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--UIG Points to Continued Rise in Trend Inflation
--Full Data Set Measure Up on Strong Purchasing Managers Survey Data
By Jean Yung
     WASHINGTON (MNI) - A widening differential between a broad-based gauge of
trend inflation and a more restrictive version out of the Federal Reserve Bank
of New York offers further evidence that an acceleration in trend inflation is
underway, driven by changes in fiscal policy, rising confidence, and global
tailwinds.
     In March, the "full data set" Underlying Inflation Gauge, which considers
some 100 real and financial variables in addition to nominal price data, hit a
12-year high of 3.14%, New York Fed Assistant Vice President Rob Rich told MNI
in an interview. It is now nearly a full percentage point higher than the
"prices-only" UIG, which is calculated using just goods and services prices. 
     "We estimate the range for trend CPI to be between 2.2% and 3.2%, the
differential of the two measures," Rich said. That's a pick-up from two years
ago, when both UIG measures estimated trend CPI near 1.9%.
     Notably, the UIG measure that incorporates the larger data set has
continued to lift away from the prices-only measure in recent months. The last
time the differential was wider was in March 2005, in the midst of the last
expansion with the Fed raising interest rates at every meeting. 
     Prices-only UIG came in at 2.23% in March, remaining range-bound between
2.0% and 2.3% over the past year. During the same period, CPI growth fell as low
as 1.6% in June on declines in energy prices then rebounded as high as 2.5% last
month, while core CPI ranged between 1.7% and 2.1%. The UIG was developed
precisely to filter out some of the short-term transitory price changes from the
more persistent components of inflation that interest policymakers and
investors. 
     --ECONOMY HEATING UP
     The Institute for Supply Management's monthly surveys of purchasing and
supply executives across the nation, proxies for current and future economic
activity, appear to be key drivers in the widening gulf between the two UIG
gauges, according to Rich. 
     "What we discovered was that divergence between the full data set and
prices only measures is principally coming from real-activity variables --
specifically the ISM manufacturing and nonmanufacturing indexes," he said. 
     That finding is not unique to this current episode. When the full data set
measure rose more than a half percentage point above its prices only counterpart
in the past -- during boom periods 2004-2006 and 1999-2000 -- it can also be
traced to cycle highs in the ISM indexes. 
     "It could be because the surveys that are filled out by individuals whose
price setting behavior would have an important role in the series, or it might
be statistical," Rich said. "We haven't had an opportunity to more fully
investigate a specific theory or channel to explain it." 
     --LABOR, SUPPLY CONSTRAINTS
     For months, ISM survey results have reflected elevated levels of sentiment,
with businesses anticipating a boost to demand from tax cuts and strong growth
overseas. A depreciating dollar has also improved conditions for the
manufacturing sector. 
     The non-manufacturing and manufacturing indexes spiked to a 12- and
13-year-highs, respectively, in January and February, consistent with annualized
GDP growth of roughly 5%. But along with that torrid pace of activity have come
signs of supply bottlenecks and inflationary pressures. 
     "Demand remains robust, but the nation's employment resources and supply
chains are still struggling to keep up," ISM manufacturing survey chair Tim
Fiore said in the March report. 
     --FURTHER TIGHTENING WARRANTED
     Ultimately, the New York Fed's full-data UIG, incorporating booming
conditions on the supply side of the economy, bolsters the view of Chair Jay
Powell and others that further rate hikes may be needed this year to get ahead
of inflationary pressures. 
     With the output gap largely eliminated, growth well above the economy's
potential points to a steady rise in underlying inflation, giving Fed officials
reason to be confident that inflation will rise to their 2% target by next year.
     Initially developed in 2005, UIG 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 New York Fed 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.
--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com
[TOPICS: MMUFE$,M$U$$$,MT$$$$,MX$$$$]

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