Low in­fla­tion is Fed­eral Re­serve’s flat tyre on road to re­cov­ery

The National - News - Business - - Analysis - Hus­sein Sayed Hus­sein Sayed is the chief mar­ket strate­gist at FXTM, an on­line for­eign ex­change bro­ker­age

The US Fed­eral Re­serve’s eco­nomic pol­icy has a lot of mov­ing parts, one of which is not per­form­ing as well as it should.

In­fla­tion is the flat tyre on the Fed’s drive to­wards full re­cov­ery. Its re­fusal to rise is com­pli­cat­ing eco­nomic pol­i­cy­mak­ers’ lives. It ap­pears that con­sumers are not spend­ing the way they used to be­fore the cri­sis, in spite of a more re­silient jobs mar­ket.

Closer anal­y­sis re­veals one strong un­der­ly­ing trend that kept in­fla­tion flat last month.

There are sev­eral rea­sons for the slow­down in the Con­sumer Price In­dex (CPI) but the main pres­sure is the fall in en­ergy prices. Lower crude oil prices have plagued the oil mar­kets. En­ergy prices fell by 2.7 per cent in the US, with a sig­nif­i­cant de­crease of 6.7 per cent in the gaso­line sec­tor. The fall in en­ergy prices trimmed price gains in other sec­tors.

As a re­sult, the over­all CPI in the US fell by 0.1 per cent last month, ac­cord­ing to of­fi­cial fig­ures. Where con­sumers gain with lower petrol prices, oil pro­duc­ers are los­ing with re­duced in­come and prof­its. The GCC rift with Qatar has added con­sid­er­able re­sis­tance to the oil price. In­creased pro­duc­tion in the US makes the bar­rel run over. The oil mar­kets ap­pear to be re­turn­ing to their pre-Opec deal glut.

As long as the Qatar cri­sis threat­ens to de­rail the Opec sup­ply-cut deal, traders are tread­ing war­ily. Even the bulls are hanging back, re­fus­ing to charge.

Sub­sid­ing in­fla­tion didn’t stop the Fed­eral Re­serve from hik­ing its key in­ter­est rate 25 ba­sis points to 1.25 per cent in June. But there’s only so long you can drive with a flat tyre.

At the time of writ­ing, yields are fall­ing, and the gold price is re­cov­er­ing as traders price in the new sit­u­a­tion. Like in­fla­tion, yields are flat­ten­ing, giv­ing the Fed’s eco­nomic pol­icy another chal­lenge.

One of the risks of rais­ing rates too fast, too soon is the pos­si­ble neg­a­tive im­pacts on yields, bor­row­ing and spend­ing.

Rais­ing rates usu­ally has a pos­i­tive im­pact on yields and not the op­po­site. But what we are ex­pe­ri­enc­ing now is bond in­vestors not be­liev­ing the Fed can fol­low through with fur­ther rate in­creases this year.

In my opin­ion Janet Yellen and her team are try­ing to con­vince the mar­kets that in­fla­tion is around the cor­ner. By do­ing so the Fed en­cour­ages con­sumers to spend more and com­pa­nies to in­vest and lend more. If this ex­per­i­ment works then it will have a pos­i­tive im­pact on the econ­omy, but the ev­i­dence isn’t con­vinc­ing enough yet.

Was last month’s CPI just a one-off re­sult, with in­fla­tion set to keep ris­ing for the sec­ond half of the year? If so, it would be good news for the Fed, be­cause nor­mal­is­ing mone­tary pol­icy would give it more tools in case another re­ces­sion hits the econ­omy.

Food and en­ergy were the weak points, ac­cord­ing to the Bu­reau of La­bor Statis­tics.

If you take out the im­pact of en­ergy prices on CPI, all other sec­tors show ris­ing price trends. The in­dex ac­tu­ally rose 0.1 per cent once food and en­ergy were re­moved from the equa­tion. This sug­gests that as long as en­ergy prices stay sub­dued, US in­fla­tion is on a knife-edge.

As a safe-haven buy, gold rarely lies. In­vestors ap­pear wary of the sit­u­a­tion with US in­fla­tion. Bets are be­ing hedged and the next eco­nomic in­di­ca­tors are sharply in fo­cus.

This month’s NFP will need to be stronger than May’s 138,000 jobs added, which was lower than the ex­pected 174,000 jobs.

Other than the head­line NFP fig­ure, in­vestors are watch­ing wage growth for signs of strength or weak­ness.

If there are more signs of a soft­en­ing jobs mar­ket in ad­di­tion to lower in­fla­tion, the Fed may mod­er­ate its hawk­ish­ness.

In that case, re­duced ex­pec­ta­tions of more rate cuts might put pres­sure the dol­lar and sup­port the gold price un­til the end of the year.

In that sce­nario, bond yields would also re­main un­der pres­sure, and the hawks would face heav­ier head­winds.

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