The Federal Reserve’s target measure of inflation - changes in personal consumption expenditure (PCE) prices - is now running well above the central bank’s 2% goal as the chart below shows.
US core inflation jumped from 1.9% in March to 3.1% in April after PCE prices - excluding food and energy costs - rose more than expected by 0.7% last month as the US economy reopened.
Source: Bank of Singapore, Bloomberg
The surge in prices will increase the focus on May’s employment report on Friday. Payrolls are likely to have risen by 500,000. But even with such a large gain, the US would still be 7.7 million jobs short from its pre-pandemic levels, keeping the Fed far from its goal of maximum employment.
The Fed’s other goal is to secure stable 2% inflation for the US economy.
Source: Bank of Singapore, Bloomberg
Though core PCE prices rose by 0.7% last month, the Fed expects summer increases in inflation above its 2% target to be only temporary.
The economy’s reopening is causing consumer prices to jump as demand outstrips supply. But the Fed expects goods shortages to wane as key bottlenecks - for example, in semiconductors - ease over time. Similarly, surges in demand for services are set to tail off once activity returns to its pre-pandemic levels while scarce labour is likely to improve as more workers become vaccinated, schools reopen and top-ups to jobless benefits end in September.
Last week, Fed Vice Chair Clarida said inflationary pressures would ‘prove to be largely transitory.’ Fed Governor Brainard also noted: ‘a very important part of inflation dynamics is longer-term inflation expectations and those have been extremely well anchored, implying that if we saw some development pushing inflation up, I wouldn’t expect that to get embedded in the ongoing inflation rate.’
The second chart shows measures of inflation expectations including 10Y breakeven rates and University of Michigan survey data have increased in 2021 but remain in their ranges from the last two decades. Thus, we expect the Fed to look through summer surges in inflation and keep its quantitative easing intact this year until the US labour market improves further. We think the Fed will only start tapering its bond buying in early 2022, to the benefit of risk assets in 2021.
