Inflation: It will be ‘a long and winding road' to Fed's 2% target, economist says

RSM U.S. Economist Tuan Nguyen joins Yahoo Finance Live to discuss core PCE data, Fed policy, rising rates, the U.S. consumer, and the outlook for the economy.

Video Transcript

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JULIE HYMAN: Personal consumption expenditures came in hotter than expected. Joining us now to break it all down, RSM US economist Tuan Nguyen. Tuan, let's talk about what we had here, and in particular, I just want to jump right to not just the preferred inflation gauge, but the preferred gauge within the gauge. That is, the measure of services inflation here that excludes housing and really is the one that the Fed is zeroed in on. It, too, was hot. How problematic is this?

TUAN NGUYEN: Good morning, it's great to be on the show. Today's data really shows that both prices and spending were robust in January. And when you have rising prices and rising spending volume at the same time, that means there's an increase in overall spending demand. And obviously, that should not give the Fed Reserve or market participant any relief, as the Federal Reserve is trying to tame overall demand.

Now, you mentioned the so-called super core component, which is core services, ex-housing. And that's really the things that driving most of the conversations around the Federal Reserve policy at the moment. And based on our estimate this morning, we are looking at 4.6% in January for the super core component on a three-month moving average, which is up from 4% in the prior month.

And that should add to the case that inflation will be sticky in our base case in around 3% and 4% moving forward in the next six to 12 months. And overall, the data today really speak to the fact that while we have passed the worst of inflation, it certainly will be a long and winding road toward the 2% target rate.

JARED BLIKRE: Yeah, that 4.6% super core, the highest level since October. Sticking with the report, we also got numbers on personal spending and personal income. Now, both of those exceed, now, both of those were positive, but personal income came a bit light, only 6/10 of a percent for the month of January versus expectations of 1%.

1% is a huge month over month, or would have been a huge number there. Personal spending came in hot, 1.8% versus 1.4%. How do you, what do you, how does this factor into your analysis of the inflation figures that we got as well?

TUAN NGUYEN: So when we look at income, it's really important to also look at the one-time increase in Social Security benefit in January, which is a big factor for the increase in income. Now, there's, I think there are a lot of reasons to be cautious when we look at the strong spending number and the strong income number, because if you really think about the average American consumers, there are only three things that will keep their spending up.

The first one is saving, the second one is income, and the third one is credit card. Now, when we look at excess saving and we are, and I'm talking about the lower and the middle income Americans here, which are really the majority of Americans, they're having their excess saving drawn down to around $200 billion in our latest estimate at the end of 2022. That's only 20% of the $1 trillion in excess saving. So they are very tight in terms of excess saving.

And the second thing, income. Even though we're seeing income wage growth at a very high level in recent months, when you look at disposable income and you factor in inflation, inflation actually has taken a big bite out of income.

And if you look at real disposable income, it has actually been stagnant in the last two years. So there's not a lot of dry powder for the average American consumer to spend moving forward. That's why we're seeing a big spike in terms of credit card usage in recent months.

JULIE HYMAN: There's still this expectation that inflation is going to abate this year. And I know that this is one month, right, but how alarmed should we be by these numbers? How shaken in the seeming conviction that inflation is, that we're going to get disinflation this year?

TUAN NGUYEN: Now, besides the super core component that we just talked about, I think the other point that we have to be concerned about is how goods prices actually rose in January. Now, before January report, good prices were one of the factors that drove inflation down in recent months, right.

So the increase in goods prices actually speak to what Federal Chairman Jerome Powell talk in December, that there's going to be a lot of volatility around goods prices. And maybe we have seen the bottom of goods prices. So moving forward, we're going to see again, a lot of uncertainties around good prices on top of the super called components.

Therefore, if you look at the year over year headline inflation number, maybe we see this inflationary period moving forward. However, the month over month, again, is going to be a very long and bumpy road towards that 2% target rate.

JARED BLIKRE: Yeah, long and bumpy road here. One more question. Just thinking about how all of this data may influence the Fed, and all the voting members are going to release their statement of economic projections based on what they've seen over the last month.

And we've gotten a lot of hot inflation data. The bond market just finally catching up to the Fed's own predictions of the terminal rate and such going forward. Just wondering what you think the Fed may, or how the Fed may adjust their own projections of the economy?

TUAN NGUYEN: Yeah, before today's report, our base case showed that we're at, we're going to be at 5.25% in terms of the peak policy rate. But after this report, I think we can mark it up to 5.5%. And this is exactly what the market is thinking at the moment, 5.5% this morning.

And I think moving forward, there's going to be a lot of upside risks around that Fed policy rate if we have another strong job report or another strong inflation report in the coming months. Now, I have been making the case that the market should not underestimate the Federal Reserve focus to bring down inflation to 2%.

And if you think about what the market has done in the past couple of months, it actually got ahead of itself by prematurely pricing in for a rate cut by the end of 2023. Now the market has come to realization that the Federal Reserve is really determined to bring down inflation.

And I think the short-term traders, they will always do what they do, is riding the rallies. But for the medium and longer term investor, I think it's going to be very important that you have the saying, we don't time the markets. I think it applies also here for the Fed Reserve. We should not time the Federal Reserve.

Because economic conditions at the moment is very different than the economic conditions that everybody used to 10 years leading up to the pandemics, everything is so strange now. The rate of the growth, the economic growth is so unusual at the moment. So when we talk about soft landing, no landing, or hard landing, we have to keep in mind that the economy is running at the speed of a jet fighter, not a commercial plane.

JARED BLIKRE: Couldn't agree with you more. That means more volatility in the economic data ahead. Really appreciate your insights. RSM US economist Tuan Nguyen. Thanks for joining us.