Sobering speech from San Fran Fed (interest, tax, cost, inflation)

[Wild Style]

Janit Yellin President and CEO of San Francisco Fed Reserve gave a very interesting speech the other day. Worth a read for those trying to understand where we are at right now. link

two highlights

Turning to the national economy, it was recently reported that growth in the second quarter came in at a fairly robust rate of 3¼ percent. This seems like good news--especially considering what the economy has just been through. Growth slowed sharply in the fourth quarter of last year, and, indeed, the data show that activity actually contracted slightly. Though growth turned positive in the first quarter, it was tepid at best.

While one might be tempted to interpret the recent strong numbers as a sign that things are turning around, there are three important reasons to think that the strength will not hold up, and that economic performance will be decidedly subpar in the second half of the year. First, consumer spending in the second quarter came in at only a moderate rate, even though it was boosted by substantial tax rebates. But there are no plans in place to repeat those rebates, so by the fourth quarter, the economy will no longer benefit from that fiscal stimulus.

Now let me turn to inflation where recent performance has been a serious concern. As of July, the headline PCE Price Index was up by a whopping 4¼ percent over the past year, compared to 2½ percent over the prior year. An important reason why inflation was so high, of course, was because of the steep increases we experienced in food and energy prices. Moreover, the rise in commodity prices raised the costs of the wide array of businesses that use them as inputs and some have responded by passing those cost increases through to their own prices. The consequence is that core inflation, which excludes food and energy is also up. The core PCE Price Index rose by 2½ percent over the past twelve months, which is somewhat above the range that I consider consistent with price stability, but close to its pace of increase over the last several years.

What can we expect going forward? Headline inflation is likely to remain much higher than I would like for a quarter or two as previous increases in commodity prices boost the prices paid by consumers for food and energy. With regard to core inflation, I wouldn't be surprised if it runs modestly higher for a while, too, as businesses pass on some of their higher energy, transportation, and other costs to customers. However, for several reasons, I expect both headline and core inflation to move down to a much more moderate rate of just over 2 percent next year.

I think the inflation decline call will be true for as long as oil remains in the 80 to 100 range (still much higher than last year though). But many are saying that wont last that long because of supply/demand coupled with peak oil.