The key line from Powell at Wedensday's FOMC press conference was "it's kind of fallen apart", which isn't the kind of thing you want to hear from a Fed chair in any context.
But what was the context? A reporter asks Powell if what's driving the hawkish shift is the election but he pushes back strongly. The whole thing is worth a read:
Q: If I could follow up on that. You mentioned the risk of uncertainty indexes toward the back of the document. The upside risk to inflation jumped quite substantially. The only thing, really, that’s happened you mentioned that the disinflationary story remains intact. Yet, the risk weighting has jumped to the upside. The only real thing that’s happened is November 5th in the meantime. Is it fair to say that that’s what’s driving the higher sense of upside risk on inflation?
MR. POWELL: Actually, that’s not the only thing that’s happened. Well, what’s happened is that our forecast for inflation for this year, I think, are five tenths higher than they were in September. So you’ve got—you had two months of higher inflation, September and October. As I mentioned, November is back on track. But, you know, once again, we’ve—you know, we’ve had a year-end projection for inflation and it’s kind of fallen apart as we’ve approached the end of the year. So that is certainly a large factor in people’s thinking. I can tell you that might be the single biggest factor, is inflation has once again underperformed relative to expectations.
It’s still, you know, going to be between 2 ½ and 3. It’s way below where it was. But, you know, we really want to see progress on inflation. You know, as I mentioned, as we think about further cuts we’re going to be looking for progress on inflation. We have been moving sideways on 12-month inflation, as the 12-month window moves. That’s in part because inflation was very, very low, measured in the fourth quarter of 2023. Nonetheless, as we go forward we’re going to want to be seeing further progress on bringing inflation down, and keeping a solid labor market.
So what's the broader context here?
Here are the PCE inflation forecasts in the latest summary of economic projections:
- 2024: 2.4% → Up from 2.3%
- 2025: 2.5% → Up from 2.1%
- 2026: 2.1% → Up from 2.0%
- 2027: 2.0% → No change
It might even be worse than that with Powell yesterday highlighting that CPI numbers indicate 2.5% PCE inflation (and 2.8% core).
PCE Core Inflation Median:
- 2024: 2.8% → Up from 2.6%
- 2025: 2.5% → Up from 2.2%
- 2026: 2.2% → Up from 2.0%
- 2027: 2.0% → No change
If you go back to September, the median PCE forecast was 2.3% on the headline and 2.6% on the core, so we're 0.2 pp above that. If you got back to this time last year, they were both at 2.4% which means that while headline is close, core is 0.4 pp higher than forecast.
So what's the real message here?
Powell and the Fed are worried about inflation again. The emphasis has tilted from the employment side of the mandate back to inflation. You can see that in rising Treasury yields in the aftermath of the decision. Add in tariffs, corporate tax cuts and other potential election largess and it may take awhile for those worries to go away.
Ultimately, I think they will because there are strong deflationary impulses in goods and the services (esp housing) drags are slow to pass through. Part of the drag is that longer-term rates are higher now and 30-year fixed rates are back at 7% with home builders getting beaten up. That will eventually win out and that's why I would be buying bonds if they can get to 5% but we're not there yet.
