US CPI Preview: Steady state inflation

The Bureau of Labor Statistics will release the March consumer price index on Wednesday April 10th at 8:30 am EDT, 12:30 GMT

Forecast: Adjustment not change

Annual core inflation is predicted to be unchanged at 2.1% in March, with the monthly change moving to 0.2% from 0.1% in February.  Headline consumer inflation will rise to 1.8% on the year from 1.5% as the monthly variation rises to 03% from 0.2%

FXStreet

Inflation and the Federal Reserve

One of the great successes of central bank policy over the past generation has been the restraint of inflation. From the 12% high in the US in early 1980s inflationary expectations in the general economy have been so diminished that any serious reduction in demand has the Fed worrying that inflation is too low. Rate policy over the decade since the financial crisis and recession has had a stated goal of raising inflation to the Fed’s 2% target.

The Fed’s latest projection for the US economy, released at the March 20^th FOMC meeting, reduced the personal consumption price index (PCE) estimate for 2019 to 1.8% from 1.9% and kept core PCE stable at 2%.  This is in agreement with the expectations for CPI which tends to run a bit stronger than the Fed’s preferred PCE scale.

The change in Fed rate policy from tightening to neutral that began with revised December material, which reduced inflation, economic growth and rate projections for the first time in two years, has become the market standard.  The Fed Funds futures now list the probability that there will be a rate reductions by the December 11^th FOMC meeting as slightly higher 51.2% to 48.8% than rates will be unchanged from the current 2.5% upper limit.

CME Group

Core PCE versus Core CPI

The Fed’s preferred inflation measure is the core personal consumption expenditures price index, core PCE for short. The target is 2%.  Core PCE is an updated version of the consumer price index, CPI.  Its different statistical composition results in a lower inflation rate. The PCE index has price data back to 1960. The consumer price index returns to 1958.  

Inflation, the Fed Pause and the Dollar

Inflation is not the Fed’s chief concern for the US economy. Beginning at the December meeting and elaborated since the bank and its governors have tied their policy change to the fragile state of the global economy. Particularly the threats offered by the US/China trade dispute and the UK exit from the EU to  global economic growth.

Market interest in CPI is limited to its role as a signal for the core PCE rate. The correlation between the two rates is strong though CPI is generally higher. The current trend in CPI and the March expectations anticipate little change in prices. The stable core rate backs up the Fed change in policy. If inflation is not a threat rate increases are superfluous in an economy expanding at 3% or less.

The dollar has been treading water for five months. Its rate advantage in Fed policy has ended but the ECB’s own policy shift, adding liquidity through a new loan program has neutered the euro’s brief benefit.

Inflation has ceased to be an immediate Fed interest. There is no pressure on rate policy from rising prices. If anything the lack of inflationary impetus despite the strong US economy and booming labor market reinforces the logic of the Fed rate pause.  If the economy does falter it would likely take inflation down with it.

The March CPI result will not move markets but if it is weaker than expected it will bring rate cut speculation that much closer.