The Phaserl


Rising Inflation, Four Rate Hikes, Financial Repression on Menu in 2017: Fed Heads

by Wolf Richter, Wolf Street:

Bondholders, savers, consumers to be put through inflation wringer.

Inflation will rise above target, and that’s OK, the Fed heads who’ve been talking since last week’s meeting said. The Fed will hike rates, maybe faster than expected, but they won’t catch up with inflation, keeping the Fed purposefully behind the curve, and inflation will overshoot, and real interest rates will be deeply negative, whether you like it or not. That’s the Fed’s message emerging since the last meeting.

Today, Philadelphia Fed President Patrick Harker and Chicago Fed President Charles Evans echoed Fed Chair Janet Yellen who’d suggested on Wednesday that the Fed could try to push inflation above the 2% “target.”

But the Fed’s measure of inflation is the Personal Consumption Expenditure index (PCE index), which is significantly below the Consumer Price Index (CPI) which already jumped 2.74% in February, year-over-year.

Harker, a voting member this year on the policy-setting committee (FOMC), told CNBC today that three interest rate hikes for 2017 make sense, and getting one of them “out of the way” in March allows the Fed to spread them out during the year.

“We don’t want to get behind the curve,” he said. But the Fed is already woefully behind the curve: The FOMC last week raised the target for the federal funds rate a quarter point to a range of 0.75% to 1.0%. The effective federal funds rate is at only 0.91%. That’s a real (after inflation) effective federal funds rate of negative -1.83%.

The Fed prefers the PCE inflation index, over CPI, because it understates actual increases in the costs of living even more than CPI. Headline PCE inflation index rose 1.9% year-over-year, as Harker pointed out, and core PCE rose 1.7%. Versus the 2.7% increase in CPI.

These differences are cumulative and get large over time. The two charts below, via Doug Short of Advisor Perspectives, show the differences. The first chart shows the gap between the core measures (without food and energy) of PCE and CPI every month going back to 1960. The green bars indicate by how much CPI exceeded PCE in percentage points. The occasional red bars indicate when CPI was smaller than PCE inflation:

And the chart below shows the cumulative effects of this understatement of inflation by PCE (red line) versus CPI (blue line).

So inflation as measured by PCE, is “within shooting distance of our target,” which is 2%, Harker pointed out. Hitting that PCE target would likely cause CPI to move closer to 3%. But it’s still not going to be enough for the Fed:

“I think we’re there, and we’re moving in the right direction,” Harker said. “There will be a little bit of an overshoot, and that’s OK, it’s appropriate.” The target of 2% is “not a ceiling” but “just a target.”

“You need to be concerned about is not so much the number itself but the momentum,” he said. “To me it’s more like what it feels like. Is it accelerating? Is it decelerating? We want to stay around 2%. I think we’re pretty close to that, and the momentum is in the right direction.”

Evens, also a voting member this year on the FOMC, chimed in today on Fox Business Network TV: Three rate hikes in 2017 are “entirely possible,” he said. “As I gain more confidence in the outlook I could support three total this year. If inflation began to pick up, that would certainly solidify. It could be three. It could be two. It could be four if things really pick up.”

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