Core PCE Inflation Lull Should Be Short-Lived

posted by Michael Lewis on April 26, 2019 - 5:05pm

FMI’s commentary on this morning’s “shockingly low” 19Q1 core PCE deflator.

While this morning’s +3.2% rush in 19Q1 real GDP growth beat all estimates handily, the markets’ attention and that of many analysts has been focused on another number: meager +1.3% annualized core PCE inflation for the quarter.
Their read was that the very “cautious” FOMC would turn even more dovish because of “too low” inflation. FMI agrees, for now.
We believe that the FOMC will not raise (or cut!) the fed funds target rate for the next few quarters. However, Powell’s caution was predicated on “downside risks” to the U.S. economy, and those appear to be fading fast.
In March, FOMC members forecast that 2019 real growth would be just below +2% (Q4-Q4). After this morning’s GDP report, FMI is tracking at least +2.5% for the year. While there will be some near-term payback in trade and inventories, consumption is poised for a solid rebound in 19Q2 in the wake of robust March retail sales. The federal government’s contribution is guaranteed an automatic jump vs. the shutdown-inhibited 19Q1. After a brisk 19Q2 real GDP gain, we anticipate that respectable momentum will continue.
Meanwhile, the inflation situation is hardly sanguine. Today’s “shock” was amplified because the government shutdown delayed February inflation results (February and March PCE detail will be included in Monday’s March personal income report). Nonetheless, recent CPI and PPI detail did point to a further moderation in core PCE inflation.
This 19Q1 core PCE lull, FMI believes, says more about the volatility of the data than about the current trend. Since 2011, quarterly core PCE deflator readings have come in below +1.5% a third of the time and above +1.9% about a third of the time. The average has been +1.7% over the period, not that much below the Fed’s +2% target.
Other price metrics have shown less restraint of late. Or none at all. CPI ex-food & energy rose +2.3% annualized in 19Q1; the Cleveland and Atlanta Fed takes on core CPI data ran even higher. As did core PPI and other measures.
FMI continues to expect core PCE inflation to move up, reaching +2%, possibly higher, by year-end. With better growth and on-target inflation, the Fed should shed much of this caution.