MNI INTERVIEW: NY Fed's Inflation Gauge Hits Fresh Highs

--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

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