Forget about 3% US inflation. McGeever: It's headed for 4%.

Is 4% now the new 2%?

The U.S. has had an inflation rate that is so high compared to the Federal Reserve target for such a long time, many observers think policymakers are accepting a higher level. Now, the concern is that inflation will continue to rise.

Consumers, businesses and investors might think that policymakers are happy with 3% inflation despite their commitment to the Fed's goal of 2%.

Since 2005, headline annual PCE and CPI rates have consistently exceeded the Fed's 2% target. Core inflation, which excludes volatile energy and food costs, has also been above the Fed's 2% target for five years.

The problem will only get worse. Energy prices are rising so fast due to the Strait of Hormuz closure, including gasoline, diesel, and jet fuel. The U.S. is now experiencing inflation of 4%.

Last week, figures revealed that the PCE Price Index - the Federal Reserve preferred measure of inflation -- had reached 3.5% for the year in March. This was the highest level in almost three years. The jump of 0.7 percentage points from the previous month was the largest in five years.

The Fed also pays close attention to core?PCE inflation. It rose slower, to 3.2%. The longer energy prices stay high, the more likely it is that they will eventually affect core inflation. In this regard, policymakers should be concerned.

Upside Risks

According to the Cleveland Fed's "Inflation Nowcasting Model", which is a real-time model, annual core PCE currently stands at 3.7%. Headline PCE follows at 5.4% while headline CPI is at a staggering 6.1%. The red flags have become a deeper shade of purple.

UBS economist Alan Detmeister cites the rise in gasoline prices as the reason for the 4.3% headline CPI inflation in May. This is a jump of nearly two full percentage points compared to the 2.4% headline CPI of February before the start of the "Iran War". It's also one of the biggest three-month changes of headline CPI seen in decades.

Detmeister predicts that the headline CPI will rise by 8.51% over a three-month period in May. This would be "the fifth largest reading since 1982, excluding 2021-2022's pandemic years."

He says that "given the recent?jump' in gasoline prices, I believe the risks are on the upside for our headline CPI estimate for May."

A spike in inflation of this magnitude is possible.

According to the American Automobile Association, the average price at the gas pump is $4.45 per gallon. This represents a nearly 50% increase since the beginning of the war. Analysts claim that this is the largest increase in 30 years. Fuel oil has risen by over 70% and jet fuel by over 90% since the start of the war.

Policymakers can relax a bit if these increases do not spill over to core prices. But that is a big 'if'. Fed appears to be worried, as last week's meeting had the highest number of dissenters since 1992.

BAPTISM FIRE

Kevin Warsh's timing couldn't be worse. He is expected to be confirmed by the Fed as its new chair at the end of this month. This casts doubt on his suggestion that "the Fed should reconsider its main inflation measure."

Warsh floated the idea that the PCE index should be replaced as the main inflation guide by a "underlying" measure, which is yet to be determined. This would resemble the "trimmed mean" calculated by the Dallas Fed and Cleveland Fed.

Dallas Fed and Cleveland Fed's trimmed average annual rates of inflation currently are lower than more established PCE or CPI measures. The Cleveland Fed's rate was 2.3% and the Dallas Fed's was 2.9% in March.

Warsh may find it hard to convince his colleagues that these gauges are more reliable when those on which the Fed has relied for decades flash red.

Bob Elliott, CEO at Unlimited and CIO, believes that most developed countries will experience 4% inflation in the near future if oil prices remain high.

Elliott says that "3% is the new 2%." "When inflation is already high, it will be much more difficult to shock the system.

It's probably a good idea. Warsh should learn from Jerome Powell to not use the T-word.

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(source: Reuters)