Rarely have market prognosticators disagreed by such a broad margin on the path forward for inflation and the Federal Reserve’s efforts to fight it. That’s in part because the government’s two main price gauges leave a lot of open ground for the interpretation of the facts.
The underlying signal from the personal consumption expenditures price index — the so-called trimmed-mean version — suggests that it has been converging on more normal levels; the consumer price index, on the other hand, remains unusually high. It’s a mistake to focus entirely on one indicator over the other, and the Fed isn’t likely to stop raising interest rates until it sees strong evidence that both are clearly coming down.
Consider the PCE, the preferred metric of market doves. The Fed decided to focus on PCE in 2000 after a period of extensive analysis, noting in a February 2000 report to Congress that it is both “more comprehensive” and a “more consistent series over time.” Its weights can also change as people’s consumption preferences shift, allowing for substitution effects if families decide, for instance, to favor chicken over beef.
But members of the Federal Open Market Committee frequently talk about CPI, whose reading for May is scheduled to be released on Friday. As Harvard University economist Judd Cramer pointed out to me, CPI directly influences tens of millions of workers and retirees. According to Bureau of Labor Statistics figures, it’s tied to wages for more than 2 million workers under collective-bargaining agreements. It’s also linked to the incomes of about 48 million Social Security beneficiaries, 4.1 million military and civil service retirees and their families and some 22 million recipients of food assistance.
What’s more, CPI is published before PCE each month and draws most of the big news headlines, meaning it has an outsized role in the public’s thinking about inflation — the all important “inflation expectations” that economic policy makers measure diligently through surveys and market indicators and believe can turn into self-fulfilling prophecies.
So why are CPI and PCE diverging? A significant reason is the treatment of housing, which has a much larger weighting in the CPI basket. Housing inflation as reflected in the indexes — which in both cases demonstrably lags behind changes in market rents and home prices — is widely expected to keep rising, potentially exacerbating some of the differences.
But it’s a mistake to give either index short shift. As the chief US economist for Bloomberg Economics, Anna Wong, told me, the Fed isn’t likely to back off its pace of interest rate increases unless it sees clear evidence that both are falling.
The PCE versus CPI debate is just one of many that are raging among inflation watchers. Multiple variations exist in each index, and you could land on different ones depending on your answers to the following questions: How exactly do you define the underlying trend in inflation? Should you throw out volatile food and energy prices? Should you throw out the outliers and focus on the inside distribution of prices? Is it prudent to focus on monthly shifts or compare data with the same period a year earlier?
Those are important debates, but investors who search for the “one true metric” are likely to miss the forest for the trees. “Everyone reads the inflation reports very carefully and looks for details that look positive and that kind of thing,” Fed Chair Jerome Powell told the Wall Street Journal in an interview last month. “But truthfully this is not a time for tremendously nuanced readings of inflation. We need to see inflation coming down in a convincing way.”
The Fed and markets outsmarted themselves last year when policy makers looked deep into the bowels of the inflation reports and determined that inflation was “transitory” even though the too-obvious headline numbers were flashing warning signs. This time, policy makers aren’t likely to back off until all signs are pointing unmistakably in the right direction.
Bloomberg News provided this article. For more articles like this please visit
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