MNI INTERVIEW:Fed Model Sees 18 Months Of 2.4% Trend Inflation

Trend U.S. inflation is set to stay elevated at around 2.4% over the next year and a half, levels not seen since before the financial crisis, according to economist Tyler Atkinson of the Dallas Fed, which publishes a "trimmed mean" PCE inflation measure widely followed within the Fed system.

While headline PCE inflation rose to an annual 3.9% in May, the trimmed mean PCE inflation rate over the 12 months through May has been 1.9%, slightly below the Fed's goal of 2%. "That's led a lot of people to conclude that high inflation will be transitory," Atkinson said in an interview. "But the fact that overall prices have increased nearly 4% over the past year does tell us something about what the trimmed mean is likely to be over the coming year."

CPI data Tuesday showed that gauge of inflation soar to 5.4% in June, the biggest year-on-year increase since 2008, reflecting spikes in used car prices and other goods and services affected by supply bottlenecks which have thus far been "trimmed out" of the trimmed mean measure.

"We expect to see that supply-demand imbalance show up in a little higher inflation in a broader set of consumer goods over the coming year. That will cause the trimmed mean to move up much less than headline inflation, but in the same direction," Atkinson said.

That phenomenon matches what the Dallas Fed is hearing from regional business contacts, who say the semiconductor shortage is likely to be more persistent and begin affecting prices of goods outside of new and used cars.

NO LABOR SLACK

The Fed has said it will hold rates near zero until the economy sees full employment and inflation has risen to 2% and is "on track to moderately exceed 2% for some time." In June, officials said they expect inflation to come back down sharply in 2022, to only 2.1% from 3.4% this year.

Underlying the Dallas Fed's forecast are beliefs that elevated unemployment will exert little to no downward pressure on inflation over the coming year, and that inflation expectations remain anchored at 2%.

Trimmed mean inflation fell only as low as 1.6% during the pandemic, a markedly different performance to that during the financial crisis, when it troughed at 0.8%, and an indication that "the labor market is tighter than headline unemployment figures would suggest," Atkinson said.

"Over the next year, we expect the unemployment rate to come down and employment to increase, but it might not represent a tightening of the labor market," he said. But there's high uncertainty surround that assumption. "It's very unusual within the cycle. The tightness of the labor market could change in either direction in a way that we don't expect as labor supply comes back online."