The markets were up last week as soft US economic data led many to believe the Federal Reserve Board (FRB) may hold off action till 2016. The consumer may have something to say about that…
The case against a rate hike:
There was plenty of data on the market to support low rates into 2016. Consumer Price Index (CPI) soften -0.2% month over month in September. This was driven by continued soft oil prices. Retail sales, excluding autos, were down in September by -0.3% showing a weakness in consumption. All be it international, German Confidence fell off and headline CPI for the Eurozone slipped back into deflationary territory at -0.1% year over year. Many view the softening inflation data as cause to believe that the European Central Bank (ECB) will take additional stimulus actions.
This data sounds like more than enough cause for rates to remain low well into 2016. So where is the case for a rate hike in 2016???
The case for a rate hike:
There are a few reasons to think the FRB may raise rates sooner rather than later.
CPI, while important, is very volatile. The far more prudent number to look at is core CPI as it removes food and fuel and provides a clearer picture of how much prices are changing over time. Core CPI for the US is currently 1.9% year over year through September. Just 0.1% off the FRB’s desired rate.
Core CPI is also an indication of where inflation is heading. Once we pass the one year mark from when oil prices fell (last December) headline CPI is going to rise and be reasonably in line with core CPI.
Consumer spending was down for the month of September. This shouldn’t be shocking after the 0.2% increase in August (back to school season) and before the holiday season. You have to reach back to 2012 the last time that the fall didn’t have a swoon before the holiday buying season. If consumer spending picks up during the 4th quarter this could add to the underlying inflationary pressures.
Usually it takes something happening to cause a concern for inflation, i.e. a countries oil production falls off line, heavy consumer spending, or FRB inaction in the face of inflation. This time all it will take is time… Once the sharp oil price decline from last year falls off, we will begin to see headline inflation return to a realistic number. Should we see a countries production fall off line, or perhaps OPEC lowering output, we could see a sharp increase in inflation. So, that being said, there is little doubt to the inflation concern being real.
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