The Fed’s favorite inflation measure surged in April. On Friday, the US Department of Commerce reported that the core personal consumption expenditures index (PCE), the Fed’s favorite gauge of overall inflation, rose 3.1% year over year. The surge was far higher than the Fed’s preferred 2% level, which it has advertised ad nauseum over the years, even though the gauge has undershot that level on a sustained basis for more than a decade. Does this latest reading mean inflation is here to stay?

Our take: Fed officials believe the inflation surge, fueled largely by skewed year-over-year comparisons when the economy was at a near standstill, coupled with production bottlenecks, will be temporary and is determined to look through them. Are they wrong? We think not. Looking at another gauge of inflation – the consumer price index (CPI) – which was released back on May 12^th, consider that close to 60% of the CPI’s month-over-month increase came from just five components: lodging, airfares, used cars, rental cars, and food away from home.  It is well understood that the increase in each of these categories is the result of acute supply-demand imbalances, and that each is likely to recover quickly after significant weakness, as the economy emerges from its pandemic stupor.

However, once the reopening impulse subsides, long-running disinflationary trends in place prior to the pandemic, as well as the roughly seven million currently unemployed, will serve as a drag on inflation. For evidence of this, look no further than flat-lined prices seen in other categories essential to any sustained rise in inflation: medical care services (0.0% in the CPI report vs. 0.1% prior), personal care (0.2% vs. 0.6%), and one of the biggest CPI components, rent of shelter (0.2% vs 0.2% prior). We’ll get the next read on the CPI on June 10th.

Regardless of your view, get comfortable with the inflation fear-mongers lurking around every corner throughout the summer as inflation gauges run hot, driven by supply shortages and aftershocks from fiscal stimulus, while year-over-year inflation comparisons continue to skew the data.

Other, mixed data releases backed up the Fed’s status-quo stance. Elsewhere, the Commerce Department reported that personal income, after surging 20.9% in March on fiscal stimulus payments, fell 13.7% in April. The savings rate remained elevated at 14.9%, while consumer spending rose a measly 0.5%. Other data released earlier in the week last week were also mixed, showing a slowdown in home sales as price rises and low inventories kept many buyers on the sidelines. Durable goods orders fell at the headline level although core orders rose. Q1 GDP was unrevised at 6.4%, while jobless claims fell to the lowest level of the pandemic at 406K.

All-told, US economic surprises have been to the downside lately, cooling fears that the Fed will have to abruptly shift away from its ultra-loose policy stance. The bond markets agree; the benchmark 10-year Treasury yield barely budged after the release of the surprising PCE data, treasury yield volatility continues its slow and steady decline, and one of the best market views of inflation – the Treasury yield curve – is no steeper than it was in early March – all conditions the Fed wants to see.