An unsuspecting Federal Reserve meets this week. For the better part of last year, our central bankers completely missed predicting the slowdown in the U.S. economy. Once again, our central bankers are falling prey to complacency. Inflation is accelerating and should peak in the first quarter of 2017.
Investors should be weary. If the Fed falls behind on the inflation front, interest rates could rise a lot faster than is currently expected.
This Week's Fed Meeting: Falling Behind on Inflation
#Fed #Yellen #Inflation
On Tuesday, the Fed kicks off its first meeting since raising interest rates in December. For some time now, Fed chair Janet Yellen and others have been confounded by inflation that's remained below the central bank's 2% target. Here's an excerpt from the Fed's statement last month:
"In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run."
The Consumer Price Index (CPI) attempts to measure monthly changes in prices. Price stability is closely watched by the Federal Reserve, since falling prices are viewed as a negative for economic growth. Economic theory suggests that Americans save more and consume less when prices fall because they can expect to buy goods tomorrow at a relatively cheaper price. Inflation that's not-too-hot, therefore, is viewed as positive for the economy.
The Fed will meet eight times in 2017 and currently expects three rates hikes for the year. If inflation heats up as we expect, more than three increases could be in the offing.
The Fed gets what they've wished for.
#CPI #RateHike
Inflationary data has finally picked up. Two weeks ago, CPI hit a year-over-year rate of 2.1% for the month of December, up from 1.7% in the prior month. This effectively ended 30 straight months of inflation readings that were stubbornly below the Fed’s 2% target.
This is only the beginning. After a protracted slowdown, commodities like oil, gas, and copper are headed higher once again. As you can see in the Chart of the Day below, our proprietary leading indicator suggests this could cause year-over-year inflation to hit three, even four, percent in the first quarter of 2017.
This would shock Yellen & Co. An inflation rate at or above 4% hasn't been seen since September of 2008.
Bottom Line
If we're right, the Fed will likely raise rates a lot faster than the market currently expects. As inflation data gets a boost along with U.S. growth accelerating, that's positive for sectors like Financials (XLF) and Oil & Gas Exploration and Production ETF (XOP).
