Where to Begin
The Federal Reserve's ongoing battle with inflation has taken a new turn, as a key trimmed-mean inflation gauge drops to multi-year lows, providing fresh data for policy discussions.
Why the Trimmed-Mean Metric Matters
On July 30, the U.S. Personal Consumption Expenditures (PCE) price index for June posted its first monthly decline in six years. The Dallas Fed's trimmed-mean inflation rate, calculated on an annualized monthly basis, fell sharply to 1.4%. This level is not only below the Fed's 2% target but also represents the lowest reading since November 2020.
This development has captured market attention, especially in light of Federal Reserve Chair Jerome Powell's stated intention to review the framework for measuring inflation. Concurrently, an unusual number of dissenting votes has emerged within the Federal Open Market Committee (FOMC).
Dallas Fed President Lorie Logan, Minneapolis Fed President Neel Kashkari, and Cleveland Fed President Beth Hammack all voted against the decision to keep interest rates unchanged, arguing that inflationary pressures remain too high and require immediate action.
Trimmed-Mean Indicator Hits a Multi-Year Low
The trimmed-mean inflation measure removes the most extreme price movements at both ends of the distribution to reflect the true trend in the prices of most goods and services. The Dallas Fed's version excludes the bottom 24% and top 31% of the PCE price index components to capture a more representative median trend.
June data showed the Dallas Fed's trimmed-mean annualized monthly inflation rate at 1.4%, a sharp decrease of 1.3 percentage points from May. The 12-month rolling figure, more closely watched by policymakers, dropped to 2.2%, down 0.2 percentage points from the previous month and the lowest since July 2021.
Cleveland Fed's "16% trimmed-mean CPI," based on the Consumer Price Index, includes components with price changes between the 8th and 92nd percentiles. This indicator stood at 2.63% in June, which, on an unrounded basis, is also the lowest reading since May 2021.
Beyond the trimmed-mean data, the Commerce Department's overall PCE reading for June showed a 0.1% monthly decline, primarily driven by a sharp drop in fuel costs. The core PCE, which excludes food and energy, rose 0.1% month-over-month. Year-over-year, headline PCE and core PCE increased by 3.7% and 3.3%, respectively, still significantly above the Fed's 2% target.
Citigroup economist Andrew Hollenhorst noted that the fact underlying inflation continues to drift back toward the target is evident across a broad array of indicators, making this particularly important given Chair Powell's indication that he will analyze inflation pressures by looking at multiple metrics.
Powell's Framework Reassessment and Market Expectations
The trimmed-mean data has garnered extra attention partly due to recent comments from Chair Powell. He has signaled an intention to evaluate inflation pressures by examining a broader matrix of indicators rather than relying on a single yardstick.
Andrew Hollenhorst pointed out that the trimmed-mean data should now be moving closer to a level consistent with the target. He added that since Chair Powell has hinted at analyzing inflation pressure through a wide range of indicators, the fact that underlying inflation continues to decelerate toward the target becomes more crucial. His team expects the market to gradually price in rate hikes over the coming months under the influence of inflation data, and then begin to price in rate cuts as the unemployment rate rises as forecast.
However, the signals from Chair Powell himself this week have been cautious. He stated that while there are some positive signs on the production side, the Fed still has considerable work to do. He emphasized that none of his FOMC colleagues harbor any illusions, acknowledging that they have turned a new page but understand that over five years of high inflation cannot be resolved in nine weeks or with a single month of modest price declines.
Internal Dissent Reflects Disagreement on Inflation Outlook
Despite the lower trimmed-mean data, there is clear caution within the Fed regarding its interpretation. Dallas Fed President Logan, who has direct oversight of this indicator, explicitly warned against overinterpreting it. She noted that researchers at the Dallas Fed have found changes in the composition of price increases and decreases mean the trimmed-mean is currently excluding too many rising items, an effect that could be causing the metric to understate the true inflation trend.
Logan subsequently voted against maintaining the current interest rate, advocating for a 25-basis-point increase. She argued that even accounting for productivity gains and temporary supply shocks, inflation appears to be converging to an intermediate level above 2% rather than fully returning to the target, with risks tilted to the upside.
The positions of Kashkari and Hammack were similar to Logan's, with both stating that inflation remains uncomfortably high and that the Fed should act immediately rather than continue to wait. The bond market has also expressed doubts about the Fed's decision to hold rates, with long-term yields rising significantly this week, reflecting investor concerns about future growth and inflation prospects.
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