While many investors focus on the Consumer Price Index as a gauge of inflation, the Federal Reserve (Fed) prefers the personal consumption expenditures (PCE) index, and the PCE index has once again stayed below the Fed’s 2.0% target. PCE decreased $13.6 billion in July. After adjusting for inflation, real PCE decreased 0.2%. The bulk of the decline was driven (pardon the pun) by a decrease in spending on motor vehicles and parts.
The price index the Fed targets, the PCE price index, increased 1.6% year over year. There is a continuing divergence between prices of services and prices of goods. Year over year, the PCE price index for services increased 2.2%, while the index for goods increased 0.3%. Within the goods category, durable goods (items expected to last three years or longer) have been declining in price (-2.3% most recently) and nondurable goods have been rising slowly.
Real personal income excluding current transfer receipts (things like Social Security and unemployment benefits) has been growing but at a slowing pace. While this measure of income increased 0.2% in June, it increased a mere 0.1% in July. Because of the slow real income growth, the majority of the voting members of the Federal Open Market Committee will likely stay comfortable with the plan of ceasing to expand its balance sheet in October and lifting its target for the federal funds rate very slowly sometime in 2015. Based on federal funds rate contracts traded on the Chicago Mercantile Exchange, it looks like the market is pricing in the first rate hike taking place at the June 17, 2015, meeting.
While it’s too early for the Fed to start raising rates, it’s also too early for the European Central Bank (ECB) to engage in much more stimulus than it already has planned. There has been much chattering about the ECB doing some quantitative easing (QE), but I think it is highly unlikely the ECB will do anything beyond talking about QE when it meets next on September 4. In June, the ECB announced its Targeted Long-term Refinancing Operation (TLTRO). That program is scheduled to start releasing cheap money to eurozone banks in September. The ECB will likely wait to see how that program goes before committing to any additional stimulus.
I think the combination of the TLTRO and the completion of the ECB’s asset quality review (AQR—policymakers love their acronyms, especially European policymakers) will provide the credit-nudge the eurozone economy needs to stave off deflation. Yes, the ECB tried long-term refinancing operations before, and those pretty much went to shoring up bank balance sheets without stimulating the creation of any additional credit—but things are different today than they were in 2012. Too many people are afraid of saying “this time is different.” As John Manley has said, it’s not dangerous to say “this time is different; it is dangerous to say things will be different.” It’s important for investors to see when conditions are indeed different. When conditions are different, you can reasonably anticipate different results. Things are different in Europe, and they are likely poised to become more positive.