JOLTS Report Shows Modest Weakness

Fed Doubles Down On Heightened Inflation Expectations In Minutes

The Fed’s Minutes were released on Wednesday. There wasn’t much new to digest. The Fed seems to be locked in with its decision to raise rates a quarter point in December. The market agrees with the Fed as there’s an 88% chance the Fed raises rates at least once in December. Future hikes in 2018 are much more uncertain. The guidance seems to be for 2 hikes, but nothing is locked in as the economic data or the stock market can cause the Fed to deviate from its plans.

The key place where I strongly disagree with most members at the Fed is inflation. The Minutes stated, “Many participants continued to believe that the cyclical pressures associated with a tightening labor market or an economy operating above its potential were likely to show through to higher inflation over the medium term. In addition, many judged that at least part of the softening in inflation this year was the result of idiosyncratic or one-time factors, and, thus, their effects were likely to fade over time.” I think the situation is the opposite as the latest boost in inflation is temporary because of the hurricanes. Without these one time events, inflation would be lower. The chart below highlights my differing opinion. The 10 year break even inflation rate is down for the year, but it has been up in the past few weeks. The Fed thinks the red circle is the temporary move and I think the black circle is the one time move.

The chart below shows what the Fed looks at. The PCE and the core PCE are below the 2% target. The argument that this streak of below 2% inflation based on these gauges is temporary seems ridiculous because the streak has been going on for 8 months. Secondly, the labor market is tighter this year than last year which would imply the inflation would be higher, not lower. This is why I said in my last article that the Phillips Curve is proving to be ineffective.

In summary, most Fed members still think inflation is going to move higher in the next few months because of the tightened labor market. That might prove true at some point in the next few years, but there’s still a lot people who are underemployed. As you can see in the chart below, the M2 money supply and core PCE have had a tight correlation in the past few years. With the money supply growth falling, that implies further deceleration in inflation. Personally, I think the hurricanes will push inflation up temporarily, but this chart shows the medium term trend is lower.