” “This is not a fluke: almost all of the underlying determinants of inflation point to weakness,” writes BofA Merrill Lynch economist Ethan Harris in a note to clients today.
For all of the talk of rising government bond yields and predictions for when the Federal Reserve will taper back its bond buying, Harris says, deflation is still a bigger risk than higher inflation – and disinflation could cause the Fed to actually ramp up QE if it continues.
Several key measures of inflation are actually headed lower, and have yet to bottom out, according to Harris.
“This, along with the fiscal shock, is a good reason to fade the bond market sell-off,” he writes.
The chart below shows Core CPI, Core PPI, Median CPI (calculated by the Cleveland Fed), Core PCE, and Trimmed PCE (calculated by the Dallas Fed).
Bloomberg, Business Insider
Harris cites six forces weighing on inflation, summarized below:
- Spare capacity: Official estimates for the U.S. output gap, the difference between potential GDP and actual GDP, range from 3.6 to 5.6 percent – the widest since the 1982 recession. Moreover, the unemployment rate, at 7.9 percent, is still well above BofA’s estimate for the inflation-neutral rate (6.3 percent).
- Labor costs: High unemployment is keeping downward pressure on wages and salaries. Harris says that excepting for a distorted number in Q4, unit labor costs have been “essentially flat” over the past year.
