Low Inflation is Neither “Transitory” nor “Fluky”

Written by Richard Hokenson 

Inflation has again undershot expectations. What might have been a problematical issue for the Fed’s deliberation on interest rates was dismissed by Fed officials as “transitory”. Fed chair Janet Yellen said it was “fluky”. The Fed continues to expect that a tighter labor market will produce wage inflation which will result in price inflation. They are overlooking the importance of supply. Our view is that subdued wage inflation results from their being more slack in the labor markets – the demand for labor is clearly strong as confirmed by job growth. Nor is it a slam dunk argument that higher wage inflation would automatically translate into higher price inflation. Several commentators have suggested that higher wage inflation could spur capital spending with the result that higher productivity growth would blunt any such translation. Moreover, subdued wage and price inflation is not just an American phenomenon – it is also baffling the European Central Bank who find it difficult to comprehend that combination in conjunction with accelerating Eurozone economic growth. As a result of the drop in the value of the British Pound, the U.K. is experiencing higher price inflation but we think that the uptick will turn out to be temporary.

The comparison to the same month in the prior year shows that total CPI inflation dipped to 1.9% (see Chart 1). For Fed officials, the more important measure is the core CPI which came in at 1.7%, its lowest reading since 2015 (see Chart 2). The results for the CPI excluding shelter as well as food and energy reveal a drop to 0.6%, rivalling the most recent low established in 2004. 


Shelter is a very important component of the CPI – it represents 33.5% of the total CPI and 42.4% of the core CPI. The rate of inflation in the CPI for shelter has eased mimicking the stall in the median asking rent for vacant for rent units (see Charts 3 and 4). Here again, supply may be playing a substantial role. Although we label ourselves as structural disinflationists, we do want prices to change reflecting changes in demand and/or supply. 


Prices are a very important signal to increase supply and/or look for alternatives which is also why the secular path is a continued downtrend in real commodity prices. We do know that the demand for housing remains solidly robust as measured by household formations. If at least some if not most of the prior increase in rents was a function of excess demand, it could now be the case that supply is catching up. The number of completed housing units, i.e. supply, continues to strengthen, especially for structures with 5 or more units (see Charts 5 and 6).

Janet Yellen is quoted as saying that inflation is just around the corner. It is a forecast that we have heard for several years. We hope that she will be smarter than the perma bears who keep predicting runaway inflation – the true believers whose faith in a predicted apocalypse persists even after it fails to materialize.

This update was researched and written by Richard Hokenson, as of June 16 2017