Bullard: “Hard To Find Explanation For Low Inflation; Low-Vol Doesn’t Signal Anything”

When it comes to inflation in the US, there are generally two schools of thought:one is that inflation is woefully – and purposefully for political means – mismeasured, and that the real inflation is orders of magnitude higher than what the BLS, with its endless array of hedonic adjustments, reports. We discussed this view in May when we presented a presentation by Devonshire Research, which showed that “contrarian” CPI is closer to 8%, not the “post-modern” accepted rate of roughly 3%.

And then there is the Fed/BLS/academic school which ignore real-world prices (and shrinkflation), and instead fixes on the core CPI number reported monthly by the BLS, which as is widely known, has been well below the Fed’s “target” of 2-3%. Of course, even the Fed is not blind to the soaring cost of rent, healthcare and education, but it conveniently masks these up by assigning specific, and very low, weights to these “outlier” items in the BLS’ inflation basket so that overall inflation appears surprisingly tame to most Americans who see a vastly different reality every time they go shopping.

It was the second view that St. Louis Fed president James Bullard was more focused on today during a speech delivered at the 2017 conference of America’s Cotton Marketing Cooperatives on Monday.

Speaking about inflation, Bullard noted that the U.S. inflation rate has been below the FOMC’s 2 percent inflation target since 2012 saying “recent inflation data have surprised to the downside and call into question the idea that U.S. inflation is reliably returning toward target.” He also examined several inflation measures that try to control for particularly volatile movements in individual prices and noted that those readings have been lower this year.

Bullard added that global commodity prices have been an important factor affecting U.S. headline inflation. “Crude oil prices, in particular, tend to influence the headline inflation rate,” he said, adding that global commodity prices are sensitive to perceived and actual supply and demand developments in the global crude oil market. Another factor – and with this we actually agree – may be the financialization of global commodity markets in recent years, which may have made many commodities more highly correlated with oil prices than they otherwise would have been, Bullard noted.

Amusingly, Bullard – perhaps thinking of the Fed’s $4.4 trillion balance sheet – said that “it is hard to find good explanations for the low-inflation era being experienced by the U.S., but the impact of new technology could be one of the forces influencing price pressures.”

To be sure, one thing that the Fed fails to mention when talking about inflation is that the central bank usually envisions wage inflation, and here Bullard and his peers are spot on that there has been no inflation whatsoever. Even his colleague, Neel Kashkari said in a subsequent appearance, tha the US “hasn’t seen wages grow very quickly.” Bullard also said that “recent labor market outcomes have been relatively good”, but do not signal a substantial upside for inflation, and in the latest Fed cop out, added that “Nominal wages are not a good predictor of future inflation,” noting “they tend to be a lagging indicator.”

There was the cursory discussion of the now defunct Phillips Curve: Bullard said that recent labor market outcomes have been relatively good and discussed the question of whether the low U.S. unemployment rate—at 4.3% in the July reading—might signal a substantial rise in inflation. “The short answer is no, based on current estimates of the relationship between unemployment and inflation,” he said. “Even if the U.S. unemployment rate declines substantially further, the effects on U.S. inflation are likely to be small.”

In looking at U.S. economic growth, Bullard said data since the financial crisis suggest that the U.S. has converged to real GDP growth of 2 percent, which is slow by historical standards. “Second-quarter real GDP growth showed some improvement from the first quarter, but not enough to move the U.S. economy away from a regime characterized by 2 percent trend growth,” he said. Real GDP grew at an annual rate of 1.9 percent in the first half of 2017. “The 2 percent growth regime appears to remain intact,” he added. The silver lining, according to Bullard, will come from abroad: he said that the IMF upgraded its world economic outlook for 2017, with key upgrades for Japan, Europe and China, and blamed the hawkish ECB for the weaker dollar: “The value of the U.S. dollar has declined in 2017, a consequence of the brighter growth outlook for Europe and expectations for a somewhat more hawkish European Central Bank,” he added.

In addition to inflation, the FOMC non-voter had some comments on monetary policy, and when discussing the Fed balance-sheet unwind, said “I am ready to get going in September. I don’t know where my colleagues will come down on that” while on rates he said that “we think best policy would be to leave rates where they are.” It’s not clear just who the “we” included.

Refuting recent statements from virtually every banks, Bullard remained optimistic and said the upcoming balance-sheet unwind “is going to be very slow and I don’t think there will be a lot of impact on the markets.”

Finally, on the hot topic of whether the Fed is seeking to push asset prices lower and tighten financial conditions, he said that “financial conditions indexes are at very easy conditions” right now and when asked about complacency in financial markets, says “I don’t think low volatility or low stress necessarily signals anything.”

In other words, everything is great, wages will rise at some point, inflation will (eventually) converge with the Fed’s modeled 2.0% core CPI, balance sheet unwind is priced in, and as for the market, Bullard has no concerns whatsoever.


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Author: Tyler Durden

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