Inflation Worrywarts Just Need to Calm Down

The Fed isn't rattled by a little rise in jobs and wages. That's what it's been seeking for years.

Now that's what you call inflation.

Photographer: Stephanie Keith/Getty Images

The Federal Reserve isn't alarmed about inflation. Should everybody else be worried?

No, and a big reason is that many traders and investors who are now demanding inflation-fighting belt-tightening by the Fed seem to have lost perspective on the subject. For all the psychodrama unleashed by the hiring and wage gains documented in the Feb. 2 U.S. employment report — the one cited as the fuse that ignited this month's market tumult — not much has really changed about the trajectory of the economy.

Not that the Fed is always right; it's made some big mistakes. It's more that there is very little to see here, folks. One of the most frustrating things about the widespread inflation panic of the past month has been the short memories on display. Positive short-term developments like a little more wage growth and a whisper of progress toward achieving the Fed's long-sought goal of 2 percent inflation were denounced amid a slide in stocks and a spike in bond yields.

QuickTake Q&A: Why Measuring Inflation Is Tricky

It's as if six years of hand-wringing about lack of inflation never happened. To recap, the issue is that even with unemployment near historic lows in most of the major economies, wages aren't rising much and inflation is lagging below levels needed for vigorous economic growth. Nonetheless, the little jump in pay displayed in the January U.S. jobs data produced shrieks of terror from market participants that inflation was about to zoom out of control.

The Fed's preferred measure of inflation, the Personal Consumption Expenditures Index, was last at 2 percent a year ago. That's been the Fed's preferred standard for a healthy economy for six years, but it didn't last, and the index retreated to 1.4 percent. It started to edge back up in September, reaching 1.8 percent in November and 1.7 percent in December. 

Inflation? What Inflation?

U.S. unemployment rate and personal consumption expenditure price index

Source: Bureau of Labor Statistics

*Seasonally adjusted **An inflation measure often used by the Fed

The index has lagged the Fed's goal for the most of the time since the target was set in January 2012. So why would a small rise signal the end of the world? Even if inflation accelerates a little bit past the target, that would just give the economy a chance to stabilize around 2 percent, allowing for a few monthly misses. 

Investors hoping for some breakthrough insight in the minutes of the Federal Open Market Committee meeting of Jan. 30-31, released this week, were disappointed. Officials are a bit more confident in the strength of the economy than they were a few months ago, and a bit more confident about inflation rising to 2 percent and hanging around there. There's no sense of a sea change in their view of the world.

Are interest rates headed higher? Sure, but that was always going to be the case. The Fed's own projections in December told us that. In 2017, unlike the previous two years, the Fed did exactly what it said it would do: raise rates three times and begin the process of reducing the bloat in its balance sheet that resulted from a decade of stimulative bond-buying. You would never know that either, from public discourse.

Intriguingly, the minutes show some musing that the corporate tax cuts signed by President Donald Trump may actually weaken inflation. The idea is that lower tax rates might encourage some firms to simply cut prices. We'll have to keep an eye on that one.

So are inflation and interest rates headed higher? You bet. Dramatically? Probably not. Whether the Fed raises borrowing costs three times or four times, whether inflation ends the year at 2 percent or a tad above, remember the context. The sky isn't falling.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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