Published on September 30, 2021

The Fed continues to assert that elevated inflation is largely due to “transitory factors,” but the Underlying Inflation Gauge, which is published by their own New York branch, tells a different story. To understand where inflation is heading, we advise investors to pay close attention to UIG data, even it if the Fed doesn’t.

Over the past few months, the topic of inflation has been hotly debated – specifically, whether it will be transitory or persistent. In particular, much attention has been paid to short-term supply shocks, which the Fed and others have routinely cited as the explanation for the recent rise in prices. The distinction between transitory and persistent inflation is critically important, as Fed policy hinges on long-term expectations – their view will determine when they taper bond purchases and, ultimately, normalize interest rates.

Hard data about supply imbalances is supported by countless anecdotes, but these only paint a contemporaneous view of inflation and do not offer strong insight into whether the current surge is something we will be tackling months or years from now. The drivers are many and diverse, and the resolution of these drivers are less clear.

After combing through dozens of inflation indicators, we believe a single one emerges as the most accurate predictor of persistent inflation – the Underlying Inflation Gauge. We’ve discussed UIG previously, and we continue to feel it is the most reliable forward-looking indicator of macroeconomic activity for the coming months. It is published by the Federal Reserve Bank of New York, so even though it is little used by market participants, one can assume it is part of the Fed’s data arsenal, in addition to traditional metrics such as CPI, PPI, and the PCE Price Index.

According to the FAQ section of the New York Fed’s website, “UIG provides a measure of underlying inflation and is defined as the persistent part of the common component of monthly inflation.”


Source: FRBNY

As you can see from the above chart, the index is divided into two subindices – a “prices-only” measure which includes the subcomponents of CPI, and a “full data set” measure which includes CPI components plus a slew of “nominal, real, and financial variables.” Although the two measures generally move in the same direction, they have frequently disagreed in magnitude. At the moment, however, they are nearly identical – both sitting around 4% – which suggests the current inflation level likely has some staying power (the “prices only” index is 4.05%, and the “full data set” is at 3.84%). While the Fed has officially stated that they are willing to let inflation drift above 2% in the short run, we believe 4% is likely outside their comfort zone.

To conclude, the Fed has had access to this data since inflation became an issue earlier this year, but their public comments suggest they are not paying much attention to it. In fact, in their latest statement, on September 22, they wrote that “[i]nflation is elevated, largely reflecting transitory factors” – even though UIG tells a materially different story. Our recommendation is to respect the Fed’s words for their ability to move markets, and to respect their UIG data for reflecting the truth in the evolution of inflation.

Eddy Vataru

Chief Investment Officer – Total Return


Eddy Vataru

Chief Investment Officer – Total Return

Eddy Vataru

Chief Investment Officer – Total Return

Prior to joining Osterweis Capital Management in 2016, Eddy Vataru worked in senior management positions at Incapture, LLC and Citadel, LLC. Before that he spent over 11 years at BlackRock (formerly Barclays Global Investors, BGI), where his last position was as Managing Director and Head of U.S. Rates and Mortgages. While in this role, BGI worked with the U.S. Treasury in implementing its Agency MBS Purchase Program, buying mortgages for the U.S. government from 2008-2009.

He is a principal of the firm and the lead Portfolio Manager for the total return fixed income strategy.

Mr. Vataru graduated from California Institute of Technology (B.S. in Chemistry & Economics) and from Olin Business School at Washington University in St. Louis (M.B.A.). Mr. Vataru holds the CFA designation.

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The Underlying Inflation Gauge captures sustained movements in inflation from information contained in a broad set of price, real activity, and financial data.

Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care.

Producer Price Index (PPI) is a measure of the change in the price of goods as they leave their place of production (i.e. prices received by domestic producers for their outputs either on the domestic or foreign market).

The PCE price index, released each month in the Personal Income and Outlays report, reflects changes in the prices of goods and services purchased by consumers in the United States.

These indices do not incur expenses and are not available for investment. These indices reflect the reinvestment of dividends and/or interest. Historical fixed income index data is provided for informational purposes only, not as an indication of future Fund performance.

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Osterweis Capital Management is the adviser to the Osterweis Funds, which are distributed by Quasar Distributors, LLC. [OSTE-20210928-0325]