PCE Comes in With Mixed Results, Brainerd Nominated to Vice Chair, GDP Miss Likely Doesn’t Change Fed Calculus

FS Insight Team

The Fed’s preferred measure of inflation, the Personal Consumption Expenditure Index (PCE), was reported Friday morning. The index went up 6.6% which was the most significant increase since 1981. However, when looking under the hood in the numbers there was some promising evidence that at least some problematic components of overall inflation may be mitigating. The narrower measure that omits food and energy costs climbed by just .3% in March which matched the expectations of Wall Street. The rate of core inflation also slipped to 5.2% from 5.3% which was the first month-to-month decline in over a year. So, this is a mixed bag and both sides of the inflation debate can find validation in the numbers.

Another big surprise was the GDP miss on Thursday. The decline was 1.4% compared to expectations of a 1% gain. The severity of the headline miss is mitigated by several idiosyncratic factors including an exaggerated trade deficit that should normalize as demand for goods returns closer to historic norms. The convergence of these specific factors and some data noise from Omicron make it likely that the next reading will be higher. Some of the factors that resulted in this downside surprise will be pushing to the upside in coming quarters. We think the Fed understands this well and this troublesome headline, while eye catching, will likely have little, if any, effect on the Fed’s decision-making.

This week is the calm before the big Fed meeting next week. The world’s most powerful central bank is widely expected to raise rates by 50 bps. However, some in the growing chorus of hawks and inflationistas have been urging front-loading the hikes. As we mentioned last week, some Fed Watching banks have even begun speculating on the possibility of a 75-bps hike in meetings subsequent to May. While there’s an outside possibility the FOMC would like to surprise markets, we’d put our money firmly on 50 bps for next week.

However, those looking for definitive evidence of inflation peaking likely were a bit disappointed with PCE. This report appears to be reflecting the massive disruptions from the war in Ukraine and these significant consequences are likely to be with us for a while unfortunately. The Fed has an egg on its face. It got inflation very wrong and there is reason to suspect that they are now firmly dedicated to getting it right by taking the price stability mandate more seriously.

The Fed has been approaching new mandates out of their statutory purview with more vigor than their actual mandates according to some observers. Remember, that one of the items that was supposed come of the Average Inflation Target regime was that economic gains in expansionary periods would be more concentrated in the lower income quintiles. It’s hard to tell if this was the case given the largesse of government support to citizens during the pandemic. However, the severity of inflation that has reached highs not seen since the early 1980s is definitely going to eat into the wallet of the vast majority of consumers if left unchecked.

So, a Fed that has shown its prowess in being a lender of last resort and even concocting emergency lending schemes now must shift to full inflation fighting mode. Remember the target inflation rate is 2% which is well under half of recent readings. The Fed has decidedly more modern and effective powers during crisis than it does during tightening. As powerful as the Fed is, some of its primary tools for slowing down the economy have been stripped off over the years due to de-regulation, a political unpopularity. While bank capital and direct supervision of large banks, including the prodigious orderly liquidation authority, are new tools that helped us avoid a worse financial crisis during the pandemic, its tool kit and prospects for achieving a soft-landing are much more unknown. The Senate confirmed Lael Brainard as Fed Vice Chair on Tuesday. The FOMC will meet from next week on May 3rd and 4th. The benchmark yield on the 10-Year Yield was 2.93 bps.

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