The stubborn inflation the Fed can't shake

For Federal Reserve officials scanning the inflationary horizon, the persistent stickiness of core services is becoming an analytical obsession. While headline prints have drifted lower courtesy of energy deflation and supply-chain normalization, May core PCE inflation printed at an obstinate 4.6 per cent year-on-year. The disinflationary impulse in traded physical goods has largely run its course, exposing an autoregressive core driven by domestic service wages.

The Autoregressive Anchor

Services ex-housing are deeply labour-intensive, and their prices do not adjust according to commodity cycles or shipping container spot rates. Instead, they reflect sticky annual compensation reviews and service provider pricing power. Because service consumption is relatively price-inelastic, businesses have had little difficulty passing higher wage bills onto consumers, establishing an inflationary feedback loop that resists superficial policy tweaks.

Until the labour market cools sufficiently to break the wage-services feedback loop, core inflation will remain cemented far above the Fed’s statutory target.