#1242 Darius Dale | Will Inflation Come Back Hot?

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/

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:02Anthony Pompliano?

  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?

• 0:44Anthony Pompliano?

  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 estate planning. And they just simply are using a one-size-fits-all template and just telling you, pay me thousands of dollars and I'll use the same thing for you as the guy down the street.

• 1:29Anthony Pompliano?

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• 2:10Anthony Pompliano?

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• 2:23Speaker 01

  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.

• 2:47Anthony Pompliano?

  All right, guys. Bang, bang. I've got Darius here 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?

• 2:56Speaker 02

  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's 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 have changed. 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

• 3:39Speaker 02

  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.

• 4:12Anthony Pompliano?

  So when we see the headline number accelerating again, people sort of say, oh, wait a second. But 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?

• 4:24Speaker 02

  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 weighted 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%. But we saw core services CPI was pretty flat, right around 4% three-month annualized. But we saw a pretty significant breakdown in shelter inflation from just over 5% to 4.4% on a three-month annualized basis. So that's quite positive.

• 5:03Speaker 02

  And then lastly, that bottom panel there where we show super core CPI. So that's core services x housing. You know, this is one of Jay Powell's favorite metrics to track, particularly in the PCE deflator statistics. That number's 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.

• 5:26Anthony Pompliano?

  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 that you think that this really is showing this quote-unquote sticky inflation.

• 5:44Speaker 02

  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 US 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, you know, 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. With sticky inflation. Is is this expectation based on our research that we always knew that eventually

• 6:26Speaker 02

  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, 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, you know, the stool, the theme that, you know, created a lot of the price action we've seen year to date. So in terms of this, in terms of this chart, focused 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, in the CPI basket, of which there are about 40, 400, sorry, roughly around 400 categories in CPI.

• 7:11Speaker 02

  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 CPI statistic. So it's that same, you know, basically statistics, that same median CPI, but what we're doing is we're chopping off the upper eighth percentile and the bottom eighth percentile of the, the, 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, 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, kind of getting stuck around this kind of 3%ish level.

• 7:52Speaker 02

  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, 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 eventually transition and, and really run out of immaculate disinflation at an awkward, an opportune time.

• 8:13Anthony Pompliano?

  Now, this producer price inflation, unpack a little bit, what, what exactly is that? And then what's the impact?

• 8:19Speaker 02

  Yeah, so this is the prices that, you know, people who sell things to the consumers are observing in their own cost structures, um, you know, in terms of, uh, you know, it's really what businesses are paying. This is the inflation that businesses are feeling, uh, in terms of final demand there. Uh, we're seeing, you know, 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. Uh, we saw a core PPI. It 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, uh, food, energy and trade services, which is effectively supercore PPI producer price inflation, we saw that number tick up, uh, to 3.3%. Again, the highest

• 9:02Speaker 02

  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 supercore PPI, trim mean CPI, median CPI, supercore CPI, et cetera, start to show some resistance to continuing to, you know, exhibit that downside momentum. And that is concerning for asset markets because it means a couple of things. One, you're probably going to have more dollar strength as a function of markets expecting more policy tightening out of the Fed

• 9:43Speaker 02

  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.

• 9:52Anthony Pompliano?

  Now, one of my favorite things to talk about is your last slide that you got here, which is, is the Fed going to have to actually go from a 2% target to a 3% target? Uh, it wasn't very popular idea two years ago. Now it seems to be getting some steam. You've got some data here with, uh, this inflation model. Explain what you're seeing here.

• 10:08Speaker 02

  Yeah, absolutely. So I appreciate the, the intro in this, man, because we put this model out at the beginning of last year, uh, and the, the conclusion was roughly the same in terms of, hey, we think we're going to see roughly 50 to 100% more core PCE inflation on a trend basis throughout this decade. And so how this model, what this model is designed to do is sort of, um, you know, great, uh, you know, score the change in a, of 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, you know, the, the mean or the weighted trend in that, in that, in that, in that change in that model, it's effectively saying, hey, look, core PC 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, it's right around 3.2%.

• 10:53Speaker 02

  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, uh, over the, over the long, medium to long term in this particular decade. Um, obviously, as implications for Fed policy, they talked about it at Jackson Hole about, you know, two is, you know, we're going to stick it to, it's stick it to, and we just said that's all hogwash. If, if 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, uh, 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, they came out and since then and said, well, we just picked the, the number two sounded like not too much and not too little.

• 11:37Speaker 02

  And all the rest of the world's central banks are anchored on this, you know, kind of, you know, borderline phony 2% number, uh, which obviously is incongruent with the evolution of the economy according to our secular inflation model. And so, and as it relates to our second, one final conclusion I'll make as it relates to asset markets in terms of the medium term outlook 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 the end of next year, but first half of 2025.

• 12:20Speaker 02

  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, 3.2% uh, in terms of core PCE on a trend basis, then they have not accomplished their goal. And so ultimately, it has, 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.

• 12:46Anthony Pompliano?

  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?

• 13:25Speaker 02

  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, if you, 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 re-accelerate. And that's the, that's the, you know, when you think about this from a multi-year perspective,

• 14:08Speaker 02

  and ultimately the policy response to all 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 CBOB budget projections, there's debts and deficits as far as the eye can see in terms of trillion, two trillion dollar deficits. Someone's got to buy these bonds. They're either going to financially repress the commercial banks into buying this stuff, or the Fed's going to change its inflation target, which will allow it to, you know, flex its interest rate policy a little bit more, and ultimately flex its balance sheet a little bit more in response to, you know, kind of economic and market downturns.

• 14:39Anthony Pompliano?

  Where can we send people to find you on the internet or find out more about 42 Macro?

• 14:43Speaker 02

  Hey, I'm like Coach Prime, baby. I ain't hard to find, man. Come find me at 42macro.com. You know me, 42macroweather 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 and you know, how to network with individuals, you know, kind of construct portfolios in the context of some of our systematic macro, you know, signals.

• 15:03Anthony Pompliano?

  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.

• 15:11Speaker 02

  You came, baby.

• 15:13Anthony Pompliano?

  We'll do it again in the future.

• 15:14Speaker 02

  Appreciate you, brother.