Tomorrow, we get the July PCE report (personal consumption expenditures).
This is the inflation measure the Fed cares most about. It’s the basis of their 2% inflation target (headline PCE).
The consensus view for the July report is a continuation of what the Fed perceives to be “a stall” at around 2.5%.
For perspective, if we take a step back and look at a longer term view of PCE, inflation running above the Fed’s target hasn’t historically resulted in the type of obsessive Fed response we’ve seen over the past year.
As you can see in the chart below, PCE has spent plenty of time above 2%. In fact, the average PCE dating back to 1990 is 2.22% (i.e. above target).
As we know, this stall in PCE, around 2.5%, has led the Fed to continue holding the policy rate at historically tight levels.
How tight?
If we subtract 2.5% (PCE) from 5.33% (Fed Funds Effective Rate), we get a real interest rate of 2.83%. What was the average real rate over the period on this chart above? It was 0.6%. The decade prior to the global financial crisis was just 1.73%.
So clearly the current real interest rate is historically very restrictive policy.
And with that, the result has been damage to the labor market. As we’ve discussed, while the unemployment rate remains low, the speed of change in the unemployment rate puts it in unique company of the past four recessions.
So tomorrow’s inflation report should be an uneventful one. The big event will be next Friday’s unemployment report.