Inflation: Transitory doubts

Mid Week Bond Update

Inflation: Transitory doubts

As the Fed contemplates its next move, what are the issues behind the lagging pace of inflation?


Behind the suspense about the time and scope of the Fed’s next rate cut lies a lively debate about inflation – how it’s measured, why it’s so sluggish in the face of a healthy economy, and why multi-year monetary largesse from central bankers hasn’t triggered an inflationary spiral.

This is about more than moving the Fed’s policy goalposts in the current economic cycle, or whether the Fed is doing its job effectively. The outcome will influence the tools the Fed uses in the to avert the next economic downturn – which some observers contend is already lurking in the wings.

Of course, at any given time the U.S. economy experiences a variety of inflationary pressures, making it unlikely that any single policy lever would have a uniform effect on the economy in the short run. Western Asset’s recent paper illustrates the diversity and complexity involved in understanding why inflation has been persistently below expectations during the current economic cycle, including an outline of some Fed policies currently under consideration.

Flavors of Inflation: Core Services vs. Core Goods

Chart courtesy of Western Asset.  Source: Bureau of Economic Analysis, as of 30 April, 2019.  Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

On the rise: Crude oil

The sabotage of at least two oil tankers just outside the Straits of Hormuz added to the uncertainty around the global price of crude oil, as did the downing of an expensive U.S. surveillance drone by Iran.

But there is at least one other reason for the $6.50 rise in the price of a barrel of Brent crude this month to $65.75, an unusually steep 11% rise from its June low. The OPEC oil cartel is planning to meet on July 1 and 2, and has in recent years shown  greater discipline in managing its output to support the price. Some observers believe that a $60-65 price is popular within the cartel, believed to be both profitable and relatively unlikely to provoke an unwelcome level of investment in alternative sources of energy. If the past is any guide, there will be much talk about the proper sustainable price levels between now and the meeting, though it could be drowned out by tensions in the region.
 

On the slide: The dollar

The price of the greenback has both emotional and economic impact, both inside and outside the U.S. So the fall in the dollar of about 2% against a basket of currencies of its major trading partners over the past week should have been a cause for dismay both among strong-dollar advocates and import-driven businesses in the U.S.

But the fall was more likely a technical bounce from its rapid rise earlier in the month – which, in turn, was less about the dollar than about the euro and the European Central Bank...specifically President Mario Draghi’s renewed insistence that the ECB could drive its benchmark rate even lower than its current negative -0.40% rate if needed to stimulate the region’s economy. Which underscores that there’s no simple, single way to view any given move in currency pairs.

 

All data Source: Bloomberg as of June 25, 2019 unless otherwise specified.


All data Source: Bloomberg as of June 25, 2019 unless otherwise specified.

 

Definitions:

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

The Organization of the Petroleum Exporting Countries (OPEC) is a permanent intergovernmental organization of 12 oil-exporting developing nations that coordinates and unifies the petroleum policies of its member countries.

The Personal Consumption Expenditures (PCE) Price Index is a measure of price changes in consumer goods and services; the measure includes data pertaining to durables, non-durables and services. This index takes consumers' changing consumption due to prices into account, whereas the Consumer Price Index uses a fixed basket of goods with weightings that do not change over time. Core PCE excludes food & energy prices.

Core PCE Goods and Services Inflation Indexes reflect the inflation on the goods and services components of the overall PCE Price Index.

 

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