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.
“Last Friday’s data was somewhat mixed with US consumer price inflation and retail sales coming in softer than anticipated while industrial production and consumer confidence continued to point to strength.”
“CPI for June came in at 0.0% MoM/1.6% YoY, a tenth lower than expected while the core rate, which strips out food and energy prices, was 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 added 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.”
“Meanwhile, US industrial production rose 0.4% MoM in June, a touch stronger than the 0.3% consensus, while May’s growth rate was revised up to 0.1% from flat. Within the details of the report manufacturing rose 0.2% MoM, utilities output was flat while mining output rose 1.6%.”
“Oil and gas well drilling was the strongest component, rising 6.8% MoM (and is up 108.2% in the past twelve months). This highlights how much more efficient US production has become – growing at such a strong rate despite relatively subdued energy prices. It also underlines the challenge for OPEC’s supply cut efforts to get the oil price higher.”
“With the ISM manufacturing index showing very strong order books and working hours in the sector continuing to rise we believe manufacturing output will continue to strengthen, helping to push US GDP growth rates higher after 1Q’s disappointing outcome.”
“In terms of what this all means for Fed policy the market remains focused on inflation over and above everything else. In this regard, Fed Chair Janet Yellen had been suggesting that inflation was subdued because of “transitory” factors. However, last 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 last Friday’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 to be back above 2% in 4Q 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.”
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