Slower US inflation isn’t just the result of “transitory” factors

Despite cautionary remarks from a few of its dovish members, the Federal Reserve seems determined to continue uninterrupted down its course of gradual policy tightening. The slowing of inflation since the start of the year is not yet a deterrent.

From the FOMC minutes to the June meeting released this week, our emphasis:

Recent readings on headline and core PCE price inflation had come in lower than participants had expected. On a 12-month basis, headline PCE price inflation was running somewhat below the Committee’s 2 percent objective in April, partly because of factors that appeared to be transitory.
Core PCE price inflation–which historically has been a more useful predictor of future inflation, although it, too, can be affected by transitory factors–moved down from 1.8 percent in March to 1.5 percent in April. In addition, CPI inflation in May came in lower than expected.
Most participants viewed the recent softness in these price data as largely reflecting idiosyncratic factors, including sharp declines in prices of wireless telephone services and prescription drugs, and expected these developments to have little bearing on inflation over the medium run.

Measures of inflation have fallen even further since that meeting, as both the core and headline Personal Consumption Expenditure price indexes have climbed just 1.4 per cent in the twelve months through May.

Mobile telephony (about 1.1 per cent of core PCE inflation) did experience what is likely to be a one-off shock thanks in part to the proliferation of “unlimited” wireless data plans, while drug price inflation (4 per cent of core PCE) is undergoing a correction after a period of rapid increases last year.

But there’s a problem with the “idiosyncratic factors” explanation, which is that non-idiosyncratic factors are also pressuring inflation downward:

The charts from a note by Credit Suisse economists show clearly that the recent inflation weakness extends beyond just the outsized declines in these variables.

According to the economists, with our emphasis:

Most importantly, shelter, one of the largest (18% of core PCE) and most stable components of core inflation, has appeared to roll over in recent months. Housing prices have been steadily accelerating since the crisis, but recently, many of the fundamental drivers identified in our shelter inflation model – housing price growth, rental vacancy rates, and mortgage delinquencies – have either peaked or slowed significantly. While we do not expect housing inflation to collapse anytime soon, the consistent boost to core PCE from this category has likely already begun to fade.
Core goods prices have also been soft recently, and while these prices tend to be volatile, there are reasons for concern that this weakness might persist.
Auto prices, in particular, have deteriorated and weak fundamentals in this sector suggest a strong rebound is unlikely. Used auto supply has been steadily increasing, putting downward pressure on prices and new sales. At the same time, auto credit has been tightening amid an uptick in delinquency rates.

Inflation might start rebounding soon, perhaps if economic growth itself proves to have accelerated in the second quarter. But regardless of the implications for monetary policy, it simply isn’t right to say that this year’s weakness is mainly down to big swings in a couple of fringe components.