Wednesday, September 16, 2015

There's no inflation excuse for postponing a rate hike

If the FOMC tomorrow decides to postpone raising short-term interest rates, it won't be because inflation is "too low."

The chart above shows the year over year change in the total Consumer Price Index and in the Core version of same (i.e., ex-food & energy). The total is up only 0.2% in the 12 months ended August, and that indeed is a pretty low number. But the reason it's low is almost entirely due to the big collapse in oil prices over the past year: crude oil is down by more than 50%. If we exclude food and energy, the Core CPI is up 1.83% in the past year. When there are big swings in energy prices, the Fed shouldn't be concerned, since controlling oil prices is not part of its mandate. These days, the Fed should be focusing almost exclusively on ex-energy measures of inflation.

So here it is. The chart above shows the level of the CPI ex-energy on a semi-log scale. From this perspective, inflation today is only a hair below the 2% per year it's averaged over the past 12-13 years. If anything in this chart stands out, it is the quickening of inflation in the 2006-2008 period.

And if we look at annualized changes in the total and core versions of the CPI over rolling six-month periods, as the chart above does, then we see that inflation is actually more than 2%: the CPI is up 2.35%, while the Core is up 2.05%. I haven't shown it on this chart, but the 6-mo. annualized rate of the CPI ex-energy is 1.88%. By these measures, the Fed should already be raising rates.


Unknown said...

The indecisiveness of the Fed has been mimicked by the flat-lining of SPY since Nov 2014. Sometimes sitting on your hands is accretive, sometimes it's just sitting on your hands. If they don't hike, and breadth continues to show weakness (as it necessarily should with six years of resiliency), they will have less dry powder for what is a healthy corrective phase within a long term cycle. I am a fan of creative destruction myself, but a lot of people don't like that.

Benjamin Cole said...

Scott Grannis: what is the 5-year outlook for inflation, given the TIPS market?

Scott Grannis said...

Re: 5-yr inflation expectations. The bond market currently is priced to the expectation that the CPI will rise by an annualized rate of 1.25% per year for the next 5 years.

Hans said...
This comment has been removed by the author.
Hans said...

Yes, there is no reason not to exit FedZero..They are not risk
takers, enveloped in uncertainty and fearful of being wrong.

The cost of interest, was $420 billion (2014) and would only increase
the cost of operating the federal government unit..

Operating cost would also increase as well. Why pass on this nearly one
decade of free money.

The growth outlook for GNP growth is also very tepid, which means
neither the FRB nor their overseers will be able to "grow" themselves
out of the crisis.

The national debt will continue to climb, along with debt payments
and annual deficits.

America's economic future is not bright.

BTW, a BIG thank you to Mr Grannis for changing the CAPTCHA!