In his recent Jackson Hole Speech, Fed Chair Jerome Powell explained how the Fed is thinking about core inflation in terms of its three main components1:
i) Core goods
ii) Housing
iii) Core services ex housing
It is therefore informative to look at the behaviour of these three sub-components from yesterday’s release. These are shown in Chart 1.
Investment Insights • MFN
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It’s not over yet for the Fed
In this Macro Flash Note, Daniel Murray comments on yesterday’s release of the latest “Personal Income and Outlays” data from the US. This included inflation estimates in the form of what are known as Personal Consumption Expenditure (PCE) deflators. The measure of inflation that uses the core (excluding food and energy) PCE deflator is the Federal Reserve’s preferred measure, so what happens to it is important for thinking about the future path of policy.
Chart 1. Core PCE Inflation Components (Year-over-year %)
Source: BLS and EFG calculations. Data as at 31 August 2023.
Chair Powell noted in his speech that core goods inflation “has fallen sharply” and yesterday’s release confirmed a continuation of this trend (the dark line in the chart). The chart also shows how housing inflation (the orange line in the chart) as measured by the PCE deflator has remained elevated and only recently declined from its peak; the latest value was just under 8% YoY. However, Powell also highlighted in his speech how more timely indicators of the housing market – both for rent and house prices – have definitively softened over the past few months and this is expected to feed through to lower housing inflation as measured in the PCE deflators in the months ahead.
That then leaves core services ex housing. Here the picture is less clear cut. As shown in the chart, core services inflation ex housing has been stubbornly persistent at between 4% and 5% over the past two-and-a-bit years. Yesterday’s release was consistent with this pattern. Core services inflation ex housing increased from 4.0% in June to 4.6% in July. This will be more of a worry for the Fed.
In conclusion, it is pleasing that most indicators of inflation have softened over the past few months and that is something from which the Fed and other central banks will take some comfort. Indeed, it is notable that the headline PCE inflation measure has declined meaningfully over the past year or so, from a peak of 7.0% in June last year to 3.3% in the latest reading. Similarly, annualising the past three months' data shows core PCE inflation down to around 3% in July from 5% in February. However, we are not out of the woods yet, as indicated by core services inflation ex housing. It will be necessary for the Fed to see signs of this measure declining meaningfully to be confident the fight against inflation is won. Until then rate expectations are likely to stay volatile and talk of Fed rate cuts are premature.
1https://go.pardot.com/e/931253/nts-speech-powell20230825a-htm/3j1xy/253844614?h=pdhYECNCwm_8ohkvM9ca3tyRNcc_YZevd5yBImokEBU