Fed’s Musalem: Rate hikes loom if disinflation stalls
The St. Louis Federal Reserve (Fed) President, Alberto Musalem, crossed the wires on Thursday, and said that rate hikes may be needed if inflation doesn’t ease, at a Central Bank of Iceland and Northwestern University economic conference in Reykjavik.
Musalem said that “If we don’t see disinflation in the next one or two quarters, that would concern me,” as he acknowledged that the balance of risks of the Fed’s dual mandate has tilted more towards the inflation side than the labor market side.
Key highlights:
BASELINE OUTLOOK IS THAT INFLATION WILL TAKE LONGER TO COME BACK DOWN TO TARGET
SEE RISKS THAT INFLATION MAY NOT CONVERGE TO TARGET AS WE WOULD LIKE
THERE IS A SCENARIO WHERE ECONOMY MIGHT REQUIRE A RATE INCREASE
IF WE DON'T SEE DISINFLATION IN NEXT 1-2 QUARTERS THAT WOULD CONCERN ME
HIGHER INFLATION EXPECTATIONS WOULD ALSO CONCERN ME
THERE IS ALSO A SCENARIO THAT IN 2H OF YEAR WE COULD SEE GROWTH SLOWDOWN
IF THAT WERE TO HAPPEN AND INFLATION FALLS, COULD ENVISION RATE CUT
RIGHT NOW RISKS TILTED MORE TO INFLATION SIDE
Inflation FAQs
Inflation measures the rise in the price of a representative basket of goods and services. Headline inflation is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core inflation excludes more volatile elements such as food and fuel which can fluctuate because of geopolitical and seasonal factors. Core inflation is the figure economists focus on and is the level targeted by central banks, which are mandated to keep inflation at a manageable level, usually around 2%.
The Consumer Price Index (CPI) measures the change in prices of a basket of goods and services over a period of time. It is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core CPI is the figure targeted by central banks as it excludes volatile food and fuel inputs. When Core CPI rises above 2% it usually results in higher interest rates and vice versa when it falls below 2%. Since higher interest rates are positive for a currency, higher inflation usually results in a stronger currency. The opposite is true when inflation falls.
Although it may seem counter-intuitive, high inflation in a country pushes up the value of its currency and vice versa for lower inflation. This is because the central bank will normally raise interest rates to combat the higher inflation, which attract more global capital inflows from investors looking for a lucrative place to park their money.
Formerly, Gold was the asset investors turned to in times of high inflation because it preserved its value, and whilst investors will often still buy Gold for its safe-haven properties in times of extreme market turmoil, this is not the case most of the time. This is because when inflation is high, central banks will put up interest rates to combat it. Higher interest rates are negative for Gold because they increase the opportunity-cost of holding Gold vis-a-vis an interest-bearing asset or placing the money in a cash deposit account. On the flipside, lower inflation tends to be positive for Gold as it brings interest rates down, making the bright metal a more viable investment alternative.
Author
Christian Borjon Valencia
FXStreet
Markets analyst, news editor, and trading instructor with over 14 years of experience across FX, commodities, US equity indices, and global macro markets.
