The Fed Has the Direction of Prices Correct, but Could be Undershooting the Magnitude

March 21, 2018
By Bryce Coward, CFA in Markets

Today the Fed hiked the Fed Funds rate by .25% and also updated its policy statement and the so-called dot plot, which is a compilation of the FOMC members’ projections for GDP growth, unemployment and prices. The interesting feature of today’s policy move was not the rise in rates – that was widely expected – but rather a nod that inflation could move higher in the coming months and also a dot plot that reflected a slight increase in projected inflation in each 2019 and 2020. But, is the Fed expecting enough inflation? Our own inflation regression model, which admittedly predicts core consumer price inflation rather than the Fed’s preferred gauge of core personal consumption expenditure, suggests a more brisk inflation scenario than the Fed’s baseline projections. Our model, which uses small business hiring plans, WTI crude oil prices, the US dollar index and last year’s core CPI reading, is anticipating the highest core CPI rate since late 2000. Now, we are hopeful the Fed’s models are more accurate than our own and prices will settle at a level consistent with Fed expectations, but there does appear to be upside risk to inflation, at least relative to the Fed’s baseline.

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