The Fed is determined to drive inflation higher from marks it considers extremely low. For that to happen, 1st it must convince the market and consumers that prices will accelerate going forward.
The Key problem is that the measures that bond traders and strategists rely on for longer-run inflation expectations can often give conflicting/confusing signals.
No one can agree on how best to use or decipher such signals, with even the Fed seemingly reticent to narrow the messages.
The Fed’s economists recently reviewed a mix of more than 20 gauges. Yet depending on which measure considered, inflation is still short of the Fed’s average 2% goal or may have exceeded it already.
With the Fed planning to keep rates near Zero until price pressures re-emerge, it is not academic question.
The prospect of a reversal and economic reflation lifted yields on US debt to the highest in months last week, skewing the yield curve to near its steepest in 4 yrs and bringing on bets on rate increases. While those bets dipped amid stop-start talks over a new aid/relief/ stimulus package, their resilience is a reminder for traders of what is at stake in nailing the outlook for inflation.
Inflation is not running at any alarming rate. Total CPI and core CPI, which excludes food energy, were both up 0.2% M-M in September. That left the Y-Y readings at 1.4% and 1.7%, respectively.
According to different agencies, US CPI (Consumer Price Index) inflation will be within the range from 2.1 to 2.3 percent in 2020 and average at around 2.2 percent in 2021. All agencies are consistent that CPI inflation will increase in 2020 from an average of 1.8 in 2019. Over the longer-term up to 2024, CPI inflation in the US is expected to be around 2.3 percent.
“So, what is the current situation of our economy and what does this all mean in layman’s language?
“The inflation rate was 0.4% in August 2020 according to the Consumer Price Index Summary from the U.S. Bureau of Labor Statistics. The coronavirus pandemic sharply reduced demand from March through May as state governments ordered shelter-in-place orders. Now, however, prices are creeping back up as states reopen.
“Let’s now look at a cross-section of the US economy – gasoline prices rose by 2.0% due to increasing oil prices. Oil prices make up 54% of gas prices. The Energy Information Administration’s oil price forecast for the benchmark Brent crude rose to $44 a barrel for the fourth quarter of 2020 and $49 barrel for 2021.
“The prices of used cars and trucks increased by 5.4%, while new vehicle prices remained flat. Prices for other transportation services remained flat following a 3.6% increase in July. Also, in the last 12 months, the cost of health care services rose by 5.3%. Drug prices increased by 0.8% during that time. Health care costs have risen more slowly since the last several years. Before that, prices rose by 7 to 8% a year.
“The core inflation rate was 1.7% year over year. The core rate eliminates the impact of volatile oil and food prices. Their prices change daily because they’re based upon commodities trading. Crude Oil prices also tend to rise in the spring in anticipation of higher demand from summer vacationers. High oil prices increase the prices of fertilizer and transportation costs. That creates high food prices, a cautionary note to the Fed. However, despite the foregoing, the core rate thanks to the current Administration’s effectiveness was below the Federal Reserve’s 2% inflation target.
“In August 2020, the Federal Open Market Committee (FOMC) announced it would allow inflation to rise above 2% if that would ensure maximum employment. The FOMC lowered the fed funds rate to a range between 0% and 0.25% in an emergency meeting on March 15, 2020. In January 2012, the Fed switched to the Personal Consumption Expenditures (PCE) to measure inflation. The Fed considers it to be more reflective of true underlying inflation trends. The PCE core inflation rate was 1.3% year-over-year as of July 2020, also below the Fed’s target.So how the Current Inflation Rate Affects You? The inflation rate is an important economic indicator. It tells you how fast prices are changing in the current phase of the business cycle. It’s measured by the Consumer Price Index (CPI) which is reported by the Bureau of Labor Statistics (BLS) each month.
“Now what about deflation. Falling prices warn of deflation. While this may seem like a great thing for shoppers, deflation often signals an impending recession. With a recession comes declining wages, job losses, and big hits to most investment portfolios. As a recession worsens, so does deflation. Businesses hawk ever-lower prices in desperate attempts to get consumers to buy their products and services.
“The Federal Reserve combats deflation with expansionary monetary policy which it recently has done. It reduces the fed funds rate target for once rates have hit zero, it uses other tools. Note, deflation is worse than inflation because interest rates can only be lowered to zero. As long as businesses and people feel less wealthy, they spend less, reducing demand further. They don’t care if interest rates are zero because they aren’t borrowing anyway. So, what is a good healthy inflation? Moderate inflation is actually good for economic growth. When consumers expect prices to rise, they are more likely to buy now, rather than wait. This increases demand.
“As pointed out by former Fed Chair Ben Bernanke inflation is usually driven by expectations of inflation.
“This means that, if people and investors think prices will go up, they will buy things now, increasing demand which is good for economic growth. However, on the cautionary side, it can also drive prices up depending on the extend of the demand side which is a cautionary element always watch by the Fed. To offset this, the FOMC reviews the core inflation rate. When the rate is lower than the target, the Fed may use expansionary monetary policy. It will lower the fed funds rate to boost economic growth. That’s done to prevent any possible recession, which is exactly what the current Administration is doing correctly,” says economist Bruce WD Barren, editorial contributor to Live Trading News.
Have a healthy day, Keep the Faith!