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Expect the Fed Not to Budge: Inflation is a Headwind


Surveys suggest the Fed to remove “considerable time” from their language. So what?

Christopher-LemieuxSMBullion.Directory precious metals analysis 17 December, 2014
By Christopher Lemieux
Senior FX and Commodities Analyst at FX Analytics

As risk bids on the assumption the Federal Reserve will raise interest rates sooner than later, expect the FOMC minutes report to show little diversion from the committee’s current path.

Nearly 60 percent of economists surveyed by Bloomberg News expected that the term “considerable time” would be removed from the FOMC minutes report. The reliance on the Fed’s guidance has gone so out of control, we now have surveys on what words may or may not be within the FOMC statement.

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Here is the lowdown: the Fed will not be raising rates. Why? Disinflation. The Federal Reserve has had trouble, even after printing trillions, to boost inflation up to their coveted two percent target. The stubbornly high US dollar is dis-inflationary, and it is capping inflation expectations (which have now plummeted to 2008-lows). And, a hike in the Fed funds rate will add fuel to the dollar fire. Higher interest rates strengthen currencies. It will make the dollar more “attractive,” and that is counterproductive to the Fed’s policy.

Consumer prices fell in November, largely to the collapse of oil prices and the demand for gas. Year-over-year consumer prices fell to 1.3 percent from 1.7 percent in October, missing the 1.4 percent expectation from economists. The core consumer price index (CPI), ex-food and energy, declined from 1.8 percent to 1.7 percent. Although consumer prices fell only a tenth percent, it represents the sticky nature of prices and the inability of the Fed to generate inflation. Expect broader inflation to remain low, as demand for energy is still low. Gas inventories showed, today, a surplus of 5.5 million barrels. Even as the rapid deterioration of gas prices started a few months ago, the national average of regular at $2.51 per gallon cannot force Americans to travel, and, in turn, spend.

Worse yet, the month-over-month CPI print contracted .3 percent. Yes, officially that is deflation. It is also the largest deflationary print since December 2008.

Game plan for the Fed: a weaker dollar. The Fed will actively intervene and weaken the dollar. It really has no other choice if it wants to see higher inflation because the Fed loves when Americans are charged more for the same level of goods and services because that’s “growth.”

We have seen inflation rise in countries with weakening currencies, whether done so by central bank policy or not. Japan was seen a rapid increase in inflation; and the recent trap-door selling in the Russian ruble has cause inflation to spike and merchants to quickly raise prices. And inflation has caused economical havoc.

Sooner or later, the Fed will have to join the currency war vis-a-vie more quantitative easing. When push comes to shove, the Fed will likely stay closed to raising interest rates.

The economy is not much to cheer about, and recent gas prices will not be a driving force for more consumption (as I have wrote about here). There is no substantial data to suggest this idea. Normura’s Bob Janjuah believes QE 4 is around the corner because the whole economic dream of expansion is highly dependent on the consumer. “There will need to be US consumption growth of 4 to 5 percent is this bullish outcome is going to play out. This will require the US consumer loading up on debt again,” said Janjuah. Neither him nor I believe that will happen.

He also foresees the US 10-year yield to hit 1.75 percent and the idea that lower oil prices is a huge tax cut for consumers is “simplistic.”

I expect considerable time before “considerable time” is removed. Even if it were, I believe in action. Otherwise, words mean nothing.

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