Inflation Stable, But Only In Passing
It’s a busy day for me, with month-end just past (and month-end was a busy day for many, with the first pan-billion-share day on the NYSE this year), but there is just too much to talk about to skip a comment today. But I will make it brief.
Front and center must be the huge rise in Crude Oil and Gasoline futures. Crude rose over $3 with NYMEX Crude topping $110. Some of this was due to rumors that a Saudi pipeline had been attacked and damaged, but a good portion of the run-up occurred before the rumor went around, and after the Saudis denied the rumor prices only fell back somewhat. The chart below (Source: Bloomberg) exaggerates the move in gasoline somewhat due to the fact that the front month rolled (the April contract rallied 9.45 cents/gallon, but March expired as the front month on Wednesday at $3.04 and April is now at $3.35), but however you want to look at it, this is a very high price for March 1st – in fact, the highest ever – and retail gasoline prices were already up to $3.74/gallon before this spike.
Meanwhile, the core PCE price index for January was reported this morning. While the month-on-month change didn’t round higher, the number was just enough higher-than-expected that the year-on-year number became 1.9% while economists were expecting 1.8%. Recall that core PCE is what the Fed is targeting to keep at 2.0%, and they were busy saying that the inflation dynamic had cooled (more on that later).
The Fed had previously assiduously avoided acknowledging the 15-consecutive-month acceleration in core CPI by saying that headline inflation (which they don’t normally care about) was ebbing, but now with energy prices rallying again they can’t retreat to that platitude. Core PCE is clearly still rising, and headline inflation is going to re-accelerate. I suppose Bernanke will have to focus on Nat Gas prices…that’s about the only price that’s actually falling.
Oh yes, Bernanke. Today’s second day of the Monetary Policy Report to the Congress (neé Humphrey-Hawkins) brought humor to an otherwise dry day. The Chairman was called on to defend the Fed’s extraordinary actions during the crisis (which honestly, isn’t really fair if you were busy cheering him on when they were happening, as most in Congressional oversight roles were). His defense was that (1) “we’ve had about 2.5 million jobs created,” which it turns out are the same 2.5 million jobs that the Congress and the Obama Administration say were due to their policies, (2) “We’ve seen big gains in stock prices, improvement in credit markets,” which is odd considering that he has previously claimed QE2 didn’t pump up asset markets, and (3) the actions helped produce a “more stable inflation environment.” In honor of baseball’s spring training: strike three, you’re out! I suppose a snapshot of a vase falling off a table looks stable too, as long as you don’t wait until it hits. Inflation happens to be near 2%, but that’s a coincidence of timing. It’s around 2%, on the way to someplace not particularly near 2%.
And it’s not just me who is saying so. Yesterday, Plosser was predicting the Fed could tighten policy this year and I noted a St. Louis Fed economist highlighting inflation risks; today FRB Atlanta President Lockhart predicted that if the Fed started QE3 it could cause inflation while not spurring lending. However, do not fear tighter policy yet; Lockhart considers that things have only just begun to show positive effects and just wants to ride the loan volume increase and inflationary increases for a while longer.
There are positive economic signs, but I fear these may be the best we see for a while. Auto sales, which have long languished at weak levels, surprised in February to post the strongest annualized sales pace since 2008 (see Chart, source Bloomberg). The level is almost back to the record levels where the car companies were bleeding losses back in the mid-2000s! The worst seems to be past for the automakers, although there is some suspicion that balmy weather (for February) helped the comparisons for the month. Still, the trend seems to be clear, for now.
Claims are improving, auto sales are improving, manufacturing is doing generally well (although ISM was weaker-than-expected today). As I’ve said for a while, the economy has been improving slowly, and at this point continues to improve steadily. However, the stock market has priced in a robust recovery, and with all of the great economic news out there we also have sharply rising energy prices and other tax increases (such as the expiry of the increased depreciation allowance, which may have helped provoke the weak Durables number this week). We also have Western Europe (and the less said about that right now, the better). There is plenty of time to bask in the good news by being short bonds (the 10y yield rose above 2%, again, today), hoping that I’m wrong about the disappointments we are going to begin to see, I think, this month.
Leave a Reply to Michael AshtonCancel reply
Are we sure that the Fed is targeting “core” inflation? In the great “transparency” statement they referred to pce as the target (specifically avoiding saying core). This is presumably because headline pce has recently been declining whilst core rises, thus enabling the fed to claim that inflation is falling—which they have duly done! I don’t think we’ll hear any further reference to core pce being the preferred measure from the fed—they’ve switched horses and seem to have got away with it!
You’re right the target is PCE, but over a longer time frame. Since headline inflation must converge with core inflation over time (it has historically tended to happen every 15 months or so although that has lengthened in recent years), targeting long-term PCE is the same as targeting long-term core PCE. But they do target core, because if they targeted headline then they would tend to tighten when gasoline prices were rising and cut when gasoline prices were falling. This would enhance the amplitude of the cycle rather than diminish it, and that’s the reason that on shorter horizons they target core.