Fed Hikes Still Data Dependent

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I read the May FOMC press report as signaling that the Fed will remain data dependent throughout 2018. I think it will take a breakout of inflation, real wage growth in excess of productivity or an investment slowdown to prompt a fourth 2018 hike. The Fed noted its policy is “symmetric” which says that the Fed will have to allow the PCE deflator to move a bit above 2% to retain credibility in its statements and intentions. The data already show that trend PCE inflation is lifting, currently at 1.8% up from the low of 1% in 2016 but still on top of the 20-year mean.
But how far above 2%? It strikes that this is more of a Fed-behavior question than a straight statistical question. The data show that 20-year mean in the PCE deflator is 1.8%, and that it is statistically “symmetric”. That is important but does not provide a guidepost to the Fed’s objectives. Frankly it is doubtful that the Fed will allow as much upside deviation as the -3% deviation in the financial crisis. I believe that the Fed’s reaction function will be data dependent. There are likely to be four gauges the Fed will consider: the headline itself (now at target); shorter inflation trends (six-month annualized rate now at 2.2%); core PCE inflation developments (currently at 1.7%); and real wage growth (at 0.9%, less than productivity growth). Taken together, there is not enough data for the Fed to become aggressive and begin to hike more than currently advertised - yet. Along with lessened ‘slack’ (low unemployment rate), there are reasons for them to be vigilant, but not enough to get aggressive. The stronger USD is likely to help contain oil prices (perhaps driven by Iran/Venezuela more than monetary policy) and hence inflation. - Special Guest Blogger: Tim Kearney, PhD

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