Month: April 2024

By Paul Gomme and Peter Rupert

The Bureau of Economic Analysis announced that, on an annualized basis, the personal consumption expenditures (PCE) price index increased 3.94% and core PCE (excluding food and energy) — the Fed’s preferred measure — rose 3.86%, up from 3.24% in the previous month. As we have commented many times, the monthly numbers are quite volatile and therefore we calculate a “trend” measure that we feel better captures the underlying trend, shown in red below. Both the trend measures indicate an uptick in inflation. These higher PCE inflation numbers were foreshadowed by the CPI release from about two weeks ago.

Earlier in the week the Bureau of Economic Analysis released its advance estimate for first quarter GDP. Output growth has decelerated from 4.9% in the third quarter of 2003 to 3.4% in the fourth quarter of 2023 and 1.6% in the most recent quarter. Personal consumption expenditures increased 2.5% in the first quarter after increasing 3.3% in the previous quarter. Indeed, consumer spending on services was a driving force in the most recent report. Investment increased 3.2% with the residential component increasing 13.9%, the largest increase since the fourth quarter of 2020.

The table below breaks down output growth by the contributions of its major components. The contribution of, say, investment (0.6 percentage points) is given by its growth rate (3.2%) weighted by its share of GDP (18%). Between 2023Q3 and 2024Q1, output growth has fallen by 3.3 percentage points. Of this decline, 0.4 percentage points (2.1 – 1.7) is due to consumption. Investment contributed 1.2 percentage points; government 0.8 points; and exports and imports have both contributed 0.5 points. This tells us that the fall in output growth has occurred due to all components of output, with particularly large contributions by investment and government spending.

Outlook

Over the last few months the likely prospect of several interest rate cuts became dimmer due to a rise in the underlying inflation trend. Has the deceleration in GDP growth over the last couple of quarters increased the likelihood of a rate cut? Given the rising trend in inflation it does not seem likely that a rate cut will happen any time soon.

Our measure of trend core PCE inflation now stands at 3.5% — considerably higher than the FOMC’s 2% target, and moving in the wrong direction. Some may point to the slower output growth numbers as a signal of lower future inflation. But, arguably the right thing to do at this stage is to raise interest rates. However, the FOMC has painted itself into a corner with earlier promises of lower interest rates. While it’s tempting to point to the real side weakness to justify a rate cut, in the longer term, addressing inflation is the better course of action as we learned in the 1970s when the U.S. was hit by stagflation — a stagnating real side along with high inflation.

By Paul Gomme and Peter Rupert

The BLS announced that CPI inflation rose 0.4% from February to March or 4.6% on annual basis. On a year over basis the CPI increased 3.5%. Our preferred measured of inflation rose to 4.11% in March after increasing 3.85% in February and 3.06% in January.

The core CPI inflation (excluding food and energy) also rose 0.4%, 4.39% annualized. The trend measure of inflation increased from 4.06% to 4.17% on an annualized basis.

We know that the folks on the FOMC look to core PCE inflation, not (core) CPI inflation. However, the March PCE price won’t be released for a couple of weeks. Given the overlap in the goods covered by the two price indices, the CPI presumably provides some information for what to expect of the March PCE price index. While the two price indices move together at “long” horizons (annual or longer), at a monthly frequency the relationship is looser. In other words, seeing an increase in core CPI inflation of, say, 0.2 percentage points, does not necessarily mean that the core PCE inflation rate will similarly rise by 0.2 percentage points. With all of these qualifications in mind, the March CPI inflation numbers give us little confidence that March core PCE inflation will be down — much less that it’ll be near the FOMC’s stated 2% target. Considering that the FOMC will probably like to see more than a single month’s inflation at it’s target before lowering the Fed funds rate, we would not bet on lower interest rates any time soon — especially given the continued strength of the labor market and GDP.