MNI INTERVIEW: NY Fed's Inflation Gauge Hits 10-Year High

--UIG Indicates Steady Rise in Trend Inflation, Fed Economist Rob Rich Tells MNI

Exclusively

--Strong Labor Market, Buoyant Financial Market Drive UIG to 2.95% in Nov

By Jean Yung

     WASHINGTON (MNI) - The latest reading from two broad-based inflation gauges

developed at the influential Federal Reserve Bank of New York bolsters Fed

officials' case that inflation is gathering momentum. 

     The prices-only Underlying Inflation Gauge, calculated using goods and

services prices, has held steady this year even as CPI tumbled, while a second

UIG measure that considers labor market data and asset prices soared to a

10-year high in November, New York Fed Assistant Vice President Rob Rich told

MNI in an exclusive interview.

     "The fact that the 'full data set' UIG is at a 10-year high suggests that

we've seen a steady rise in the estimate of trend inflation," Rich said Friday.

"It was fairly steady from 2011 to mid-2016, and as additional data coming in

pointed to additional strength in labor markets and financial markets, the

measure is moving upward relative to the prices-only UIG." 

     Developed in 2005 by Marlene Armstad and Simon Potter, the current markets

chief at the New York Fed, the bank's dynamic factor model for inflation has

long been used in internal policy discussion and as part of the Fed's macro

dashboard before it was made publicly available in September. 

     The pair of UIG measures offer a higher resolution picture of macroeconomic

dynamics by incorporating a wide range of relevant information including some

300 inputs including consumer and producer prices, commodity prices, labor

market data and real and financial asset prices. The Fed bank says the UIG

better detects cyclical turning points in underlying trend inflation and has a

superior track record in forecasting inflation trends compared to traditional

measures like core CPI. 

     --MARCHING STEADILY HIGHER

     In November, the so-called "full data set" UIG registered 2.95%, a rise of

110 basis points since the Fed's first post-crisis interest rate increase in

December 2015. The last time it was higher was August 2006, when it registered

3.10% and headline CPI was at 3.8%. 

     The prices-only UIG hit 2.21% in November, very close to the 2.2% annual

change in headline CPI for the month. Indeed, the prices-only UIG has hovered in

a narrow range between 2.01% and 2.26% all year even as CPI fell as low as 1.6%

in June from a multiyear high of 2.7% in February on declines in energy prices. 

     "The prices-only UIG measure has stayed relatively flat" this year, Rich

said. "The BLS's CPI measure's moving around much more was heavily influenced by

movements in energy prices. The UIG sees through that volatility because energy

prices were not expected to have a long lasting effect." 

     That the broad-based full-data-set UIG has increasingly lifted away from

the prices-only measure reflects the influence of dozens of additional labor

market and financial variables, including the unemployment rate, stock prices,

bond yields and purchasing managers' indexes. 

     "We continue to see upward movement in the full-data-set measure," Rich

said. "The pattern of the full-data-set UIG running above the prices-only

measure -- and rising with each period -- has been going on since the middle of

2016, likely due to the strength in the labor market and buoyant financial

markets." 

     --ROOM TO RISE 

     The inclusion of financial prices in UIG makes it especially germane to the

present moment, with Congress on the cusp of passing a stimulative tax reform

amid full employment and ebullient share prices.

     The New York Fed does not break out how various categories of inputs

contribute to the UIG, but at least some of the run-up in the full-data-set UIG

can be attributed to the biggest driver of equity returns this year: the

anticipated Republican tax overhaul. That would indicate that asset prices are

currently having a large and persistent impact on inflation. 

     At the same time, the stronger-than-expected labor market in 2017 has

helped drive the widening differential between the two UIG measures. 

     Fed officials said Wednesday they expect the unemployment rate to fall

further below its estimated natural level next year. That would appear to

suggest the UIG has more room to rise and support the Fed's projected path of

gradual rate hikes next year. 

     But Rich cautioned that the UIG model "doesn't really lend itself to a

forecasting aspect" and instead offers a "snapshot of what the best estimate of

trend inflation happens to be." How the factor model weighs different inputs

also evolves over time as new data is made available. 

     Viewed alongside the set of other alternative Fed gauges such as Cleveland

Fed's Median CPI and Dallas Fed's Trimmed Mean CPI, UIG supports the Federal

Open Market Committee's stance to look through the recent decline in core

inflation with the view that it should accelerate over the medium term. 

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

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