US futures are pointing to the downside ahead of the final session of the week. The latest US CPI reading is going to be a key focal point today, with the prospect of falling inflation clearly being behind the Fed’s unease when it comes to the first rate hike.
While Yellen may have suggested at previous press conferences that they want to see more improvement in the economic data before hiking rates, I think it’s quite clear that there remains only one barrier to higher rates and that’s the inflation outlook. The US is at full employment by the Fed’s own definition and wage growth is good and likely to improve as slack in the economy continues to ease.
There are, however, a couple of things that could weigh on inflation in the coming months and I think this is what the Fed is waiting on. Oil prices are only a temporary factor and only have a large impact on the inflation figures but there is a small threat that the direct impact on consumer goods could lead to lower inflation expectations, which would be dangerous. Imported deflation as a result of loosening monetary policy in the eurozone, China and Japan is another risk for the US, especially with the country being such a large importer of consumer goods.
If the Fed sees no impact of these on the inflation readings and, better yet, improving wage growth which suggests no risk of lower business inflation expectations, I think they will hike rates in September. The last thing the Fed wants is external factors driving down the inflation rate at a time when they’re hiking rates which naturally adds downside pressures.
It’s worth noting that the CPI figure is not the Fed’s preferred measure of inflation, but with that coming in a couple of weeks, it is the earliest indication we have of what that will be. This is why we can often see more of a market reaction to the CPI reading that the core personal consumption expenditure price index even though people know that the Fed’s tracks the latter more closely.
The S&P is expected to open 14 points lower, the Dow 152 points lower and the Nasdaq 46 points lower.
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