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December 2015 Minutes: PCE Inflation May Impede Future Rate Hikes

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PCE inflation: December 2015 minutes

We mentioned in the opening article of this series that the low pace of growth in inflation made the rate hike decision in December 2015 a “close call.” When central bankers talk about inflation, they’re specifically referring to PCE (personal consumption expenditure) inflation. Other popular measures of inflation include the CPI (consumer price index), but PCE inflation remains the key indicator for measuring price increases as far as policymakers are concerned.

The December 2015 minutes state, “Nearly all participants saw PCE price inflation picking up in 2016, rising further in 2017, and then reaching a rate in 2018 at or very close to the Committee’s 2 percent longer-run objective.”

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Though PCE inflation is expected to pick up in 2016, its pace was reduced from the projections made in September 2015. The graph above, taken from the December 2015 minutes, shows the distribution of participants’ expectations for PCE inflation in 2016 and 2017. Although most participants expect inflation to be in the range of 1.7%–1.8% in 2016, the overall projections range from 1.2% to 2.1%. The range is tighter for 2017, with projections ranging from 1.7% to 2.0%.

Participants’ views

FOMC participants expect inflation to gradually rise to its mandated level due to an increase in wage growth, better resource utilization, and hopes that the effects of the rise in the dollar (which suppresses imported goods’ prices) and the fall in energy prices (XOM) (COP) (CVX) will dissipate in the medium term. However, the FOMC minutes state that “for some members, the risks attending their inflation forecasts remained considerable.”

Why should investors care?

Fixed income investors (PTTAX), especially those invested in high-yield bonds and related mutual funds (SPHIX), should pay close attention to inflation. If policymakers are right in their assessment of inflation, we may actually end up seeing more than three rate hikes this year. Fixed income instruments do not do well in a rising interest rate environment. Among these instruments, high-yield bonds become prone to defaults. A higher-than-expected rise in inflation would warrant rebalancing of fixed income investments.

In the last article of this series, we’ll explore possible paths that the Fed might take in 2016.

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