Disinflation is alive and well, but the Fed's job is not over

by Eugenio J. Alemán, Chief Economist, Raymond James 

Chief Economist Eugenio J. Alemán discusses current economic conditions.

We hear and read daily analysis on how inflation is coming down and that the Federal Reserve (Fed) has beaten inflation. This is probably very close to the truth from an economics point of view. However, from an individual consumer point of view, the truth is much different. For the majority of consumers everything is more expensive today than before the COVID-19 pandemic and getting more expensive. It is true that many consumers have received increases in wages and salaries over the last several years, which have helped them catch up to inflation, but salary and wage increases normally lag behind the rate of inflation.

It is also true that a measure of inflation followed by Fed officials lately, the seasonally adjusted rate for ‘all items less food, shelter, and energy’ or what has been called ‘super core’ fell below 2.0% on a year-over- year basis. However, as we have been saying for more than a year, when inflation is relatively low and stable, year-over-year comparisons are typically good measures. However, when inflation is coming from a relatively high rate, such a measure does not reflect the actual effects for consumers. That is, when inflation has been relatively high, our preferred measure is the 12-month moving average rather than the year-over- year measure. And if we look at the 12-month moving average for super core, it was still at 3.6% in September while the overall or headline rate was at 5.1% and the core CPI was at 5.3%.

Again, year-over-year rates as well as other measures like three-months annualized rates to check on the direction of inflation are important analysts’ tools. However, these measures are not important for consumers as they continue to suffer the cumulative effects of inflation on their purchasing power. At the same time, and as we have been arguing for a while, the Fed’s target for inflation is 2.0% and we are still a long way from achieving the target.

As the table below shows, in order to achieve the Fed’s inflation target, we need to see monthly inflation not surpassing 0.15% for a sustained period of time and we are not close to those rates, even if the direction of inflation, as many continue to point out, is heading the right way.

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Did we ever say, ‘higher for longer?’

We are back at the office after participating at this year’s National Association for Business Economics (NABE) annual conference in Dallas, TX. The three-day conference had several speakers from the Fed, including Lorie K. Logan, the President and CEO of the Federal Reserve Bank of Dallas, as well as Philip N. Jefferson, the Vice Chair of the Board of Governors of the Federal Reserve System. And from their speeches as well as the question and answer sessions, it is clear that all the members of the Fed had one and only one objective and one message: ‘higher for longer.’

Many questions to Fed members during the conference tried to get them to provide more information on the future of monetary policy but Fed officials danced around those questions and provided only one certainty: ‘higher for longer.’ Fed officials were not moved by arguments that long-term interest rates had already moved considerably higher, and they provided no clues on whether they were going to increase interest rates further before the end of the year as the September dot plot seems to indicate. What they made clear was that the Fed will keep interest rates ‘higher for longer.’

Surprise discussion topic: De-dollarization

We were surprised by two conference sessions at the NABE Conference on the issue of de-dollarization. We say surprised because we thought that it was only clients and advisors who had doubts about whether the global economy was moving away from the U.S. dollar. However, that was not the case. It seems that the issue is something that has permeated across the population as a whole, so the conference had a plenary session covering the topic—a presentation by Hélène Rey, of the London Business School—and a concurrent session—presentations by Steve Kamin, Senior Fellow, American Enterprise Institute and Stephanie Curcuru, Deputy Director at the Federal Reserve Board.

The first speaker indicated that while there has been a transformation in the trade (exports) networks between 2000-2019, a world mostly dominated by the U.S. and Europe to a tripolar world dominated by the US, Europe, and China, there has been no such change in the financial network. That is, the network of financial assets remains a unipolar world, dominated by the US, with Europe a distant second and China not in contention, at least not today. The hegemony of the U.S. dollar is still strong (with available data until 2019), accounting for 62.2% of international debt issuance, 56.3% in international loans, 43.8% in foreign exchange turnover, 39.9% in global payment currency and 62.7% in foreign exchange reserves. Furthermore, U.S. GDP as a share of global GDP represented about 18% in 2018 but the proportion of “countries where the U.S. dollar is the principal anchor currency weighted by their share of world GDP” was about 75%.

The second presentation indicated that the dollar’s influence may diminish in the future but that the dollar will remain the dominant currency. That is, we are heading to a ‘multi-polar currency world’ with the U.S. dollar, the euro, and the renminbi. However, the speaker indicated that ideas of the renminbi replacing the U.S. dollar are highly overblown, arguing that “China’s economic/financial/legal system (are) not good enough to support a world currency.”

