Just Below The Surface


For months now we have watched plummeting oil prices make inflation less and less of a concern. Has it turned the corner and created a scary situation for the Federal Reserve Board (FRB) that they need to address?

No, but it does appear that it will be coming sometime in the near future. Headline Consumer Price Index (CPI) in January was flat, leaving the year over year change at 1.4%. This doesn’t seem like much since the FRB mandate is to keep inflation at 2%. The big difference is that year over year inflation through the previous month was just 0.7%[1]. Due to the volatility in fuel prices headline CPI can fluctuate greatly, that is why it is important to be aware of where Core CPI lurks.

So, why the concern, the FRB mandate is 2% and we sit at 1.4%, no problem, right? Wrong. When we strip fuel and food from the equation, Core CPI comes in at 2.2%[2]. This means that while corporate America would get a boost from an increase in oil prices… so would CPI. Even just a stabilization of oil prices would cause CPI to level off at the FRB mandate.

If we were to see a stabilization of oil prices and a strengthening of headline CPI, the FRB would come under increasing pressure to contain price growth. How does the FRB contain price growth? They would have to increase interest rates and discourage consumption in an effort to get prices to steady. Unfortunately, it is also growth prohibitive. For an economy expanding at approximately 2.2% per year, it will not take much FRB action to squelch growth.

It clearly is not a concern for this month and with the volatility we have experienced in fuel prices, it may be a year before this concern comes to a head… However, it is there, lurking just below the surface and we should be concerned about what it could do to a moderate growth expansion.

Last Week in Review
Last week was led by oil as markets came out of the gates strong. This was in response to the prospects that Saudi Arabia, Russia, Iran, Iraq, and Venezuela could come together to reduce oil production. As hopes of this non-OPEC coalition faded so did oil and equity prices. Oil prices and equity prices continued their nontraditional correlation.

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Always remember that while this is a week in review, this does not trigger or relate to trading activity on your account with Financial Future Services. Broad diversification across several asset classes with a long term holding strategy is the best strategy in any market environment.

Any and all third-party posts or responses to this blog do not reflect the views of the firm and have not been reviewed by the firm for completeness or accuracy.

[1] www.jpmorganfunds.com – economic update
[2] www.investing.com – economic calendar