On the Meaning of “Transitory”

The Fed Chair has been stretching semantics on inflation, but his growth outlook mirrors ours.

Last week, U.S. Federal Reserve Chair Jerome Powell added a new word to the central bank watcher’s lexicon: “transitory.”

Look up the word in Webster’s dictionary, and you’ll find that it means “adj. of brief duration, temporary, not persistent.” It was therefore a little surprising to hear Powell apply it to the slow rate of inflation in his latest press conference.

Hasn’t U.S. Personal Consumption Expenditure (PCE) been struggling to reach the Fed’s target of 2% annual growth for more than a decade? And should Powell’s semantic stretching raise similar questions about his upbeat take on the global economy?

Academic

“I don’t mean to diminish concerns about too-low inflation,” Powell said, “but there’s good reason to think that these low readings are particularly influenced by some transitory factors.”

There followed some debate as to whether the “transitory factors” he mentioned—low airfares, low apparel prices, low portfolio management fees because of the sell-off in financial markets last year, tweaks to indexing methodology—were really enough to move the needle either way.

But frankly, that felt academic next to the U.S. PCE trend, the decade-long downward slope for inflation indices in both the developed and the emerging worlds, and the near 30-year decline in the University of Michigan’s U.S. Consumer Inflation Expectations gauge. If this is transitory, it doesn’t seem to be in Webster’s definition of transitory.

For some time, we have maintained that investors should expect inflation to tick up as the cycle matures. But we have been clear that we believe this would likely be modest, and have acknowledged the far-from-transitory forces of globalization, automation and the “sharing economy”, among many others, that have arguably been keeping inflation low.

Consolidation

However, if Powell puzzled markets on inflation, we don’t think it follows that he was overly optimistic in his upbeat assessment of growth out of China, Europe and the U.S.

The recovery in data outside the U.S. has been at the core of our view for many months, and we held to it even through the turmoil of the fourth quarter last year. Recent releases continue to support that view.

Last week’s Purchasing Managers’ Index (PMI) data out of China were always likely to look soft after the bumper result for March, but they still showed good consolidation in expansion territory.

While PMIs in most of the euro zone remain in contraction, they are now moving in the right direction. The recent focus on weakness in manufacturing also misses the underlying strength in employment and consumer trends, which fed into last week’s upside surprise in the region’s GDP releases, showing annualized growth of 1.5%.

Triggered

Back in the U.S., trade negotiations with China appear to be progressing, the jobs scene still looks very strong and the consumer looks confident. Friday’s U.S. non-farm payrolls data release was another blockbuster, but average hourly earnings growth remains moderate at 3.2%. In addition, halfway through first-quarter earnings season, close to 80% of S&P 500 companies have beaten analysts’ estimates relative to the 10-year average of 68%. The latest data showed GDP growing at 3.2%.

That headline number owed a lot to inventory build-up and higher net exports. Domestic demand was less impressive, and last week’s Institute for Supply Management (ISM) indices also came in weaker than expected. Nonetheless, part of our global-recovery scenario depends on precisely this stabilization and return to trend-line growth in the U.S., which enables the Fed to keep rates stable, engineer a soft landing and ease some of the strong-dollar pressure on the rest of the world.

A hawkish turn by the Fed could imperil that view—which is why Powell’s “transitory” comments triggered a flight from risk assets last week. We suspect markets may have read too much into those comments. After all, the Fed’s official statement acknowledged that 12-month inflation data are no longer “near 2%” but “have declined and are running below 2%,” and Powell himself noted the importance of accommodative conditions in his upbeat assessment of the global outlook. A rate cut may not be in the cards, but a rate hike seems a ways off.

As such, while the disinflationary forces in play are not so transitory, we think last week’s wobble in equity markets may still turn out to be.

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