Fed and Its Pesky Inflation Target

There is a recurring theme in most discussions of the Federal Reserve these days — namely the growing focus on the painfully-slow progress towards its inflation target. This snail-like crawl could interrupt the always-cautious central bank’s plan to return to more normal U.S. monetary policy this year.

When the Fed’s policymaking Federal Open Market Committee decided to exit its crisis-era zero interest policy in December, officials expressed reasonable confidence that inflation over the medium term would return to the FOMC’s 2 percent objective.

Fast-forward to today, however, and prices continue to face downward pressure, calling into question whether the Fed will feel confident enough to announce additional rate hikes in 2016.

One Fed official has already indicated that inflation expectations “have declined too far for comfort.”

“I regard it as unwise to continue a normalization strategy in an environment of declining market-based inflation expectations,” St. Louis Fed President James Bullard warned in a Feb. 17 speech to financial analysts in St. Louis.

Bullard holds a voting position on the FOMC this year, so his words should not be taken lightly.

And he is not alone in thinking that perhaps the Fed should hit pause for a bit and see how things unfold.

This from Boston Fed President Eric Rosengren, in a Feb. 16 speech in Maine:

“In my own view, if inflation is slower to return to target, monetary policy normalization should be unhurried. ”

And Philadelphia Fed President Patrick Harker did not mince words during a public appearance in Delaware:

“… it might prove prudent to wait until the inflation data are stronger before we undertake a second rate hike.”

Harker is not a voter on the FOMC this year but Rosengren is, and recent data would seem to support his call for patience.

What The Numbers Show

Within the New York Fed’s Empire State Manufacturing Survey, a monthly snapshot of economic activity in its district, the price indexes suggested a continued drop in input prices and selling prices in February.

Meanwhile a Feb. 12 survey of business economists by the Philly Fed, conducted every quarter, shows an expectation for lower core inflation in 2016 and 2017— so stripping out food and energy prices — as measured by the Fed’s preferred metric.

Looking at this year alone, and on a fourth-quarter over fourth-quarter basis, core Personal Consumption Expenditures inflation is expected to average 1.6 percent in 2016; nowhere near the FOMC’s 2 percent target.

These surveys, and others like them, continue to weigh on the minds of some Fed officials, as evidenced by this excerpt from the Fed’s discussions when officials last met in January:

“ Some others expressed concern about the further decline in inflation compensation recently and the historically low levels of some survey measures of longer-run inflation expectations … . A number of participants indicated that, in light of recent developments, they viewed the outlook for inflation as somewhat more uncertain or saw the risks as being to the downside.” — Minutes from the Jan. 26–27, 2016 FOMC meeting.

So… What Does This Mean?

The next gathering of senior Fed officials to discuss monetary policy will be March 15–16. Given the supply glut that continues to depress oil prices, and the strong U.S. dollar, a marked improvement in the inflation outlook is unlikely.

So expect the Fed to remain in wait-and-see mode, increasing the odds that a second increase in short-term interest rates might not occur until the summer, or perhaps, much later in the year.