MNI INTERVIEW: Fed Economist Sees Downside Inflation Risk

By Jean Yung

     WASHINGTON (MNI) - A deceleration in the U.S. housing sector this year

could edge core inflation off the Fed's 2% target where it has sat since last

summer, Federal Reserve Bank of Dallas economist Jim Dolmas told MNI in an

interview. This would offer additional reason for Fed officials to watch and

wait before their next interest rate increase.

     Despite an increasingly uncertain economic outlook, the Fed has faced fewer

inflation worries in recent months. Core PCE inflation has posted at 1.9% or

2.0% in every month since March 2018. That's been a Goldilocks scenario for the

FOMC, with solid fundamentals and strong resource utilization bolstering prices

without triggering bottlenecks or sudden surges.

     But with growth stimulus fading and rate increases beginning to bite, most

housing indicators are trending lower. Since shelter costs account for a third

of the core PCE price index, falling rents and home prices could drag down trend

inflation for a while, Dolmas said.

     --HOUSING SLOWDOWN

     Low supply and solid demand have pressured housing costs to rise faster in

the past year than they did in the prior two expansions, when core inflation

also averaged around 2%. Owners' equivalent rent, an estimate of what homeowners

would pay in rent if they didn't own their homes, rose 3.4% over the past year,

compared to 3.1% during the 1992 to 2007 period.

     This has offset modest increases in health care prices, another large

contributor to the PCE basket. In the wake of cuts to Medicare payouts to

physicians and hospitals, prices for medical services have risen just 1.6%,

compared to 3.3% in the earlier period. Many of these payment cuts will last

well into the future, meaning the component is unlikely to rebound.

     Now it looks like rents may sag as well. Residential investment declined

further in the fourth quarter as borrowing costs climbed. In particular, market

conditions for apartments around the country have softened, according to surveys

by the National Multifamily Housing Council.

     "Given the slowing you see in the housing market and some surveys of

apartment market tightness, if housing inflation starts to fade, that's downside

risk," Dolmas said.

     --TARIFFS EFFECT

     With concerns swirling over weaker global growth and uncertain trade

policies, Fed officials have pledged patience on policy.

     In spite of a historically tight labor market, inflation has been

surprisingly muted. A range of internal Fed measures of underlying inflation

including the Dallas Fed trimmed mean PCE have been moving sideways over the

past five to six months, Dolmas said, adding: "there's no strong reason to

expect it would pick up."

     It remains to be seen whether President Donald Trump's tariffs have worked

their way through the economy, he said. Core goods prices have picked up a bit

but may rise more, representing a source of upside risk for inflation. A study

from the New York Fed this month estimated that the tariffs added about 0.3

percentage point to CPI last year.

     However, "I'd be inclined to look past that as a transitory thing," Dolmas

said.

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

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