Yardeni Research | Fed Rate Hike Still On The Table

💡Fed Chair Kevin Warsh has shifted the central bank's focus toward price stability by publicly declaring it the primary role of the Fed, as evidenced by the June FOMC statement under his leadership, which emphasized achieving price stability and omitted the prior reference to maximum employment. This contrasts sharply with his predecessor Jerome Powell, who consistently framed policy through the lens of the Fed's dual mandate, prioritizing both inflation and labor-market outcomes. Warsh's remarks at the July 1 European Central Bank forum further reinforced this stance, stating, "we’re all in the price stability business," suggesting a heightened emphasis on inflation control despite the congressional dual mandate remaining unchanged.

💡Kevin Warsh appears to target underlying inflation for monetary policy adjustments, rather than the traditional PCED inflation rate. He has not explicitly mentioned PCED inflation in his public appearances as chair, despite it being the Fed’s official measure since 2012. Instead, Warsh's congressional testimony highlights his view that "underlying inflation over longer time horizons is determined largely by monetary policy," and he describes the CPI and PPI as "imperfect measures of the state of underlying inflation." His framework distinguishes between one-time price changes and broader, persistent inflationary trends, aligning with the concept of underlying inflation as a benchmark for monetary policy.

💡Observed inflation, measured by CPI and PPI, reflects actual, current price changes, whereas underlying inflation is an estimate of the persistent, long-term trend in inflation after temporary disturbances are excluded. Warsh emphasizes this distinction, noting that CPI and PPI are "imperfect measures of the state of underlying inflation" because they capture immediate price shifts, which may not represent a sustained inflationary problem. His framework suggests that a one-time change in prices does not necessarily qualify as inflation if it is eventually offset by a supply response, aligning with the concept of underlying inflation, which strips out temporary shocks to reveal more enduring price trends.

💡Warsh's framework emphasizes underlying inflation over the traditional PCED inflation rate because he believes monetary policy should primarily address persistent inflationary trends rather than temporary price shocks. He stated that "underlying inflation over longer time horizons is determined largely by monetary policy," implying that these are the pressures the Fed can effectively influence. Warsh views one-time price changes, such as those from AI investment or supply responses, as distinct from true inflation, which he describes as a broadening out of price changes that requires monetary policy intervention. This approach aligns with focusing on measures that strip out volatile components to reveal the true underlying trend.

💡Warsh's task force is considering several candidates for measuring underlying inflation, including the traditional core PCED inflation rate, which excludes volatile food and energy prices, and alternative "trimmed" PCED inflation measures. The Dallas Trimmed Mean PCED is specifically designed to filter out extreme price swings from any category to better reveal the underlying, long-term inflation trend, showing a rate of 2.4% in May, close to the 2.0% target. Another important measure is the yearly percent change in unit labor costs, which was 0.5% y/y in Q1-2026, indicating whether a wage-price spiral is occurring. Additionally, "supercore" inflation, defined as services inflation excluding energy and housing, is also being considered due to its ability to eliminate goods price shocks and provide early warnings of persistent inflation.

💡Supercore inflation is considered a valuable gauge for assessing persistent inflation pressures because it provides a cleaner view of underlying trends by eliminating price shocks in goods, which can be temporary due to factors like tariffs or supply-chain disruptions. By focusing on services inflation excluding energy and housing, it offers an early warning of persistent inflation, as temporary shocks only become a monetary policy concern when they generate second-round effects through wages or demand. Crucially, supercore inflation is concentrated in labor-intensive service sectors, making it closely tied to wage growth and domestic demand, which are factors that the Fed can directly influence through monetary policy, unlike supply-side shocks in goods markets.

💡Meaningful upside risks for goods inflation in the coming months are indicated by several specific factors. First, last year's tariffs continue to exert inflationary pressure, with nearly half of firms still planning additional price increases to offset higher costs. Second, the AI buildout is creating significant demand for electronic components, such as memory chips, servers, and networking equipment, driving prices sharply higher. For instance, Apple has raised prices on certain MacBooks and iPads by roughly 15% to 25% due to surging memory chip demand. Third, import prices for all goods rose 6.6% during the first six months of the year, with manufactured goods up 5.0% y/y and computer and electronic products surging 8.0% y/y. Finally, the New York Fed’s supply-chain pressure index suggests ongoing global supply chain disruptions, which historically correlate with higher goods inflation.

💡Tariffs and the AI buildout are significantly contributing to increased goods inflation, particularly in tech sectors, through both direct cost pressures and heightened demand. Lingering tariffs from last year continue to fuel inflation, as research indicates nearly half of affected firms still intend to raise prices further to recover higher costs. Concurrently, the AI buildout is generating substantial demand for electronic components like memory chips, servers, and networking equipment. This surge in demand has pushed memory chip prices sharply higher, leading Apple to increase prices on some MacBooks and iPads by 15% to 25%. Furthermore, CPI data show recent sharp rises in prices for computer software and accessories, consistent with this growing AI-related demand across the technology supply chain, and import prices for computer and electronic products surged 8.0% year-over-year.

💡Persistently high underlying services inflation is a concern for the Fed's inflation outlook because it reflects inflation pressures generated by underlying economic activity, which monetary policy can directly influence. While moderating shelter inflation is expected to provide some disinflationary tailwind, core services excluding housing remain sticky, suggesting resilience in the US economy is exerting upward pressure. May's PCED service-sector inflation was elevated at 3.8% y/y, and the June PPI report showed the core PPI for final-demand services rose 5.1% y/y, indicating ongoing service-sector price pressures in the pipeline. This type of inflation is closely tied to wage growth, labor market conditions, and domestic demand, making it a key indicator for policymakers trying to distinguish between temporary shocks and inflation that monetary policy can actually address.

💡The New York Fed’s supply-chain pressure index plays a crucial role in forecasting goods inflation by indicating the level of global supply chain disruptions, which have historically been associated with higher goods inflation. A high index reading suggests that supply chains remain relatively disrupted, implying that the flow of goods is constrained. These disruptions can lead to increased costs for businesses and, subsequently, higher prices for consumers. Therefore, policymakers monitor this index to anticipate potential upward pressures on goods inflation that are related to global logistics and production issues, rather than domestic demand or monetary factors, contributing to the overall inflation outlook.