Much has been made of last Friday's speech by Federal Reserve Chair Janet Yellen. The key takeaway was that the pace of rate hikes — expected to start in June or September — could be reversed, stopped or slowed should the economy falter or inflation fail to recover. The latter is looking more and more likely, increasing the odds that the Fed will have to be satisfied with a "one-and-done" or "none-and-done" policy tightening cycle this year.
Part of the problem — which was reflected in modifications to the Fed's estimate of "full employment" in its latest forecast — is that it's taking longer than usual for wage inflation to show up. As a result, the Fed’s forecasters knocked down the full employment level of the unemployment rate to a range of 5.0 percent to 5.2 percent, down from 5.2 percent to 5.5 percent previously.
Translated, this means they believe more progress in the labor market will be required to start putting upward pressure on wages. And based on their unemployment rate projections, we may not see this until as late as 2017.
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If so, despite the removal of the language about patience from their last policy statement, the Fed may be forced to wait before raising rates for the first time since 2006 from their current levels near zero percent. Yellen has said that as long as she is "reasonably confident" higher wages are coming, she will act.
But the data is far from confidence-inspiring.
The February inflation data contained in the personal income report released earlier this week showed that the deflator on core personal consumption expenditures, the Fed's preferred inflation measure, remains stuck at 1.5 percent, half a percentage point below their 2.0 percent target.
Moreover, it's been hovering at this level for the past 10 months. The worry is that the drop in overall PCE inflation, indicated by the blue line in the chart below, will have a dampening effect in the months to come as the drop in energy prices trickles down into the prices of goods and services throughout the economy.
This could already be happening in a small way: Ed Yardeni of Yardeni Research notes that the three-month percentage change in core PCE inflation, on a seasonally adjusted annual basis, fell in January to a level not seen since the start of the recession. It rebounded slightly for February but remains at levels last seen in 2010.
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Additional downside could come from renewed weakness in energy prices, something I recently wrote about. Already, gasoline futures have broken out of the three-month uptrend that saw prices rebound nearly 61 percent from their January low.