In this quarter’s Economic Perspectives, we take closer look at why the Fed continues to struggle with its “data dependent” approach to determining when to hike interest rates again. We also explore the evolution of Fed expectations for the economy and interest rates in recent years.
Headline CPI in September rose by 0.3%, in line with economists’ expectations. The core index increased by 0.1%, softer than the projected increase of 0.2%.
Over the past year, the headline index increased by 1.5%. Crude oil prices have recovered from their July decline and are currently hovering around $50 a barrel. This recent increase has translated to a rebound in overall energy prices, which has contributed to the recent uptick in inflationary pressures. Nonetheless, energy costs are still down over the past year, keeping a lid on the one-year change. Core inflation, which excludes the impact of food and energy costs, has been running higher, but the rate of increase edged modestly lower in September, rising by 2.2% over the preceding twelve months.
Wage growth slightly undershot expectations in the September employment report, with hourly earnings increasing by 0.2%. In spite of this miss, wages continue to creep upward. Stronger sustained wage growth may provide additional fuel for consumer spending, but is likely to act as an additional catalyst for higher inflation, particularly in the absence of stronger productivity gains.
While the labor market as a whole appears relatively healthy and conditions have tightened considerably, core PCE – the Fed’s favored inflation indicator – continues to fall short of the FOMC’s target of 2%. Although inflationary pressures continue to build slowly, recent statements from Fed Chair Janet Yellen suggest that the Fed may be willing to let the economy “run hot” to encourage stronger growth. That flies in the face of indications that a rate hike may have been closer to a reality in September than many believed, and market expectations for a December hike have recently diminished. So will the Fed hike before year-end or not? If the anticipated second half acceleration in growth fails to materialize, it won’t be a slam dunk.
The question may ultimately be whether or not the hawks or the doves on the FOMC will prevail, and whether Chair Yellen can maintain a coalition within the committee that will support her dovish policy stance.