Beckner: At Long Last, the Fed Getting the Increased Inflation It's Wanted

15 January 2018

12th January 2018

By Steven K. Beckner

Sub-par inflation has helped restrain the Federal Reserve's interest rate "normalization," but at long last evidence of faster price and wage increases could strengthen the case for lifting rates, provided the uptrend is sustained. Faster inflation and the resulting increase in bond yields could also calm fears about a potentially recessionary "inverted yield curve" and dampen talk about a revamped monetary policy framework. Inflation has fallen well short of the Fed's two percent for five years. In November, the year-over-year rise in the Fed's preferred price index for personal consumption expenditures (PCE) accelerated from 1.6 percent to 1.8 percent, but the core PCE was up only 1.5 percent. Largely because of below target inflation, the rate-setting Federal Open Market Committee has boosted the federal funds rate only five times since lifting off from the zero lower bound two years ago. Joining Minneapolis Fed President Neel Kashkari in dissenting against the December hike, Chicago Fed chief Charles Evans was "concerned that persistent factors are holding down inflation, rather than idiosyncratic transitory ones." This week, new Atlanta Fed President Raphael Bostic, a 2018 FOMC voter, warned, "inflation expectations risk becoming anchored below 2 percent," making it "increasingly difficult for the Fed to hit our 2 percent target." Against that backdrop, the December consumer price index comes as a relief to the Fed. The Labor Department says the CPI rose just 0.1 percent overall, but the core CPI rose 0.3%. That left the headline CPI up 2.1 percent year-over-year. The core CPI is up 1.8 percent from a year ago, but over the past three months it has averaged well above two. Previously the agency had reported an uptick in wage growth. Even before the CPI release, market anticipation of increased inflation helped pushed the 10-year Treasury note yield above 2.5 percent. It pushed toward 2.6 percent afterward. Signifying increased inflation expectations, the "break-even" spread between yields on conventional and inflation protected securities (TIPs) has been climbing as well. That makes the yield curve less flat and prone to inverting. It's too soon to say whether this trend will be sustained and induce the FOMC to raise rates more aggressively, but the news goes in that direction. Even before the CPI report, New York Fed President William Dudley was encouraged, predicting late Thursday inflation "will stabilize" around 2 percent "over the medium term," because "above-trend growth should tighten the labor market further, pushing up wage inflation and eventually services prices." "In fact, we have already seen some increase in inflation in recent months," Dudley observed, noting that over the three months ending with November, the core PCE rose at a 1.8 percent annual rate, up from 0.4 percent last May. He said "transitory factors" have held down year-over-year inflation rates, but "when these transitory influences drop out of the year-over-year numbers this spring, the inflation rate is likely to move higher." Following the report, Philadelphia Fed President Patrick Harker remained "guarded," but said he "expect(s) inflation in the U.S. to continue to run just under our mark this year, rise a bit above target in 2019, and then come back down to our 2 percent goal the following year." He said he sees two rate hikes "as the likely appropriate path for 2018," but said he will "monitor the data as they roll in." If better inflation numbers continue, officials are apt to become more inclined to raise rates, and we should hear less talk about abandoning or amending the Fed's inflation target.