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Indicators Point to Firming in Inflationary Conditions

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Falling oil prices and the strong U.S. dollar have dampened headline consumer price index (or CPI) inflation, but the recent core CPI print suggests a clear firming in inflationary conditions. In addition, 10-year U.S. inflation expectations are now at the highest level since October, though still below last year’s level.

To be sure, the Fed’s preferred core inflation gauge—personal consumption expenditures (or PCE)—stood at just 1.4% in March. This is well below the central bank’s 2% target. However, the Fed has said it doesn’t expect to see inflation hit its target before raising rates. The effects of an aging population and rapid technological innovation are suppressing inflation and nominal growth, and goods prices have been stagnant over the past five years, dragging overall inflation lower.

firming in inflationary conditions

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Market Realist:

As you can see in the above graph, the Consumer Price Index has taken a beating over the last year from a surging US dollar (UUP) and plummeting oil prices (USO) (BNO). However, the core Consumer Price Index, which excludes volatile items like food and energy (XLE) prices, shows some firming in inflationary conditions. The Core CPI has been ticking upward for the last three consecutive months and stood at 1.75% (percent change from a year ago) in March 2015.

firming in inflationary conditions

Inflationary expectations have also been rising over the past month and are currently at their highest since October 2014. According to EPFR Global, US inflation-protected bond funds (TIP) saw inflows of $1.4 billion in the first three weeks of April 2015—more than the previous three months of daily flows combined.

The rise in inflationary expectations has hiked interest in precious metals like gold (GLD) (IAU) and silver (SLV), leading to outflows from US Treasuries (TLT) (IEF).

firming in inflationary conditions

The previous graph shows how inflation has been running below the Fed’s target over the past few years. The Federal Reserve uses the Personal Consumption Expenditure price index for its inflation estimates. As described above, the Fed aims to hike rates even if the inflation target of 2% is not achieved. So, inflationary trends are not likely to derail the Fed’s rate hike timeline.

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