MV Weekly Market Flash: What’s...
Inflation is back at the top of the list of economic concerns felt by everyone from the voting members of the Federal Open Market Committee, to portfolio managers trying to figure out target maturities for their bond allocations, and to families dreading the next trip to the grocery store. A couple weeks ago, those concerns heated up with the publication of the January Consumer Price Index (CPI) report, a function of the Bureau of Labor Statistics, which showed inflation coming in hotter than expected.
This morning, though, we got a second take on the subject with the Personal Income and Outlays report issued by the Bureau of Economic Analysis. This report contains the Personal Consumption Expenditures (PCE) index, which happens to be the inflation indicator most closely studied by the Fed in its monetary policy deliberations. Happily for all of us worried about inflation’s recent stickiness, the PCE numbers for January were right in line with expectations. Significantly, the year-on-year gain in core PCE, which excludes the volatile categories of food and energy, fell to 2.6 percent from 2.9 percent last month.
Similar But Different
Any macroeconomic data point, whether trying to measure growth in output, changes in the labor market or changes in consumer prices, is imperfect; it applies a formula to measure some subset of all the possible data available. The CPI and the PCE both measure consumer prices, but the methodology is different. The Bureau of Labor Statistics, the organization responsible for the CPI, has a helpful little guide to tell us that there are four basic differences in approach that lead to the variations we observe between the two indexes: (i) the formula used (notably, the PCE reflects consumer substitution among detailed items as relative prices change), (ii) the relative weights applied to different categories of goods and services; (iii) the scope effect (the PCE includes the change in prices, not just of items consumed by households but also by institutions serving households such as employer coverage of health care costs); and (iv) other effects, a sort of grab bag of residual differences such as seasonal adjustment methodologies. One of the outcomes of the “scope effect” difference is that the PCE encompasses a wider range of products and services covered – i.e., its “market basket” is bigger than that of the CPI. This is perhaps one of the key reasons why the Fed is more inclined to use the PCE as its go-to inflation metric when deliberating changes to monetary policy.
Still Stuck Above Two
Investors were relieved to see the PCE in line with expectations; a hotter reading probably would have knocked out whatever good feelings remained after a tough week that has pushed both the S&P 500 and the Nasdaq Composite into negative territory for the year to date. As we write this on Friday morning, US stocks are trading flat to slightly down. The main concern, of course, is that with both inflation measures still stuck above the Fed’s two percent target rate, the next few months may not be as benign. In the eternal will-they-won’t-they guessing game about tariffs, the latest word is that the 25 percent hit to products from Canada and Mexico is still on track for March 4, which leaves March 3 (next Monday) as the last day for one of those famous last minute rabbits out of the hat to kick the can down the road.
More concerning than the pinballing policy decrees, though, is growing evidence that inflationary expectations among households and businesses are taking root more firmly than they did three years ago when the indexes were at their high points. Back then, sentiment surveys showed that most people expected inflation to be transitory and back to normal within two to three years. Those expectations are changing now, given both the stickiness in prices over the past half year and the specter of tariffs hanging over the near future. We can only hope that some policymakers are paying attention. There is no sugarcoating the potential detrimental effect of excessive tariffs, on consumer prices and on growth.