3. Inflation remains subdued.
The Fed has significant latitude to take its time. Most measures of inflation are closer to 1% rather than the Fed’s long-term target of 2%. If anything, over the next year, deflation is probably a greater threat than inflation.
Market Realist – Low inflation could mean interest rates also could remain low for a while.
The graph above shows year-over-year inflation rates based on the CPI (Consumer Price Index), the core CPI, and the PCE (Personal Consumption Expenditures) for the last 10 years. The core CPI excludes items like food and energy (XLE), which tend to be volatile.
The latest figures show that inflation has dipped. According to the CPI, the inflation rate is 1.3% compared to 1.2% based on PCE. However, according to the core CPI, inflation is 1.7%. This is mainly because oil (USO) prices have dipped considerably. Since the core CPI excludes oil prices, core inflation has remained constant, unlike CPI and PCE, which include oil.
The Fed usually hikes interest rates to control the inflation rate. Currently, the inflation rate is low due to a number of factors. However, it could continue to stay low because crude oil prices have fallen dramatically.
The graph shows that inflation remains subdued by all measures. Since inflation is way below the Fed’s long-term target, the Fed can afford to keep interest rates lower for a little longer.
Low interest rates boost consumption and business investment. Currently, the Fed Funds rate is close to zero. This has been the case since 2008. Low interest rates discourage individuals from saving.