On a number of occasions, including three weeks ago, Federal Reserve Chair Janet Yellen and her colleagues at the Fed have made it clear that in order to begin to normalize interest rates, U.S. inflation readings must, at the very least, not decline. Today’s data on March consumer prices, which for a third month posted an above-trend 0.2% gain in core prices (all consumer prices minus food and energy), meet this simple criteria. Here’s how the Fed chief put it in her March 27th speech (emphases ours):
“I have argued that a pickup in neither wage nor price inflation is indispensable for me to achieve reasonable confidence that inflation will move back to 2 percent over time. That said, I would be uncomfortable raising the federal funds rate if readings on wage growth, core consumer prices, and other indicators of underlying inflation pressures were to weaken, if market-based measures of inflation compensation were to fall appreciably further, or if survey-based measures were to begin to decline noticeably.”
Of course it will take more than a cessation of declines for the Fed to be “reasonably confident” that inflation will move back toward its 2% target, in particular evidence of a rebound in U.S. economic growth from the first quarter’s weakness and a recovery in jobs data following a disappointing set of data in March. Nevertheless, high-frequency data point toward a rebound, including weekly data on jobless claims, chain store sales, mortgage applications, bank lending and port traffic. If these data are corroborated by monthly economic reports, conditions set by the Fed for the initiation of its first rate hike will be met.
We suggest investors stay focused on the entirety of the Fed’s path on rates rather than the initial date of the first hike. We continue to expect a slow and shallow path.