years, Acme Packing Company summarily acquired Indian. At the time of the sale, Acme was controlled by New England Supply Company. The uniform supply chain thus disrupted, a rivalry was born?

Afraid history would have to be rewritten as the Philadelphia Eagles didn’t even come into being for another 12 years. It was the Chicago Bears who were and remain traditional Packers rivals. And yet, we can learn a lot more about the history of raucous football fans and supply chains from Philadelphia, home of the longest-running manic fanbase and Federal Reserve manufacturing survey, which dates to 1968.

As Fed officials have wasted no time communicating, there’s a raging debate surrounding inflation’s stickiness. Is the surge we’ve seen of late temporary or the start of a more lasting trend? Despite the tough rate hike talk, a wholly different scene is being set, one that allows the Fed even more leeway in the event inflation retreats anew.

Did someone mention the Philly Fed survey? A cursory glance at the New Orders index within the monthly survey is highly alarming when viewed through history’s prism. Think in standard deviations, as in that bell curve that threw your test scores in school, and how many standard deviations from the middle a data point is. That’s called a z-score.

As of May, New Orders were on fire; white hot two standard deviations above the norm. So, this inflation scare is no head fake? Well, look again. Future New Orders are moving in the exact opposite direction, meaning there’s precious little faith on manufacturers’ part that the need to continue building stocks will be necessary.

It all comes down to one impulse, that of panic, as in sudden uncontrollable anxiety which often causes wildly unthinking behavior, in this case on supply managers’ parts.

The panic buying started with last year’s natural disasters which produced a record $300 billion in insurance proceeds that flowed back into the economy and depleted stocks. Then came the tax bill and budget, the latter of which will generate another $300 billion in government spending.

The fuel to this fire came in the form of tariff and trade war fear disruption which triggered a short-run spike in New Orders, which has been evident across regional manufacturing surveys in Philadelphia and the rest of the country, especially the goods-intensive Midwest. If Vince Lombardi was still with us today he might demand, in his famous words, to know, “What the hell is going on out here? Everybody’s grabbing, not tackling! Grab, grab, grab!”

With the difference between future and current (selling) prices received, a.k.a., pricing pressure, crashing to historic lows, the menu choices have been reduced to three: lower future costs, lower future profits or a combination platter of the two. Whatever balance sheet disruption risk you’re craving, the answer is the same: indigestion. First choice speaks to inflation switching to disinflation/deflation, risk of inflation curve inversion and risk of nominal yield curve inversion. Second choice speaks to peak profits and risks for lower equity prices and wider credit spreads. Third choice: reread the last two sentences.

As for hopes this is an aberration, capital spending plans in that same Philly Fed report collapsed to the lowest level since November 2016.

No matter how they begin, it would seem supply chain disruptions end in the same way – with someone reaching for the TUMS.

VIPS:

• Marriot International’s CEO Arne Sorenson recently cited tight labor markets for an inability to hire sufficient construction workers to keep production schedules on track
• For the moment, it would seem the overall industry is in fine form. Last year, occupancy, average daily rates and revenue per available room all clocked in at record high
• new hotel construction relative to the country’s population growth only rivals the historic buildup seen during in the run up to the Great Recession
• Has the number of hotel workers and their total hours worked peaks? In the past two cycles, those peaks have coincided with bear markets in Consumer Discretionary stocks.

Sometimes it pays to be green. On a recent trip abroad, pay vouchers were offered to those who opted out of having their hotel rooms cleaned on a per diem basis. Hang your towel, make your bed, tidy up and receive a €5 voucher in return.

Perhaps this tack should be adopted by Europe’s American counterparts. Anecdotal evidence suggests that it’s become increasingly challenging to source housekeepers to keep U.S. hotel rooms clean. One mid-size hotelier reported the shortage extends beyond manning the maids’ carts. Front desk personnel are so short-handed they’ve implemented rolling checkout times to gain the staff more time and prevent guest-irritating long queue times.

The worker scarcity outside the business of operating hotels is apparently even more acute. Marriot International’s CEO Arne Sorenson recently cited tight labor markets for an inability to hire sufficient construction workers to keep production schedules on track.

That rationally leads one to ask whether hotel construction workers’ ranks, aggregate hours worked and average workweek topping out are attributable to slowing demand or supply.

In a recent interview, Sorenson trailed off a laundry list of impediments to be an efficient operator in the hotel space: “We have seen the cost of land increase, the cost of construction increase, the development period take longer, which impacts cost of capital, and we are on the front edge of seeing the cost of debt increase.”

For the moment, it would seem the overall industry is in fine form. Last year, occupancy, average daily rates and revenue per available room all clocked in at record highs. Records were also set for supply, with an estimated 1.87 billion room nights available, and demand, at roughly 1.23 billion room nights sold according to data from STR, a hospitality industry data provider.

Indeed, while Sorenson said opportunities were more robust outside the U.S. market, the domestic hotel sector nevertheless, “is still healthy compared to returns on other real-estate classes or investments.” Well, alright. He may have a point when you consider the carnage in retail and the increasingly apparent oversupply in office properties.

And yet, we’ve seen new hotel construction relative to the country’s population growth only rivals the historic buildup seen in the run up tothe Great Recession.

As for what’s to come, our in-house Economist would tell you it’s beginning to look like it’s time to whip out that gray crayon, as in the one that draws those gray recession bars onto economists’ graphs. Is it a case of our economist needing to get out more? Or is he rather on to something in noting that the fun is over when the number of hotel workers and their total hours worked peaks? In the past two cycles, those peaks have coincided with bear markets in Consumer Discretionary stocks.Fun Is Over

Is there anything else at stake in this exercise? Well, you tell me. Not to mention, Commercial Mortgage-Backed Security (CMBS) conduit exposure to lodging is about 15% in the 2018 vintage thus far. That’s encouragingly down a hair from 16% in 2017. But then, hotel collateral accounts for nearly 50% of single-borrower CMBS deals priced year-to-date. And that is up from 2017’s 45% level.

Has debt continued to flock to this asset class, as Sorenson suggested it should, for rational reasons or does the money simply not have a better place to call home?