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By HaleStewart December 3, 2017 7:34 am
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US Bond Market Week in Review: A Variety of Views on Inflation

            There is little debate among Fed policy makers about the jobs market; there exists a near-universal consensus that we’re at employment.  Inflation, however, is a different story.  Several Fed presidents made speeches that week perfectly exemplified the current state of debate.  First up is Neal Kashkari:

“Because inflation is low, I am seeing no reason to tap the brakes on the economy,” Kashkari said in a Town Hall event at Winona State University in Minnesota and broadcast via the Minneapolis Fed’s website. A rate hike would be expected to slow the economy by reducing incentives for borrowing, investing and hiring.

He’s been making this argument for some time now.  As I’ve noted before, there is ample evidence to support his claim, especially when using the PCE price index:

Above are the 3, 6 and 12-month rolling averages of the total and core PCE price index.  While the overall index (top chart) has at least hit 2% in the recent past, the core level (bottom chart) hasn’t been near 2% in over 5 years.

            In the opposite camp is New York Fed President Dudley:

Dudley, a close ally of Fed Chair Janet Yellen who is set to step down in mid-2018, said that with unemployment having fallen to 4.1% the U.S. central bank thinks the economy has reached “full employment.” Theoretically, that is that unemployment can get without prompting inflation; the Fed’s preferred price measure has drifted down to 1.4% this year, below a 2-% target.

Dudley still believes that low inflation is transitory and will eventually rise to 2% due to the natural pressures from full employment.  This is based on the belief that the Fed’s model of the economy – which includes the Phillip’s Curve -- is correct.  The last five years are considered an aberration.

            And finally, there is Yellen (who will soon be departing):

Even with a step-up in growth of economic activity and a stronger labor market, inflation has continued to run below the 2 percent rate that the Federal Open Market Committee (FOMC) judges most consistent with our congressional mandate to foster both maximum employment and price stability. Increases in gasoline prices in the aftermath of the hurricanes temporarily pushed up measures of overall consumer price inflation, but inflation for items other than food and energy has remained surprisingly subdued. The total price index for personal consumption expenditures increased 1.6 percent over the 12 months ending in September, while the core price index, which excludes energy and food prices, rose just 1.3 percent over the same period, about 1/2 percentage point slower than a year earlier. In my view, the recent lower readings on inflation likely reflect transitory factors. As these transitory factors fade, I anticipate that inflation will stabilize around 2 percent over the medium term. However, it is also possible that this year's low inflation could reflect something more persistent. Indeed, inflation has been below the Committee's 2 percent objective for most of the past five years. Against this backdrop, the FOMC has indicated that it intends to carefully monitor actual and expected progress toward our inflation goal.

As I noted last week, it appears the Fed’s thinking is changing.  At first, they were dismissive of the idea that inflation would remain below 2% for the foreseeable future.  But at the last meeting, the discussed why inflation had been weak, specifically highlighting several different theories.  What’s most important here is to note that the Fed’s thinking, which changes at an aggravatingly slow glacial pace, acknowledges that low inflation may be the norm in the current environment.  

In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program.  He is the author of three books: U.S. Captive Insurance LawCaptive Insurance in Plain English and The Lifetime Income Security Solution.  He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog.  He is also an investment adviser with Thompson Creek Wealth Advisors. 

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