Massive PCE Inflation Revision Coming in September

The core Y/Y PCE Price Index is likely to be revised down by up as much as .8% on September 30^tth from 3.3% to as low as 2.5% when the BEA reforms its methodology for estimating portfolio management and software inflation.   Both estimates were deeply flawed as portfolio management fees were based on stock price changes and software failed to correct for technology improvements.  In addition, over the last 3 months PCE inflation prints without financial services inflation would have been: .2%, .1% and .1% which annualizes to only a 1.6% rate of inflation.  If one corrects for the deeply flawed shelter component (see our calculation at infracapfunds.com), year over year Core PCE inflation would be approximately 2%.

The Fed is extremely unlikely to raise rates in September.  The current FOMC is highly motivated to raise rates in order to demonstrate independence from the Trump Administration and due to the fact the members believe in the fallacious “Expectations” theory of inflation.  They will not raise rates, however, as the inflation data does not support it.  Core CPI Y/Y has declined from 2.9% to 2.5% over the last 3 months and the last 3 months annualized rate is only 1.6%. In addition, CPI Core Y/Y corrected for the 2-year delayed shelter component is only 1.2% (see infracapfunds.com).  In addition, the revised PCE data discussed above shows a similar deceleration.  Also, as discussed below, the Fed’s hawkish policy stance has dramatically tightened financial conditions over the last four months.  The interest rate sensitive sectors of the US economy are already in recession.

Warsh and the hawkish FOMC have tightened financial conditions dramatically.  Real 10-year interest rates have surged from 1.9% to 2.4% over the last four months, which represents a dramatic tightening of monetary policy.  The surge corresponds with an increase in market expectations to two rate hikes within the next year.  In addition, inflationary expectations have plunged from 3.4% to only 2.3% based on treasury implied inflation. The 10-year almost always trades at approximately 100 over the expected Fed Funds rate, which implies that the treasury market does not expect any rate increases as the 10-year bond has only risen 25bp over the last 4 months while the expected Fed Funds rate has risen 75bp.