Disinflation NOT Reflation

Written by Richard Hokenson 

We began this year with the forecast that wage growth would remain modest and that price inflation would surprise to the downside, expectations that continue to be confirmed by recent developments. The expectation that wage inflation (see Chart 1) would remain subdued was based on our conclusion that there is more slack in the labor market than perceived by most. The May payroll employment was a bit soft but still okay. Those who interpreted the decline in employment, labor force and the participation rate as a disaster obviously never bothered to examine the detail. Teenagers and young adults (20-24) accounted for nearly 75% of the declines. The most likely explanation for that outcome is that the timing of the survey was at odds with the academic calendar—we expect it to be reversed with the June data.


Lest anyone be concerned that subdued wage gains might impinge on the consumer’s ability to spend, the fact that more workers are working more weeks in the year means that their annual income is better than the monthly income that can be inferred from the employment release (see Charts 2 and 3).


The drop in the rate of inflation as measured by the core PCE deflator (the Fed’s preferred measure of inflation) results from the fact that the rate of growth of global demand remains relatively restrained (see Chart 4). European growth is improving but is being countered by slower growth in China. A synchronized world business cycle could produce a cyclical bout of reflation but that does not seem very likely at this time.


As of right now, it seems most likely that the Fed will increase interest rates when it meets next week. Their view of the need for higher rates is in good part based on the notion that the decline in the inflation rate is temporary. We disagree as does the bond market which should impact policy deliberations past next week.


This update was researched and written by Richard Hokenson, as of June 9 2017