Thursday, 24 May, 2018

Inflation -- and rate hike -- fears have investors wary

The Fed’s policymaking body will reveal its decision tomorrow The Fed’s policymaking body will reveal its decision tomorrowBRENDAN SMIALOWSKI AFP GETTY IMAGES
Jodi Jackson | 04 May, 2018, 14:19

The Fed left the interest rate unchanged as expected but made some dovish comments that markets seized upon.

"On a 12-month basis, both overall inflation and inflation for items other than food and energy have moved close to 2 percent", the Fed's statement said.

Tradables CPI, which includes goods and services that compete with worldwide rivals, fell 0.1 percent in the first quarter and slipped 0.4 percent on the year, keeping headline inflation near the bottom of the bank's 1 percent-to-3 percent range.

"To be fair, the USA economy has historically experienced weaker growth at the start of a new year as consumers front-load spending into Q4 amid the holiday season", Piegza wrote. But unlike in their March statement, Fed officials this time didn't also say that the economic outlook had strengthened in recent months.

The Fed's confidence in the economic outlook was also highlighted by its assertion that business fixed investment had continued to grow strongly.

So far it has been a strong earnings season, with the year-on-year blended earnings growth estimate coming in at more than 25 percent in the first quarter for S&P 500 companies, according to Thomson Reuters I/B/E/S data, while the equivalent figure for the MSCI EMU index (European Economic and Monetary Union) is 14.6 percent in dollar terms. External factors like demand for the Dollar is dictating the majority of swings in the global currency markets, explaining why the Dollar unexpectedly making a turnaround over the previous fortnight has resulted in the Rand moving back to levels not seen since December 2017. Officials indicated in March they expect a total of three or four hikes in 2018.

It held short-term rates unchanged at 1.5% to 1.75%, but that will change, soon, probably at the Fed's meeting in mid-June. We think this further reinforces the case for rates not be hiked at next week's MPC meeting.

In fact the Federal Reserve seemingly hinted that U.S. inflation may be allowed to pass (slightly) above the 2 percent (y/y) target, implying that further rising United States inflation may not become a cause for more aggressive monetary tightening.

Sluggish inflation stood in the way of quicker rate rises previous year, but headline inflation has recently returned to the Fed's target of 2 per cent, leaving policymakers better placed to forge ahead with their rate-lifting plans.

The central bank is meeting as its board is undergoing a makeover, with a raft of new Trump appointees who appear generally supportive of the Fed's cautious approach to rates since the Great Recession ended.

The question remains how quickly and high Jay Powell, the Fed chairman, and his colleagues boost borrowing costs as they attempt to prevent the U.S. from overheating while keeping the economy moving at a steady pace. But interest rates are still at a very low level compared to where they were during much of the 1990s and early 2000s, when interest rates over 4 per cent were common. As the dollar is now in overbought territory, we expect the currency to continue giving up some of its recent gains.

"The Fed's gradual approach to interest rate increases was justified by inflation running below 2 percent, but with inflation now on the cusp of that threshold the Fed may become more proactive about raising rates in an effort to keep inflation contained", Bankrate.com Chief Financial Analyst Greg McBride said.

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