Is the Fed Ignoring Its Own Inflation Data?
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
Featuring
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.
Related Insight
For more information about this strategy, please send us an email or call us at (800) 700-3316.
Opinions expressed are those of the author, are subject to change at any time, are not guaranteed and should not be considered investment advice.
Mutual fund investing involves risk. Principal loss is possible. Investments in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities.” The Osterweis Total Return Fund may invest in fixed income securities which are subject to credit, default, extension, interest rate and prepayment risks. It may also make investments in derivatives that may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. The Fund may invest in debt securities that are un-rated or rated below investment grade. Lower-rated securities may present an increased possibility of default, price volatility or illiquidity compared to higher-rated securities. Investments in foreign and emerging market securities involve greater volatility and political, economic and currency risks and differences in accounting methods. These risks may increase for emerging markets. Leverage may cause the effect of an increase or decrease in the value of the portfolio securities to be magnified and the fund to be more volatile than if leverage was not used. Investments in preferred securities have an inverse relationship with changes in the prevailing interest rate. Investments in Asset Backed and Mortgage Backed Securities include additional risks that investors should be aware of such as credit risk, prepayment risk, possible illiquidity and default, as well as increased susceptibility to adverse economic developments. It may also make investments in derivatives that may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. The Fund may invest in municipal securities which are subject to the risk of default.
Performance data quoted represent past performance; past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the Fund may be higher or lower than the performance quoted. Performance data current to the most recent month end may be obtained by calling shareholder services toll free at (866) 236-0050.
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.
The Osterweis Funds are available by prospectus only. The Funds’ investment objectives, risks, charges and expenses must be considered carefully before investing. The summary and statutory prospectuses contain this and other important information about the Funds. You may obtain a summary or statutory prospectus by calling toll free at (866) 236-0050, or by visiting www.osterweis.com/statpro. Please read the prospectus carefully before investing to ensure the Fund is appropriate for your goals and risk tolerance.
Osterweis Capital Management is the adviser to the Osterweis Funds, which are distributed by Quasar Distributors, LLC. [OSTE-20210928-0325]
