Inflation Unexpectedly Fell in January, Suggesting the Fed Went Too Far

A closely-watched measure of inflation unexpectedly turned negative in January, providing the latest evidence that the Federal Reserve’s 2018 rate hikes went too far.

The Fed’s preferred inflation gauge, the price index for personal-consumption expenditures, fell 0.1 percent in January from December. Economists had expected prices to remain flat.

Compared with the prior year, the index is up just 1.4 percent, the Commerce Department said Friday.

Lower energy prices played a role in holding down inflation. The so-called core PCE price index, which strips out volatile food and energy components, rose 0.1 percent from December. That was also below expectations for a 0.2 percent rise. Compared with a year ago, core PCE was up 1.8 percent.

Both the headline number and the core figure are below the Federal Reserve’s target of 2 percent inflation. The Fed has undershot its inflation target on an annual basis ever since the Great Recession, with a brief exception in 2012.

In January, the Fed changed its monetary policy from gradual rate hikes to “patience,” meaning the Fed would hold off on further hikes until more evidence came in about the strength of the economy and inflation. Projections of Fed policymakers released after the Fed’s meeting last week showed most of the central bankers do not foresee moving the Fed’s target rate from a range of 2.25 percent and 2.5 percent this year.

The market in fed funds futures now appears to be pricing in at least one rate cut by the end of the year and gives a 25 percent chance of a second rate cut. Last week, the yield curve inverted, a sign that traders think interest rates will decline in the future. An inverted yield curve is considered a harbinger of recessions, particularly if the curve stays inverted for several months.

Stephen Moore, the economic pundit Trump is expected to appoint to a vacant seat on the Federal Reserve’s board, has said he thinks the Fed should reverse its last two rate hikes. Moore was severely critical of those hikes and even called for Fed chair Powell to resign after December’s rate raise, a stance Moore now says he regrets.

Fed Vice Chair Randall Quarles on Friday said he believes the economy will be strong enough to support a rate hike, seeming to push back against market expectations that the next move in rates will be downward.