Energy prices depress inflation – no surprise
In the previous article of this series, we established why inflation, or specifically, the PCE (personal consumption expenditures) price index has declined. Yet this decline in inflation, led by crude oil (USO) (OIH), hasn’t come as a surprise. Policymakers expected inflation to be pressured by falling energy prices. The question is where do policymakers see inflation headed from here on?
Consumer spending expected to help
Though low energy prices are expected to put downward pressure on inflation in the near term, the effect is expected to wear off in the medium term. One factor that is expected to help inflation rebound is consumer spending.
Even though consumer spending has remained low, contrary to expectations, policymakers are hopeful that sooner rather than later, consumers will come out to spend their windfall from the drop in gasoline prices.
Improvement in labor market could help as well
An improvement in the labor market is closely tied to a bump in consumer spending. More people with jobs automatically ensures higher spending. A widespread availability of jobs is likely to return consumers to their usual consumption pattern, which should lead to greater consumption of staple products. This would help companies like Proctor & Gamble (PG), Unilever (UN), and Colgate-Palmolive (CL).
A wider availability of jobs should also help workers negotiate higher wages. This would eventually lead to consumers buying more discretionary products, and would help auto companies such as Ford (F) and home improvement companies such as Lowe’s (LOW) and Home Depot (HD).
As you can see in the graph above, policymakers drastically reduced their 2015 inflation expectations in March compared to where they were in December 2014. Nevertheless, the picture is better for 2016. Inflation is yet to even return to a climb.
However, it’s early days in 2015. Remember that inflation doesn’t need to reach a 2% year-over-year rate for the Fed to take action. A return to a growth path should give policymakers enough confidence to raise the federal funds rate.
We touched on the labor market earlier in this article. Let’s look at the policymakers’ take on it in the next part of our series.