So, today the Fed passed on hiking rates in March. But more important, the Fed also published its new quarterly Summary of Economic Projections (SEP). The median projection of the FOMC for the year-end Fed Funds rate was lowered by 50 basis points, in effect saying there will be only two rate hikes this year, not the four they had suggested in the last SEP released in
December. Short-term rates, in other words, will remain below 1% for the rest of the year. The news was greeted by some (like me) as a total capitulation by the central bank to the more dovish views held by traders in the financial markets and adds fuel to the fire for the growing narrative that central banks have lost control and are letting markets dictate monetary policy.
To be sure, there has been plenty of turmoil around the world and early year weakness in the financial markets for the Fed to cite. But the central bank’s dual mandate calls for maximizing full employment while also maintaining a stable general price level. Arguably, huge progress has already been made on the employment mandate with unemployment now down to 4.9%. And, until recently, fears about a sliding general price level or deflation were worth considering in the conduct of policy. But recent data, to which the FOMC seems to have turned a blind eye, suggests the Fed’s efforts to avoid deflation are rapidly turning into allowing inflation to surge.
Most notable in that regard was the SEP new median projection on the core PCE deflator for year-end 2016. At 1.6%, it was the same as the projection from last December… extraordinary, given that the January core PCE deflator has already reached 1.7%. This means the Committee members must be expecting their preferred inflation measure to go sideways-to-down over the balance of the year. Maybe the Fed knows something we don’t know -- like when the February number comes out, it will indeed drop back. This morning, however, the CPI for February came out, and it was pretty interesting in light of the Fed's decision to sit on raising rates!
As shown above, "Core CPI" has hit a cycle high of 2.3%. But, what really stands out as the striking number is the "services" component which accounts for 75% of the core index. That just hit 3.1%, the highest since September '08! Such numbers would be ringing the inflation alarm bells were they not being masked by the debacle in commodity markets. But as “goods” prices begin to rebound, watch out! We all know what oil has already done. Indeed, check the green line. Looks like the first time in four years that core goods inflation has broken through 0%. Increasingly, it looks to us as if before long, the Fed will be playing catch-up to surging reported inflation numbers. That will have big implications on a number of investment themes we've been writing and talking about.
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