US CPI underwhelms
The US CPI (consumer price index) for August rose 0.2% sequentially compared to the 0.3% growth that was expected by economists. In the 12 months through the end of August, the CPI rose 2.7%, lower than July’s 2.9% rise.
The core CPI, which excludes the volatile food and energy components, rose 2.2% in the 12 months through August, also lower than July’s 2.4% rise. Most of August’s gains in gasoline (USO) and rent were offset by falls in healthcare and apparel costs.
Markets focus on inflation figures
The markets have placed huge importance on inflation figures in 2018, as inflation has been one of the most important deciding factors related to the Fed’s future interest rate path. Investors may recall that after the average hourly earnings rose the most since the recession in January (though this was later revised downward), the US stock markets fell due to the expectations of more aggressive rate hikes by the Fed.
Due to lower-than-expected inflation in August, US equity indexes have been trading higher. As of 10:10 AM EDT on September 13, the S&P 500 Index (SPY), the Dow Jones Industrial Average (DIA), and the NASDAQ Composite Index (QQQ) are trading at rises of 0.63%, 0.69%, and 1.1%, respectively.
Gold (GLD), which is very sensitive to interest rates, has also risen 0.40%. The Invesco DB Dollar Bullish ETF (UUP), on the other hand, is trading at a fall of 0.34%. A weaker dollar also boosts gold prices, as gold is denominated in US dollars.
Inflation, interest rates and gold
The Fed has raised rates twice this year, and the market is expecting two more hikes in the remainder of the year. It’s widely expected to increase rates by 25 basis points at its September 25–26 policy meeting. The Fed’s preferred gauge of inflation is the core PCE (personal consumption expenditure) index, which rose 2.0% in July.
The latest inflation figures should keep the Fed steady on its path of gradual interest rate hikes but should not encourage it to be very aggressive. The impact of inflation on gold could be twofold. On the one hand, higher inflation is positive for gold (IAU) as investors rush to it as an inflation hedge. On the other hand, if inflation keeps overshooting expectations, the Fed may have to raise rates more aggressively to keep the economy from overheating, which would be detrimental to gold’s (GLD) investment appeal.