Must-know: How the Fed influences restaurant sales

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Part 6
Must-know: How the Fed influences restaurant sales PART 6 OF 7

Why personal consumption affects restaurants and the Fed

The personal consumption expenditure price index

While the CPI (Consumer Price Index) is widely reported, the indicator watched by the Fed is the PCEPI (Personal Consumption Expenditure Price Index), as it announced in its Monetary Policy Report to the Congress, February 17, 2000. This is because the PCEPI is considered more comprehensive than the CPI and adjusts for the changes in goods that consumers purchase based on prices.1 It’s the core personal consumption expenditure price index, which strips out the more volatile energy and food costs, through which the Fed tries to achieve a target of 2.0% inflation (see the graph below).

Why personal consumption affects restaurants and the Fed

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PCEPI near half of the Fed’s target

Although the year-over-year change in the core PCEPI had hit 2.0% near the end of 2011 and early 2012, inflation has been falling since, with the latest data showing a 1.2% year-over-year growth for July 2013. The current level of consumer inflation is fairly close to where it was during the lows of 2009 and 2010–2011. These lows have coincided with the expansion of QE1 and QE2. When core inflation was climbing to 2.0% along with the unemployment rate, and economies outside the United States were entering recession, the Fed got creative and announced Operation Twist, a process of selling short-term bonds and buying long-term bonds in order to keep the long-term interest (the benchmark for large purchases like cars and houses) low.

Since the announcement of QE3, investors might have noticed that major markets haven’t seen large corrections like the ones that happened in mid-2010 and 2011. What the Fed did with QE3 was unprecedented. Prior to QE3, the Fed had issued policies based on a timeline. Now, it’s basing its policies on economic fundamentals. So while tapering could happen, expect it to be gradual.

Low inflation is positive for restaurant stocks

Unless core inflation starts hitting 2.0%, the Fed is unlikely to start tightening monetary policy—even after significant reduction in tapering. This would keep interest rates low for consumers and companies to borrow and spend, which should help employment and restaurant sales. As long as core consumer inflation doesn’t shoot above the Fed’s target’s of 2.0%, consider it a long-term positive for consumer stocks such as McDonald’s Corp. (MCD), Chipotle Mexican Grill Inc. (CMG), Yum! Brands Inc. (YUM), and AFC Enterprises Inc. (AFCE). Consumer ETFs like the Dow Jones Consumer Services ETF (IYC) and Consumer Discretionary Select Sector SPDR ETF (XLY) will also benefit. As is often quoted on Wall Street, “Don’t fight the Fed.” But does this approach always work? See the next article in this series.

  1. Unlike the CPI, the PCEPI is calculated based on actual purchases made by consumers. As the prices of certain goods rise, consumers will often purchase cheaper substitutes. The CPI is measured based on the price change of a basket of goods that economists alter once in a few years. The PCEPI, on the other hand, is based on changes in the actual purchases consumers make. So the PCEPI tends to show growth that’s only two-thirds of what the CPI reports, and it’s much preferred by the Fed.

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