Signal & Noise Filter

Mencho’d

This note picks up where Friday’s PPI recap left off: observing the highest inflation print in two years in the context of a low hire/low fire labor market, popping credit spreads, a flattening yield curve, and now, a kinetic strike on Iran that introduces oil risk into inflation risk premia.

Noise vs. Signal.

There is a lot of wood to chop, and we are getting after it here, far from Mexican cartels and Iranian mullahs. En-Shala. 🙏

This is what spot inflation looks like.

The first question is how much of this is a noisy echo from past policy choices (tariffs + big fiscal + prior rate cuts over the past two quarters) and how much of this represents a forward-looking inflection point?

The second and more important question is, what is the FOMC’s most likely reaction function?

1. Transitory inflation look-through which prioritizes the labor market in the face of high spot inflation but with the expectation of future lower trend inflation, which has been the policy Rx by Romer & Romer for this cycle?

To spare new reader search within the above link, the relevant passage is provided:

“To do so, the Fed is employing the Romer & Romer playbook that was referenced in the inaugural note of this series. Recall:

“In particular, we now also look for times when policymakers believed that they were at a stable level of economic activity but took actions to lower the unemployment rate—and were willing to accept adverse consequences for inflation.

That is, we look for times when policymakers were deliberately shifting the aggregate demand curve out because of a change in their view of the acceptable or desirable level of unemployment.

If monetary policy has real effects, output should rise following such actions.”

-(Romer & Romer 2023).

2. Shotting Romer & Romer in the head and abandoning the labor market?

3. Some combination of the above.

To form an understanding of the above, we must look at the sources of the inflationary impulse, and the likelihood of their persistence.