Inflation: Too High, Too Low, or Just Right?
Citing that the job market “has continued to strengthen,” the Fed raised rates by a quarter of a point today. Earlier in the day, CPI inflation was dropped to 1.9% in May from 2.2% in April. But the big surprise was that core inflation (excluding volatile food and energy categories) dropped to 1.7% in May from 1.9% in April. Fixed-income markets welcomed the news, with the 10-year Treasury yield down 10 basis points (bps) and core bond indices up.
Weak core inflation (only up 0.1% from April to May) was driven by slower growth in housing costs and declining prices for apparel, airline fares, communication, cars, and medical care services. Hotel rates were almost flat, after a large rise in April.
Core inflation hitting a two-year low is surprising in an environment of strong downward trends in unemployment numbers (unemployment hit a 16-year low in May) and record-high job opening numbers (>6M in April, highest on record!).
A relatively strong U.S. dollar (USD) and very low inflation overseas are factors inhibiting inflation, but technological changes and automation are also causing structural downward pressure on costs and prices in many industries. It is important to note that many of these structural changes also enable the economy to operate at a higher activity level without stoking inflation pressures. Essentially, the economy’s “speed limit” is higher. This means that the economic expansion can be sustained for longer time without the need for aggressive policy tightening from the Fed.
Today’s inflation numbers surprised on the downside, but we caution against ruling inflation completely out. At 1.9%, inflation is higher than its 10-year average of 1.6%. With increasing signs of labor market tightness, a stabilizing USD (in fact, the USD is down YTD) and signs of firming commodity prices, core inflation is more likely to trend up than down over the next 6-12 months.
Sources of data: Bureau of Labor Statistics (BLS) and Bloomberg, as of 6/14/17.
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Basis point (BPS) refer to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01% (0.0001), and is used to denote the percentage change in a financial instrument
The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them.
Core Inflation is a measure of inflation which excludes transitory or temporary price volatility as in the case of some commodities such as food items, energy products, etc. It reflects the inflation trend in an economy.
Commodities are raw materials or primary agricultural products that can be bought and sold, such as copper or coffee.
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