One interpretation of this is that inflation expectations are being overly influenced by a supply-driven correction in oil. However, it’s also worth highlighting that the drop in oil (BNO) prices has occurred coincident to a broader correction in commodities (DBC), itself a function of a slowdown in global growth. Apart from concerns over the global economy, other factors are also driving down inflation expectations: Evidence of wage growth has been elusive, and low capacity utilization rates suggest few factory bottlenecks to push up prices.
Market Realist – Why are we likely to see muted inflation pressures?
As you can see in the graph above, capacity utilization has been declining this year. Capacity utilization stood at 79% in December 2014 compared to the current level of 77.6%. Factory production fell by 0.5% in August, which is the highest decline since January 2014. Tepid demand from abroad, elevated inventories in the US, and an appreciating dollar (UUP) signal muted order growth.
The US manufacturing sector (XLI) (DIA) just about stayed in the positive for September. The ISM manufacturing PMI (purchasing managers’ index) came in at 50.2 for September. While it remained above the 50 mark, which suggests expansion, growth in the sector has been declining as the second graph shows. The index stood at a solid 57.5 in October 2014. Meanwhile, the backlog of orders index has slumped to 41, which suggests that a further slowdown in the sector is likely. Weak manufacturing is only going to keep inflation low.
Meanwhile, one of the main drivers of inflation, wage growth, remains weak. This has led to muted consumption. Also, consumers have used the savings at the pump to repair their balance sheets and to save more, instead of spending more.