Inflation is still stuck on us
Sticky inflation provides ammunition for another Fed hike
It becomes increasingly difficult to justify not raising rates at the next meeting of the Federal Open Market Committee.
The Bureau of Economic Analysis released its personal consumption expenditure (PCE) price index for April. Wall Street expected the price index to climb 0.3% after rising just 0.1% in March. Since this index comes out weeks after the Labor Department’s Consumer Price and Producer Price Index, it should be fairly predictable based on similar data already received.
Yet we have a good surprise. PCE inflation rose four tenths of a percentage point. Over the past 12 months, PCE inflation is up 4.4%, also a tenth of a point higher than expected and two tenths off the March reading.
Core PCE inflation, which excludes food and energy prices, also rose 0.4% from the previous month. For the past year, base prices have been 4.7%. Both were higher than March. figures and higher than Wall Street expected.
Core PCE inflation has been in a narrow range of 4.6 to 4.7 for the past five months. This suggests the Fed hasn’t made much headway on inflation.
Watch what the Fed is watching
THE Federal Reserve uses PCE inflation for its 2% target as well as in the Summary of Economic Projections (SEP) that is released at each FOMC meeting. Fed officials are also forecasting core inflation from the PCE to the SEP. While Fed Chairman Jerome Powell and others pointed out that they are also looking at other measures of inflation, PCE inflation is certainly considered the Fed’s “preferred” measure. So it’s getting a lot of attention from anyone trying to figure out where rates are heading.
The latest SEP was released at the March meeting. It showed that the median PCE headline inflation expectation for 2023 was 3.3%, down from 3.1% in the previous December summary. The range of projections was between 2.8% and 4.1%. Core PCE is expected to come in at 3.6% for the year, down from 3.5%.
These projections now seem unrealistic. It would take a very severe drop in inflation over the last eight months of the year to bring the stock down to 3.3% and the core to 3.6%. Achieving this would require a significant decline in consumer spending and a sharp increase in unemployment. This means that Fed officials are likely to raise their inflation forecasts at the next meeting.
An alternative measure that has been repeatedly singled out by Powell is PCE basic services inflation excluding housing. That rose 0.42% in April, equivalent to an annualized rate of 5.2%. Powell would probably look at the annualized rate for the last three months, which comes out at 4.4%. The six-month annualized rate is 4.9% and the 12-month rate is 4.9%. As Nick Timiraos of the the wall street journal underlinethis measure has practically slipped for several months.
The core PCE had seen disinflation in goods offset by inflation in housing. Now, the acceleration in housing is slowing, but so is disinflation in goods.
Basic services excluding housing over 12 months remain stable
Jan 4.7% pic.twitter.com/ENPqVUrBf0
— Nick Timiraos (@NickTimiraos) May 26, 2023
The second point raised by Timiraos is also worth emphasizing. Disinflation in basic goods prices has slowed, offsetting the ceiling on real estate inflation. Many economists were expecting outright deflation – that is, falling prices – of goods after last year’s huge increases. This does not happen.
In his speech earlier this week, Fed Governor Christopher Waller aware of this exact dynamic:
We hope there will be a continued slowdown in property price increases, but we are not seeing deflation in this category as we did before the pandemic. A second concern relates to rent increases, which make up the bulk of a category called housing services and are a major component of inflation. Lower rent increases from last year’s lease renewals are slowly making their way into the inflation data, but more recently a rebound in the housing market is raising questions about the sustainability of these lower rent increases. While house prices actually have less of a short-term effect on rents than commonly thought, this housing market recovery, which is even accompanied by significantly higher mortgage rates, has raised questions about whether the benefit of slowing rental growth will last as long as we expected.
The median is the message
This is where the inflation has been. Where is he going ? For that, we return to our old friends, median and trimmed inflation.
The Cleveland Fed calculates median PCE inflation every month, and we consider it a reasonably reliable guide to underlying inflationary forces that can help predict where inflation is likely to be in the months ahead. This also rose 0.4% for the month, exactly like the headline and the core. This is a signal that inflation is no longer influenced by peripheral factors, but is now broad-based.
The only detectable trend in median PCE inflation is sideways. It has been 0.4% in five of the last six months. The exception was in January, when it rose 0.6%. The resulting message is that Probably can’t expect PCE inflation to come down much. It’s definitely not on a reliable path to 2%.
The Dallas Fed calculates 16% lower average PCE inflation, which excludes 8% of both ends of the basket of goods and services from the calculation of the PCE price index. It is another measure intended to reveal underlying inflation and provide a basis for forecasting the trend of inflation. It is reported on an annualized basis for one month, six months and 12 months. The one-month annualized figure for April was 4.4%, down from 3.8% in March and tied with February as the second-highest reading over the past six months. The six-month annualized trimmed average is also 4.4%, exactly where it was in March. The 12-month annualized trimmed average rose to 4.8% from 4.7%.
Like the median inflation, the trimmed mean indicates that inflation is not falling at all.
It is still possible that the Fed will decide to keep its key rates unchanged at its June meeting. A strong employment report next Friday, however, could extinguish this possibility.. The market is looking for around 180,000 jobs. Anything above 200,000 will create a lot of pressure for the Fed to rise. And even if the Fed chooses to keep rates unchanged, it will likely send the message that this is a “jump” to the July meeting rather than the start of a long-term pause.
Like Cleveland Federal Reserve Chair Loretta Mester said in an interview on Friday: “The data coming in this morning suggests we still have work to do.”