Markets might have to grapple with a different nuance of
“patient.”
The inflation index that the Fed has anointed to be the yardstick for its
inflation target – the PCE price index without the volatile food and energy
components – rose 0.19% in May from April, according to the Bureau
of Economic Analysis this morning. This increase in “core PCE” was near
the top of the range since 2010. It followed the 0.25% jump in April, which
had been the third largest increase since 2010:
Fed Chair Jerome Powell, at the press conference following the
no-rate-hike FOMC meeting last week, gave a clear
and succinct summary of the US economy. It was mostly in good shape, he
said, in particular where it mattered the most: “All of the underlying
fundamentals for the consumer-spending part of the economy, which is 70% of
the economy, are quite solid,” he said.
He acknowledged that there were some problems, including the slowdown in
manufacturing and the current bust in the vast
US oil-and-gas sector, and that the Fed would be watching for further
deterioration in the economy, before it would take action. But “low”
inflation was another matter.
Sustained “low” consumer-price inflation – as the Fed defines it – worries
the Fed, though it’s a godsent for consumers. If inflation, as measured by
the core PCE price index, drops in a sustained manner below the Fed’s pain
threshold, wherever that may be, the Fed would likely adjust monetary policy
no matter what the economy does.
The Fed’s “symmetric” target is a 2% annual increase in the core PCE
index, meaning the increase can fluctuate some above or below the target
without causing the Fed to act.
Core PCE inflation was in the 2%-range for much of last year. But early
this year, the increases softened. So in his opening remarks at the press
conference, Powell said that “committee participants expressed concerns about
the pace of inflation’s return to 2 percent.”
So that everyone understood, he added: “We are firmly committed to our
symmetric 2 percent inflation objective, and we are well aware that inflation
weakness that persists even in a healthy economy could precipitate a
difficult-to-arrest downward drift in longer-run inflation expectations.”
In other words, a trigger for a rate cut would be a “sustained” period
significantly below the 2% target. Inflation data is volatile and jumps up
and down. Earlier this year, when core PCE inflation fell significantly below
2%, Powell said that the factors behind this low inflation were “transitory.”
Janet Yellen, when she was still Fed Chair, also used “transitory” to
describe the factors that in early and mid-2017 were causing an actual dip in
core PCE – which hasn’t happened this year. And a few months later, she was
proven right.
After today’s data on the increase in the core PCE index, following the
jump in April, the three-month increase – March, April, and May – has now hit
0.50%. Annualized, this amounts to 2.0% core PCE inflation over the past
three months, in the bull’s eye of the Fed’s symmetrical target, with the
last two months being substantially above the Fed’s target. But note the
sharp decline in January, February, and March, and how it has now reversed:
This data is volatile, and is likely to move in either direction. But the
“low inflation” scare early this year seems to have dissipated. And this
gives the Fed one more reason to be “patient” and observe developments as
they unfold before making a move with monetary policy at its meeting at the
end of July.
What we’re watching here are the “cyclical” dynamics of inflation, which
move on a monthly and yearly basis.
But there are also “structural” factors why inflation has been “low,” by
central-bank definitions, for years. Powell mentioned this in the press
conference. These factors, in place for over two decades, have to do with the
internet, globalization, the search for cheap labor, efficiencies in
manufacturing and transportation, and the like.
These factors have led to a sharp split in inflation: Services such as
healthcare, rent, and financial services have experienced red-hot inflation;
and consumer goods have experienced ice-cold inflation. Here is the data, and
what my couch, jeans, car, PC, sheets, and phone are saying about
globalization and the internet, and how they impact prices. Read… My
Perspective on the Murk of Official Retail-Sales Inflation, with Some
Surprising Illustrations
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