Why the Fed’s Inflation Targets Finally Look Reasonable and Present

Source: Thinkstock

The week of November 13 to 17 may not quite be a barn-burning week for major economic releases that can move the markets, but investors, economists and consumers are going to get to see the semi-live inflation readings. The Department Labor is set to release its Producer Price Index on Tuesday and will then release the Consumer Price Index on Wednesday.

What matters to the public is that inflation has by and large remained under the elusive 2.0% to 2.5% target range of the Federal Reserve. If inflation gets up to that range and is sustainable, then Janet Yellen and the Fed’s FOMC members will have more cover for interest rate hikes in 2018.

Bloomberg is calling for October’s producer prices (PPI) to be up 0.1% on the all-index reading and is calling for a 0.2% gain on the core ex-food and energy reading. Those are the month-over month readings, and would be versus gains of 0.4% in headline PPI and 0.4% on the core PPI readings from September.

On the annualized PPI readings, September’s headline PPI was 2.6% higher than in September of 2016. The annualized core (ex-food and energy) PPI reading was up 2.2% in September. These annualized numbers are actually the ones that the FOMC uses to determine inflation, and stronger producer prices equate to wholesale inflation — and sustained wholesale inflation eventually works its way down to higher consumer inflation.

When the consumer prices (CPI) are released on Wednesday morning, Bloomberg’s consensus estimates for October are 0.1% on headline CPI and up 0.2% on the core (ex-food and energy) reading. That would be under the 0.5% headline gain but just above the core gain of 0.1% seen in September.

The annualized CPI readings, also which are used as the annual inflation readings, will matter more in the grand scheme of things than the monthly gains. Bloomberg’s consensus estimates are 2.0% on the annualized CPI reading for October, slighly under the 2.2% annualized reading released in September. The core annualized gain is expected to be 1.7% for October, the same as the annualized 1.7% gain seen in Septmebr if you back out food and energy.

The Fed’s 2.0% to 2.5% range has been elusive, but the reality is that prices have started to get closer to those levels of late. This should give the Federal Reserve cover for more rate hikes ahead if that level is achieved and sustainable. Then couple the stronger prices with the stronger 3.0% reading for gross domestic product (GDP) and the stronger payrolls and unemployment. Maybe the markets will yet again start to believe that 2.0% to 2.5% inflation is sustainable again.

It’s easy to expect, it’s harder to accept that the readings are sustainable. We all have to remember that most attempts to see inflation remain at or above the 2.0% threshold have been followed by real disappointment for quite some time.

Unless there are some very nasty surprises, most traders and investors are still calling for the FOMC to raise interest rates at the December FOMC meeting. Fed funds have been stuck in a 1.00% to 1.25% target range since the last interest rate hike back in June of this year.

The CME FedWatch Tool currently shows a 91.5% chance for fed funds to go to a 1.25% to 1.50% target range at the December 13, 2017 FOMC meeting. That same FedWatch Tool is not looking for a ‘highly likely’ rate hike probability to get fed funds to a target range of 1.50% to 1.75% until May or even June of 2018.

Inflation probably sounds bad to most of us, particularly why they would want to see prices rise 2% or more each year. After all, don’t higher prices erode purchasing power? Still, the markets had to deal with the serious deflationary threat (where prices would keep sinking) during and after the great recession. Most of us do not know what true deflation looks like, but the most common answer you will find now in describing deflation is simple enough — “You might not know what real deflation looks like, but you won’t like it one bit once you actually see it.”