Weak energy prices set to weigh on US inflation through until next year
Last week’s stellar US October jobs report has really shifted the dial of expectations for a rise in interest rates at next month’s Federal Reserve rate meeting, which will be the final meeting of 2015, with the hope that Fed policymakers will be able to fulfil their often repeated pledge to raise rates this year.
At first glance all of the main internals of the report were unambiguously positive, with the unemployment and underemployment rate falling back, while average earnings data rose 2.5% year on year.
The rebound in the jobs market was all the more welcome given that it had come against a backdrop of much weaker August and September jobs numbers; however it remains notable that there remains clear evidence of a slowdown in the longer term trend for job gains with the three month average well below the 200k level.
While US jobs growth has been positive, the other pillar of the Federal Reserve’s mandate has continued to remain worryingly weak, with inflation pressures remaining subdued.
US CPI is currently sitting at 0%, and while the Fed’s preferred measure of PCE remains above that, it still remains well below the 2% target mandated by the Fed’s charter.
While investors are pricing in a 70% probability of a move on rates next month the one fly in the ointment that might cause the Fed to blink is the lack of inflation, and while that seems unlikely at this point, one should never underestimate the ability of a central bank to get cold feet and catch the market off balance, as the Bank of England did last week, and the Federal Reserve did in September.
An analysis of commodity prices over the past twelve months suggests that we could well see further weakness in prices and if US CPI were to go negative, or PCE weaken further in the next six weeks, then suddenly the prospect of a rate rise in December might suddenly become less of a sure thing.
In the last twelve months from the beginning of October 2014 oil, natural gas and gasoline prices in the US have all slid by as much as 50% with no prospect of an uptick much before February next year.
This suggests that US CPI could well go negative in the weeks leading up to next month’s Federal Reserve rate meeting, with the October numbers due out next week, while the November CPI numbers are out the day before the Fed makes its final decision.
While there is no question that the US Federal Reserve wants to get off the zero lower bound the message on how they do that will need to be carefully managed in the event that US CPI prices for November dip into negative territory the day before the Fed announcement is made.
While some have suggested that a rate rise is now a done deal, the reality is that it is anything but.
Benjamin Franklin, one of the founding fathers of the US once said that "nothing can be said to be certain, except death and taxes." while Pliny the Elder said that "the only certainty is that nothing is certain" and investors would do well to remember that in the coming weeks.
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