In September 2021, after inflation rose more than twice the Fed's 2% target for three consecutive months, Fed staff and policymakers changed their description of inflation to "persistently high."
After the PCE price index, which the Fed uses to set its inflation target, exceeded 4% in May, June and July of that year, that “elevated” description remained in the policy statement of the Federal Open Market Committee (FOMC), which is responsible for setting interest rates, even though the PCE price index has now fallen to 2.6% and appears to be falling.
The Fed's policy meeting next week could ultimately remove the phrase from its policy statement. If so, it would be the strongest signal yet that the central bank plans to cut interest rates as early as September, a date investors now view as a near certainty, and begin the easing phase of its monetary policy cycle.
Downgrading the description of inflation to something more benign than “elevated” could also lead the Fed to revise another key sentence in its current policy statement, which says it will not cut rates until officials are “more confident that inflation is moving sustainably toward 2 percent.”
Fed staff stopped describing inflation as “elevated” after the PCE price index fell below 3% in January, and policymakers noted ahead of their July 30-31 meeting that inflation was slowing across the economy and that they were more confident that the slowdown would persist.
They began using phrases like “getting closer” to describe how close a policy shift is and hinted at some of the circumstances that could cause the Fed to change its response to the economy and its policies.
Atlanta Fed President Raphael Bostic, in comments to reporters in late June, said he would be "surprised" if "any inflation reading above 0.5 percentage point would be considered low," and indirectly pointed to 2.5% or lower as a benchmark to at least consider changing the description of inflation.
Many economists believe that threshold will be reached or exceeded when PCE data for June is released on July 26.
Richmond Fed President Thomas Barkin told reporters last week that the opening sentence of the policy statement, including descriptions of growth, the job market and inflation, is used to "make a judgment call about the economy." With new PCE data coming out ahead of the meeting, "we'll see what that number is and make the necessary adjustments to it."
Proper verbal guidance is important
Some economists think the change is justified.
“They should be more forthcoming about acknowledging that inflation has cooled,” said Neil Dutta, head of macroeconomic research at Renaissance, who noted in a recent analysis that the inflation problems that have plagued Fed officials now appear to be moving in their favor.
For example, the Bureau of Labor Statistics developed a new housing inflation measure that reflects housing inflation trends more quickly than the CPI index and showed that rents were "decelerating meaningfully" throughout the second quarter.
"Housing rental inflation is easing further," Dutta added.
Minutes from recent Federal Reserve meetings show that Fed staff have made changes in how they describe inflation.
At its December meeting, as data showed inflation at 3%, Fed staff said inflation had "ease somewhat over the past year but remains elevated."
But at the following month's meeting, as the PCE price index fell to an annual rate of 2.6% in December last year, the description of "high" was revised in the report, and the staff only said that inflation "remained above 2% after a sharp decline throughout the year."
Staff comments on the economy typically go unnoticed because the Fed's deep cadre of economists are not the ones who make the decisions, but their opinions do influence the discussion, and changes in tone can provide signals about the direction of Fed policy.
As inflation accelerated in 2021, Fed staff and policymakers were the first to acknowledge that inflation “had risen,” a phrase used in the Fed’s policy statements in April, June and July of that year.
The PCE price index was just 1.8% annualized in February 2021, but rose to 2.7% in March. The data had not actually been released when the Fed met in April of that year, but economists could estimate it closely based on other data.
Staff described inflation as "elevated" in September 2021, as did the policy statement.
The Fed's inflation rate has continued to rise from then on, peaking at 7.1% in June 2022. Since then, inflation has fallen sharply and the slowdown has become increasingly broad-based.
Commodity prices have been falling, a reliable “drag” on inflation in the decade before the pandemic, and have recovered, at least for now. Wages are falling, while “sticky” service price increases are also falling.
New York Fed President John Williams said in an interview last week that the U.S. is "getting closer and closer to the inflation trend that we are looking for."
Omair Sharif, head of inflation insights and a close observer of price trends, said the evidence seems clear. Sharif pointed out that excluding the high inflation in early 2024 that appears to be noise rather than trend, core inflation has averaged the Fed's 2% target in 10 of the past 13 months. Sharif said:
“I look at this from the perspective of last summer, when core inflation, which excludes volatile food and energy prices, began to decline. Against this backdrop, removing references to inflation being ‘elevated’ would not only make sense but could be a good way to signal at the July meeting that a first rate cut in September was indeed possible.”
The article is forwarded from: Jinshi Data
