Core PCE data could point to even higher inflation

Yahoo Finance’s Brian Cheung breaks down the rise in core PCE, consumer spending, and outlook on inflation.

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SIBILE MARCELLUS: The Fed is holding tight to their position of keeping interest rates unchanged. That's in spite of the fact that their preferred measure of inflation shows that prices rose 1.8% year over year, a record since the start of the pandemic. To break this all down, I want to bring in Yahoo Finance's Brian Cheung. Brian.

BRIAN CHEUNG: Well, Sibile, we got new data from the Bureau of Economic Analysis this morning showing that inflation increased 5.4% in March. That's when you exclude those more volatile pricing components like food and energy, which means that on a year over year basis, as you mentioned, prices increased by 1.8%. That is a pandemic high, again, as you just said. But what's interesting about that BEA report this morning are the underlying components that say inflation could rise even faster in the coming months, when you consider personal income up 21%, disposable personal income up almost 24%. And the savings rate among consumers was about 27.6%.

So you have income going up, savings also going up, which means that as people get bigger wallets and as the economy reopens, vaccines get into more arms, people might be spending even more. And that's the reason why you've heard from the likes of Morgan Stanley saying in a note this morning, they say core personal consumption expenditures could rise as high as 2.6% in April and May.

For the Federal Reserve's part, we heard from Fed Chairman Jay Powell earlier this week on Wednesday. He said that these are likely due to transitory factors, like the way that you're measuring year over year changes, in addition to temporary supply chain issues. So the Fed chairman saying, don't let these things scare you. That's going to continue to keep rates low and steady at least for right now.

ALEXIS CHRISTOFOROUS: OK, Brian, I don't know how much the market is believing Fed Chair Powell. If inflation were to surpass their 2% mark, how has Powell indicated how hot inflation would need to run, even if it is transitory, for them to move on interest rates?

BRIAN CHEUNG: Yeah, and that was a question that was directly asked of the Fed chairman in the press conference on Wednesday. But the Fed chairman said we're not going to put a number on how high that core PCE reading will have to be for us to all of a sudden start raising rates. So it's not like it needs to hit a certain bright line test, be that 2.8% or 2.9%. The Fed just says it's going to measure the broad-based measures of inflation expectations, in addition to, obviously, the current lagging inflation readings, like not just PCE, but also CPI, to see whether or not those types of prices are going up.

But again, the Fed chairman saying that for right now, the priority is not necessarily inflation. Over the last 10 years, we haven't seen those pressures really rise all that much. The key is really getting that over eight million figure of people who have lost their jobs compared to pre-pandemic levels back into the labor market.

SIBILE MARCELLUS: And Brian, we saw personal income soar to record high levels. What's your feelings on consumer sentiment right now?

BRIAN CHEUNG: Yeah, well, consumer sentiment is very interesting because in addition to the personal income measurements that you just mentioned, we also did get a reading of consumer sentiment from the University of Michigan. Their final reading was actually 88.3. That's up from the first reading that they had had, which covered that month of April. And it is also higher than the March reading. And in fact, that's actually the highest reading since the depths of the pandemic. Now, of course, we're still climbing back up to the near 100 levels on that index that we saw pre-pandemic.

But it all goes to show, people are getting more income, partially because of that stimulus check, the third round that we got at the beginning of this year, in addition to the other fiscal stimulus that's been delivered since that period of time. People have larger wallets, which means that as more restaurants and businesses open up, maybe people are willing to travel again. Those prices could continue to go up, as these businesses say, hey, people are willing to buy our stuff, so let's increase the prices a little bit.

ALEXIS CHRISTOFOROUS: So, Brian, do you think, though, that-- I mean, we haven't seen inflation now for about a decade in a meaningful way. We're seeing people's incomes rise. We're seeing them save more. Will, do you think, consumers be able to, say, sort of take that impact of higher prices and have it not trip up the economic recovery?

BRIAN CHEUNG: Well, that's the big question that the Federal Reserve is trying to figure out right now. Let's say, for example, people and the demand for things goes up to a point where you do start to see runaway inflation, not necessarily 1970s level, but what would happen if [INAUDIBLE] personal consumption goes up to 3%, 3 and 1/2% because of the surge of people going out and spending?

Well, if that is the case, the Federal Reserve needs to say, OK, is that a temporary cause or effect that's a result of maybe all the stimulus checks that have been going into people's pockets, or is this, again, part of the one-time changes that we're seeing right now, as lumber prices are temporarily going up? Everyone kind of says that should be relieved in terms of pressure again sometime soon, or even just things like the Suez Canal. You remember the boat that was stuck there not so long ago. Obviously, that type of issue could result in producers and sellers wanting to raise their prices again as well.

So I think those types of things, trying to parse out what is temporary or transitory, as the Federal Reserve has used the language, is going to be very difficult for the Fed to do, not only because there's just so much going on and it's happening at such a rapid pace, but also because of the measurement issues. Again, I talk about those base effects. The reason why you might see a 1.8% figure as kind of large compared to previous months is because when you look at the March versus March measurement, of course it's going to be very low because you're comparing against a very deep March 2020. So that could be the reason behind that, but worth watching as the Fed does continue to engineer its policy over the coming weeks.

SIBILE MARCELLUS: Yeah, definitely worth watching. Brian Cheung, thanks so much.