Post from First Trust Economics Blog

Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist 

March 31st, 2025

During the ten years prior to COVID, PCE inflation, the

Fed’s preferred measure, averaged about 1.5% per year. Jerome

Powell said it was too low and he wanted inflation to “average”

2% over time. Well, he got his wish, and more. PCE inflation

has averaged 3.7% in the past five years and 2.6% over the past

ten years.

In other words, because of its misguided policies during

COVID, the Fed has pushed inflation above both its short-term

and long-term target. Any apparent success at bringing it back

down appears to be “transitory.”

In the past 12 months, PCE prices are up 2.5%, barely better

than the 2.6% gain in the year ending in February 2024 in spite

of the Fed thinking that monetary policy is currently restrictive

or tight. Core PCE prices are up 2.8% in the past year versus

2.9% in the year ending February 2024.

Some investors might still think this is due to the lags

associated with housing rents, but the Fed developed a measure

a few years ago called the SuperCore, which excludes food,

energy, other goods, and housing rents, and that measure of

prices is up 3.3% in the past year. No wonder the Fed doesn’t

mention it anymore.

It’s not tariffs that concern us. They may boost some prices,

but they also reduce demand of other goods and services. So,

why are we pessimistic about the Fed keeping inflation

persistently at 2.0% or below? Because ultimately inflation is a

monetary phenomenon and the consensus among economists in

favor of low inflation has broken down.

Back in the 1990s and early 2000s, both liberal and

conservative economists generally agreed that low inflation was

better – it should be low enough that it wasn’t a factor in business

decisions. Now, with debt levels so high, and the stock market

addicted to easy money, higher inflation has some benefits to

policymakers even if it comes with some downside.

One of the problems is that the Fed is still fixated on where

it sets the level of short-term interest rates rather than paying

attention to the M2 measure of the money supply. That measure

was up almost 4.0% in February from a year ago – a moderate

pace – but may have accelerated since the last report, with the

Treasury General Account in March 2025 down about $400

billion versus the February 2024 average.

Think of that account, the TGA, as the federal

government’s checking account. When the balance in that

account goes up, the Treasury Department is pulling cash from

the banking system and effectively extinguishing part of the

money supply. But now, with the balance in that account

declining, that cash is being converted back into M2.

In the meantime, we suspect that the Fed will soon come

under increasing political pressure for more rate cuts and less

quantitative tightening (QT) regardless of economic conditions.

And the next Fed chairman – Powell’s term as chairman ends in

about a year – will have to pledge to be more flexible about rate

cuts and quantitative tightening to secure his nomination.

The bond and gold markets seem to understand this. Gold

has jumped to over $3,000/oz and the 10-year Treasury yield is

still over 4%. With this yield, our capitalized profits model says

stocks are still overvalued. Moreover, while many think Fed rate

cuts would bring down longer-term yields, the market seems to

be saying “no.” The bond market vigilantes are more worried

about debt levels and inflation than policymakers.