The last presenter indicated that the demand for U.S. dollars as a store of value is shown by the dollar’s preeminence in foreign exchange reserves, in the demand for safe assets as well as demand of banknotes, that is, U.S. dollar bills. As a medium of exchange “the U.S. dollar remains the dominant medium of exchange” in trade invoicing, global banking, foreign currency debt issuance, as well as foreign exchange transactions, with little change in recent years. As a unit of account, the U.S. dollar is used as a “currency anchor;” “50% of world GDP (excluding the U.S.) is produced in countries whose currency is anchored to the U.S. dollar;” which means that “confidence in the dollar as a unit of account remains strong.” For a more detailed analysis of this topic, refer to “The International Role of the U.S. Dollar Post-COVID Edition” following the footnote below.1

In conclusion, what was not a surprise, as we have written in several publications earlier this year, was that there is no de-dollarization process going on in the global economy, no matter what the Chinese, those who want to sell gold, or BRICS presidents may be saying.

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Consumer Price Index is a measure of inflation compiled by the US Bureau of Labor Statistics. Currencies investing is generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.

Consumer Sentiment is a consumer confidence index published monthly by the University of Michigan. The index is normalized to have a value of 100 in the first quarter of 1966. Each month at least 500 telephone interviews are conducted of a contiguous United States sample.

Personal Consumption Expenditures Price Index (PCE): The PCE is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The change in the PCE price index is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behavior.

The Consumer Confidence Index (CCI) is a survey, administered by The Conference Board, that measures how optimistic or pessimistic consumers are regarding their expected financial situation. A value above 100 signals a boost in the consumers’ confidence towards the future economic situation, as a consequence of which they are less prone to save, and more inclined to consume. The opposite applies to values under 100.

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GDP Price Index: A measure of inflation in the prices of goods and services produced in the United States. The gross domestic product price index includes the prices of U.S. goods and services exported to other countries. The prices that Americans pay for imports aren't part of this index.

The Conference Board Leading Economic Index: Intended to forecast future economic activity, it is calculated from the values of ten key variables.

The Conference Board Coincident Economic Index: An index published by the Conference Board that provides a broad-based measurement of current economic conditions.

The Conference Board lagging Economic Index: an index published monthly by the Conference Board, used to confirm and assess the direction of the economy's movements over recent months.

The U.S. Dollar Index is an index of the value of the United States dollar relative to a basket of foreign currencies, often referred to as a basket of U.S. trade partners' currencies. The Index goes up when the U.S. dollar gains "strength" when compared to other currencies.

The FHFA House Price Index (FHFA HPI®) is a comprehensive collection of public, freely available house price indexes that measure changes in single-family home values based on data from all 50 states and over 400 American cities that extend back to the mid-1970s.

Import Price Index: The import price index measure price changes in goods or services purchased from abroad by U.S. residents (imports) and sold to foreign buyers (exports). The indexes are updated once a month by the Bureau of Labor Statistics (BLS) International Price Program (IPP).

ISM New Orders Index: ISM New Order Index shows the number of new orders from customers of manufacturing firms reported by survey respondents compared to the previous month. ISM Employment Index: The ISM Manufacturing Employment Index is a component of the Manufacturing Purchasing Managers Index and reflects employment changes from industrial companies.

ISM Inventories Index: The ISM manufacturing index is a composite index that gives equal weighting to new orders, production, employment, supplier deliveries, and inventories.

ISM Production Index: The ISM manufacturing index or PMI measures the change in production levels across the U.S. economy from month to month.

ISM Services PMI Index: The Institute of Supply Management (ISM) Non-Manufacturing Purchasing Managers' Index (PMI) (also known as the ISM Services PMI) report on Business, a composite index is calculated as an indicator of the overall economic condition for the non-manufacturing sector.

Consumer Price Index (CPI) A consumer price index is a price index, the price of a weighted average market basket of consumer goods and services purchased by households. Changes in measured CPI track changes in prices over time.

Producer Price Index: A producer price index (PPI) is a price index that measures the average changes in prices received by domestic producers for their output.

Industrial production: Industrial production is a measure of output of the industrial sector of the economy. The industrial sector includes manufacturing, mining, and utilities. Although these sectors contribute only a small portion of gross domestic product, they are highly sensitive to interest rates and consumer demand.

The NAHB/Wells Fargo Housing Opportunity Index (HOI) for a given area is defined as the share of homes sold in that area that would have been affordable to a family earning the local median income, based on standard mortgage underwriting criteria.

The S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index measures the change in the value of the U.S. residential housing market by tracking the purchase prices of single-family homes.

The S&P CoreLogic Case-Shiller 20-City Composite Home Price NSA Index seeks to measures the value of residential real estate in 20 major U.S. metropolitan.

Source: FactSet, data as of 7/7/2023