Fed's target inflation measure may decline to 1.4% - BBH

Analysts at BBH point out that the Fed's target inflation measure (the core PCE deflator) may decline from 1.5% to 1.4%, according to the median forecast in the Bloomberg survey.  

Key Quotes

“That would be the lowest reading since the end of 2015 and could likely spur more speculation against another Fed hike before the end of the year.”

“Bloomberg currently calculates the odds of a hike by the end of the year to be near 33%, while the CME model puts the odds at closer to 40%.  We think the odds are somewhat greater, though not because of any special insight into the path of core inflation.  Rather, we put more emphasis on the Fed's third mandate of financial stability, which we feel the market does not appreciate sufficiently.”

“Specifically, we underscore the July FOMC minutes that showed that official concern about asset prices had been ratcheted up.  We have noted that in several speeches, the Fed's leadership and some regional presidents have made references to financial conditions.  The Fed judges that the economy requires less accommodation, and so it removes some through three increases in the Fed funds target in the past year.  The market has countered this, and financial conditions remain by some measures more accommodative than before the Fed's recent hikes.    We do not think the Fed is simply going to capitulate to market forces.”

“Indeed, the Fed's confidence in the US economy may be bolstered by yesterday's news that included the upward revision to Q2 growth, led by consumption and business investment.  The 3% annualized pace is the fastest in two years.  Elsewhere, the ADP jobs estimate was the best in five months.”

“Previously, the Fed had been concerned about the global headwinds.  The pendulum of market sentiment has swung from "How can the Fed be the only one normalizing policy?" to "Other countries are moving away from unorthodox policies, while the Fed may be too hawkish."