US: CPI and retail sales data casts doubt on Fed rate hiking strategy - ING

US inflation and retail sales came in on the softer side of expectations, reinforcing the view in the market's mind that the Fed won't carry through with the four rate hikes they are currently forecasting before end 2018, according to James Knightley, Chief international Economist at ING.

Key Quotes

“US consumer price inflation for June has come in 0.0%MoM/1.6%YoY, a tenth lower than expected while the core rate, which strips out food and energy prices as also a little softer at 0.1%/1.7%. This means that the annual rate of headline inflation is at its lowest since October last year and will add to market doubts about the Fed’s rate hiking strategy. Retail sales were also poor, falling 0.2%MoM versus expectations of a 0.1% gain. However, we note that there was a two-tenths percentage point upward revision to May.”

“Within the CPI report we can see that energy was the main downward driver (-1.6%MoM) reflecting lower gasoline prices resulting from oil price falls. There was also a fourth consecutive monthly fall in apparel prices. Tobacco, transportation and recreation also fell.”

“In terms of what this means for Fed policy, Janet Yellen had been suggesting that inflation was subdued because of “transitory” factors. However, this week’s testimony added the caveat that given inflation has been consistently below target for much of this year, “there could be more going on there”. Financial markets took this as a signal that the Fed may be wavering on their forecast that interest rates will be hiked by 25bp on four occasions over the next 18 months and today’s figures are likely to intensify this debate.”

“The market is pricing in just one and a half hikes (40bp or so). We still look for three – one more this year along with a formal start to balance sheet reduction with two more hikes in 2018. Our reasoning is that inflation is likely be back above 2% in Q4 while GDP looks set to grow by around 3% in 2Q. With the Fed also citing “easier” financial conditions as a factor that could facilitate higher interest rates and “somewhat rich” asset prices they seem to be broadening out the factors that will help them justify action.”