Low Inflation…Blame Uber (…and 4 other reasons)
Morgan Stanley'sEllen Zentner and her team have cut their core PCE forecast for 2017 to 1.4% and lowered the 2018 projections to 1.7%. As a result, Zentner et al now sees fewer interest rate hikes coming out of the Federal Reserve.
A December rate hike is still in the cards, says Zentner. But next year, she sees three, not four rate hikes.
Various forces are eating away at inflation, and offsetting the progress in segments of inflation driven by a tight labor market-i.e., the Phillips curve. Recognition of these lets us conclude that recent declines in inflation are not just'idiosyncratic' but also reflect broader trends that should persist-making it ever harder to achieve the Fed's 2%Y target.
...The FOMC is faced with an increasingly difficult trade-off-how to balance persistently low inflation, which might inform a do-nothing stance, versus easy financial conditions, which might inform continued rate increases to maintain financial stability. Yellen stands clearly on the preemptive side, as do a number of her colleagues on the FOMC. Convincing markets that further rate hikes are appropriate remains the greatest challenge.
In fact, Zentner et al see five reasons why inflation will remain tepid.
The impact of technology: We see technology as a longer-term disinflationary force. The rise of online retail for a host of goods and services, including but not limited to apparel, drugs, hotels, and, most recently, food, has kicked off price wars and lowered the pricing power of sellers. Services like Uber, Amazon and Airbnb have allowed consumers to purchase goods and services at lower cost, but similar quality.
Oversupply: In the US, oversupply in various markets, most notably in used cars, where our motor vehicle analysts anticipate unprecedented declines in used car values, and apartment rental markets, where our commercial real estate analysts expect decelerating growth in prices to continue over the near term. Pricing wars among airlines and elsewhere in the services industry can also be linked to oversupply.
Overcapacity: In 4Q16 prices for China's consumer goods pulled out of deflation and continue to rise. As yet this has resulted in little-to-no pass-through to higher consumer goods prices in the US, despite China influencing roughly 40% of the US core consumer goods basket. We expect the degree of pass-through to remain limited, but do acknowledge risk to this assessment on more recent bullishness of our economists there (see China Economics: Revising Up PPI Forecast on Supply Side Policies, September 4,2017).
Dollar bull market: Past appreciation in the nominal broad trade-weighted dollar continues to provide downward pressure on core inflation. This year's reversal in the dollar still leaves the index roughly 16% higher since mid-2014. Though we expect some offset, a deeper and longer dollar depreciation is needed for core inflation to respond more meaningfully to the recent decline.
Lower inflation expectations: Measures of inflation expectations have fallen in recent years-which we estimate may be weighing on year-over-year growth in core consumer inflation to the tune of about 0.1pp per year. Inflation expectations in Chair Yellen's model for core PCE prices are key, much more so than measures of slack. We discuss the link between inflation expectations and monetary policy further below in
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