ONE REASON FOR A MORE HAWKISH FED
The St. Louis Fed posts an alternative measure of inflation we’ve discussed in the past. This version of inflation divides PCE (personal consumption expenditure) core inflation into cyclical components, which are tied to the business cycle, and acyclical components, which are more influenced by idiosyncratic changes in supply and demand. The acyclical components are considered less sensitive to monetary policy and contain elements like health care. Historically, PCE core inflation has been fairly equally divided between the cyclical and acyclical components in attribution. But when inflation began accelerating in April of this year, the rise was 67% acyclical. Since acyclical inflation is less sensitive to monetary policy, we could see why the Fed considered the inflation increase to be “transitory” and intended to stick with easy monetary policy.
Last week this changed somewhat, as the Fed confirmed that they would likely begin reducing their bond buying program in November. In addition, the dots chart showed that the Fed Funds rate would increase sooner than they projected at the last meeting. What changed? While the Fed looks at many indicators, cyclical inflation has started accelerating, but acyclical inflation has stayed steady at its already elevated level. Though acyclical inflation remains a higher-than-average 62% of core inflation, the rise in PCE since April has been mostly contained in the cyclical part. So it is possible that the transitory part of inflation is now becoming more entrenched and affecting the cyclical component. If this trend continues or accelerates, the Fed may have to accelerate their plans for tightening as well.
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