Letter from the Dallas Fed is doing the rounds

A pair of researchers from the Dallas Fed took a look at leading indicators on inflation and how estimates change over time. They believe that prices are higher than they seem and are set to rise further.

"The analysis shows that one need not wait for official PCE inflation estimates from the U.S. Bureau of Economic Analysis to get an accurate read on inflation," Alan Armen and Evan F. Koenig write. "Moreover, the earliest official PCE inflation estimates should not be taken at face value. Recent low inflation readings will likely be revised upward."

They took a closer look at early indications of inflation pressures in these reports:

  • ISM manufacturing
  • ISM non-manufacturing
  • New York (Empire) Fed
  • Philadelphia Fed
  • Richmond Fed
  • Kansas City Fed
  • Dallas Feds Fed

They found that the prices paid numbers in the ISM non-manufacturing index as well as the aggregate signal from the regional Fed numbers were significant predictors. They are also helpful in predicting revisions to the PCE data, which is the Fed's principle measure of inflation.

Based on the model, April 2017 PCE inflation should be revised to 1.90% from 1.72%. The June data should be revised to 1.55% from 1.42%.

Two takeaways:

  • This will slightly harden the belief of the hawks that inflation is coming, or is higher than it looks
  • Those prices paid component numbers we've been reporting for years have some value, even after the first release of PCE data