MNI INTERVIEW: Risk Of Clunky Supercore Unwind- SF Fed’s Leduc

The U.S. economy still faces the risk that “supercore” inflation remains stubborn even as the job market moderates, San Francisco Fed Research Director Sylvain Leduc told MNI.

Inflation in services outside of energy, food and housing appeared to have become more sensitive to labor market strength during the pandemic, as people shied away from close-contact work, according to research by Leduc and his colleagues. The problem is that as the economy normalizes it may be harder to unwind that pricing buildup, if inflation returns to its old pattern of being less sensitive to the job market.

Put another way, it comes down to whether the slope of the Phillips Curve mapping out the relationship between inflation and unemployment has flattened out again. The return of a flatter curve would mean in general that more unemployment is needed to pull down inflation.

“The question is then, where are we now, are we on the flatter part of the relationship or still on the steep part. And there’s a risk that we’re back to where we were pre-pandemic, in a relationship that’s much more muted between supercore inflation and the unemployment rate.”

Fed Chair Jerome Powell has highlighted supercore inflation -- core services ex-housing -- to focus on a vast industry that is often driven by labor costs. Officials have cited the risk of sticky and persistent inflation as reasons to keep hiking or leave rates high for longer.

RICHER STATE LEVEL DATA

Leduc’s work in a recent paper used state-level economic data he said is better at isolating inflation and labor market trends from policy moves. The research showed a greater relationship between inflation and unemployment in 2021, but the problem is that richer data isn’t available beyond that year.

Asked what more recent data suggests about this question, Leduc said “the slope is most likely still muted by now, just because you see inflation coming down a fair amount in different categories.”

“Job gains are moderating, if you look at vacancies to unemployment, that’s also declining a little bit but it still remains fairly high suggesting that this demand for workers is still outpacing supply.”

The July U.S. unemployment rate of 3.5% is near historic lows in a year where many investors had bet on a recession, while payroll hiring has slowed to about 185,000 in the last two months from readings around 350,000 last fall. ISM services survey chief Anthony Nieves recently told MNI that while things have slowed some, he sees no major downturn and expects things to pick up towards the end of the year. (See: MNI INTERVIEW: US Services Growth Seen Rebounding Into Q4 -ISM)

SIMILAR ISSUES ABROAD

Leduc said that while risks have become more balanced over the last year they haven’t gone away. Supercore remains a big part of the inflation story, making up more than half of the core PCE index.

“One risk we’re facing is that basically that we need supercore inflation to come down. It’s still elevated when you look at numbers on a year-over-year basis,” he said. Annualized supercore inflation advanced about 4% in July according to Nomura economists who said the trend hasn't improved lately. That pace is faster than CPI inflation of 3.2% for July.

Leduc, a former BOC deputy governor, said this type of research can also be done in Canada and Europe.

“Some of the provinces if you take Canada for instance that have very similar states of the economy, I would say inflation has come back down but there is still a fair amount of pressure on services inflation because domestic demand, domestic labor markets are still fairly tight, and so some of the similar issues can be analyzed.”