Waller's Dovishness Is Built On Shaky Ground

Authored by Simon White, Bloomberg macro strategist,

The short-squeeze in bonds driven by Fed Governor Waller’s dovishness might be built on shaky ground.

Waller’s view is likely being informed by the benign market-based measure of PCE, which he drew attention to in a speech earlier this month.

He argued that the main driver of higher inflation last year came from the other-than-market-based PCE, which consists mainly of imputed prices, and which accounts for about a third of the core PCE basket.

Waller’s dovish outlook then rests on the market-based measure continuing to ease.

But stripping out the parts of inflation that are inconveniently rising hasn’t worked out well in the past for the Fed.

Arthur Burns, the bank’s Chair in the 1970s, invented core inflation, first taking energy and food prices out of the headline measure. He went further, eventually stripping out almost two-thirds of the basket.

When he left, inflation was near 7% and soon rose to almost 15%.

The market-based measure of PCE is very similar to acyclical PCE, i.e. that part of inflation least correlated to Fed policy, and is already rising.

Turning up the dovish volume now might not turn out to be a good idea.