US Outlook Report: Disinflation – What Do the Tea Leaves Say?
Last week we lowered our consumer price inflation forecast for 2015 by a half a percentage point to 1.2 percent. A strengthening U.S. dollar combined with large declines in oil and other commodity prices are expected to add to deflationary pressures in the months ahead. Over the last two week’s we have received a fresh batch of producer price index (PPI) and consumer price index (CPI) prices for September, so we thought now would be a good time to review in more detail what the latest tea leaves are saying about the direction of future U.S. prices.
First let’s turn to the dollar. The U.S. dollar has appreciated 8.4 percent against the Euro over the past six months and has appreciated 6.0 percent against a broader cross-section of our major trading partners. This will put more downward pressure on U.S. import prices and will hurt domestic producers’ ability to pass along price increases as well, as foreign price competition intensifies. Import prices fell 0.5 percent in September and are already down 0.9 percent from a year ago.
The producer price readings for September weren’t any more encouraging. The year-on-year increase for both core and headline PPI slipped to just 1.6 percent – two tenths lower than the month before and further away from the Fed’s goal on inflation. The crude goods PPI, often a leading indicator of the future direction of intermediate and finished goods producer prices, has been contracting now year-on-year over the past two months.
For now consumer inflation remains steady. The consumer price index and Core-CPI (excluding food and energy) both increased a modest 0.1 percent in September and 1.7 percent from a year ago. This is still well below the Fed’s target of 2.0 percent plus for this indicator. Moreover, market based inflation expectations appear to be forecasting far slower inflation in the near-future. Disinflation, or the slowing of price increases, at the consumer level is more likely to keep Fed rate hikes at bay until Q3 2015.
Bond investors appear to agree that disinflation is in our near future. Market based inflation expectations including the 5-year TIPS spread, the difference between the 5-year U.S. Treasury yield and 5-year Treasury Inflation Protected Securities- a measure of inflation expectations over the next five years, sank to 1.4 percent its lowest level since October 2010.
Clearly, deflationary pressures are building in the U.S. despite on-going monetary accommodation. With that said, the current deflation scare is not even close to the deflation-scare in November 2008. At the very least over the near-term, the Fed will need to be more vigilant against falling prices than they are against rising prices.
To find out more, check out this week’s US Outlook Report.
Tags: economy