Inflation Indicators and the Fed

Nominal and real rates, inflation expectations… Conditions are created for the Fed to tighten policy both by increasing interest rates and by quantitative tightening. Real rates and inflation expectations are being watched carefully for signs that inflation is approaching its peak. Bond yields weighed on the rise after the latest US inflation report reported consumer prices rose more than forecast last month. It is seen that nominal 10-year yields are positioned around the 3% band to reflect the monetary policy path the Fed can take to rein in inflation.

CPI, PCE and wage pressures… It is worth remembering that the Fed’s 2% target is based on the personal consumption expenditure index, not the CPI. However, the current 8.3% CPI inflation corresponds to a PCE of 6.6% according to current data. It is feared that if the Fed does not act decisively, the US economy will be exposed to the sticky effect of inflation. Another major concern is the feared wage-price spiral, where companies facing higher wage pressures raise their prices, causing consumers to demand further wage increases to offset their costs later in an inflationary feedback loop.

Trimmed inflation indicators… The trimmed average PCE inflation rate is an alternative core inflation measure in the personal consumption expenditures (PCE) price index. Calculated using data from the Bureau of Economic Analysis (BEA) by Dallas Fed staff. The trimmed average PCE inflation rate for the 12-month period ending April was 3.8%. According to the BEA, the overall PCE inflation rate was 6.3% on a 12-month basis, and the PCE inflation rate excluding food and energy was 4.9% on a 12-month basis.

Looking at the latest data, the trimmed average PCE peaked at 6.3% in January. It was 4.1% in February and 3% in March and April. The trend is horizontal but not moving higher than last month.

The tables present data on the trimmed average PCE inflation rate and overall PCE inflation for comparison and the PCE inflation rate excluding food and energy. The tables give annualized monthly, semi-annual and 12-month inflation rates. Source: Dallas Fed, Bloomberg

Conclusion? The impact of global energy prices as a result of Russia’s invasion of Ukraine and the fact that the course of the pandemic in China is a source of significant pressure on global supply chains still creates uncertainty. In this environment, the US has midterm elections in November (House of Representatives) and Biden’s popularity is declining as high inflation and this hurt the economic situation of his Americans.

It can be inferred that inflation approaches a cyclical peak and tends to start cooling from there. The details of the numbers show that inflation spreads from goods to services-related prices, so there is a long way to go towards the Fed’s stable inflation target. At the FOMC’s meeting on June 14-15, a 50 basis point increase is expected, and it is likely that further increases of this magnitude will follow.

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