Break inflation into cyclical and acyclical components - A better story

 

Inflation can be broken into a cyclical and an acyclical component. Cyclical inflation components are those that are sensitive to overall economic conditions while acyclical components are those that are associated with industry specific factors. The cyclical components are sensitive to the unemployment gap based on the Mahedy-Shapiro method. See the San Francisco Fed piece "Cyclical and Acyclical Core PCE Inflation". 

We have seen a decline in the acyclical component since the Fed started to raise rates, but the cyclical components have been sticky and may only now be peaking. The Fed raising rates has not be successful at curtailing cyclical inflation given there has not been any impact on the labor markets. This evidence would suggest that more rate increases may still be necessary. Of course, the alternative story is that the Fed has done its job but there has been a delay in the economic response. Neither story is good for markets. In the first case, financial costs will have to rise further. In the second case, the Fed may have overreacted given a poor understanding of lag structures.