Inflation Sinks Further

Week ending Friday September 29th 2017

The last week in September capped one of the most stable months on record for US-focused markets, with the S&P 500 posting the lowest volatility on record by some measures. Intuitively, our nominal GDP forecast was steady through September, reflecting both the importance of equity prices in the forecast as well as stability in other market inputs.

Markets

There wasn’t too much to note from markets for the week. Shares rose a bit, the five- and ten- year yields rose about 8 basis points, WTI oil gained 2% while the dollar index was about 1% higher. Reasonable people disagree on the analytical value of the VIX, but that index is at an all time low.

More of the same from Data

Weighty data releases for the week included an update to GDP/GDI, which was minimal from an NGDP outlook standpoint.

The most important release of the week generally failed to make headlines: the Personal Consumption Expenditures price index. PCE-based inflation measures (both headline and “core”) are worth carefully following in the current environment due to the Fed’s welcome admission that it does not clearly understand the determinants of inflation. If inflation marches lower, then the Fed’s prestige will continue to erode, potentially foreshadowing a change in approach.

Year-over-year changes in the PCE headline and core indices are in free fall, dipping to 1.3% on the Fed’s favored core series in the latest August data point, from around 1.8% at the end of 2016. The Fed has now gone 64 months, or five and a third years, since it very briefly hit its own target on inflation. This figure is staggering given how badly the un- and under-employed of United States needed monetary stimulus, and shows that US monetary policy is unresponsive and unaccountable to those it ostensibly serves.

The one upside to those of us who’ve made it through the non-recovery to this last quarter of 2017 is this: inflation is so embarrassingly low that just maybe the Fed will be shamed into doing something about that. It´s hard to put a precise number on the NGDP growth needed to move inflation north of 2% in 2018 and 2019, but safe to say it’s more than 4.5% and possibly more than 5%. It has averaged a meager 3.7% for the past 64 months.

Future of the FOMC

Trump met with Kevin Warsh this week, sending his probability of being the next Fed boss on PredictIt.org to 39%, from 25% the week before. Warsh is now the favorite, ahead of Jerome Powell at 28% (whom Trump also met with) and Janet Yellen at 20%. Presumably, with Trump interviewing potential replacements, Yellen is out, though the markets are not quite ready to say this.

Perhaps the Warsh and Powell interviews are one of Trump’s (in)famous negotiation gambits. There’s not much to say about Warsh; a Davos man, married into the wealthy Estee Lauder family, he has tended toward Hawkishness and shown no signs he understands monetary policy better than your typical econ-blog comments section. Trump, who showed some signs of useful monetary comprehension in an early 2008 interview with the entertainer Jim Kramer, will be keen to get someone to stamp on the accelerator: Yellen, Powell or Warsh, can he make one if his “deals”? It’s anyone’s guess.

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