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US Core Inflation Misses Forecasts

Karl Schamotta August 11, 2017

Inflation rose more slowly than expected in July, according to the US Bureau of Labor Statistics monthly consumer price index, marking a fifth month in stagnant territory. The official gauge for consumer-price changes hit 0.1 percent last month, missing expectations for a 0.2 percent print, while rising 1.7 percent on an annualized basis. Food prices rose 0.2 percent and energy fell 0.1 percent from the previous month, reflecting a 2.3 percent decline in natural gas. Excluding these more-volatile food and energy costs, the core inflation index rose by 0.1 percent, bringing gains to 1.7 percent in year-over-year terms.

Taken in combination with yesterday’s weaker-than-forecast producer price report, it is clear there is no need for imminent policy tightening. The Federal Reserve looks increasingly likely to change course on conducting another interest rate hike before year-end – but market-implied interest rates show that investors have priced in just a single hike over the coming 18 months, suggesting that there is significant room for correction if inflation surprises to the upside in the early autumn.

Amidst simmering tensions between the United States and North Korea, risk aversion remains a dominant force in markets, with further threats from President Trump triggering a 45-percent surge in the VIX equity “fear index” yesterday. Against this Strangelovian geopolitical backdrop, the dollar remains on the defensive, having rather remarkably abrogated its historical safe-haven role as investors park funds in gold and in countries with large net international investment positions (like Japan and Switzerland) instead. The Aussie, Kiwi and Canadian dollars have come under countervailing pressure at the same time, falling on a trade-weighted basis over the past few days – but investors are likely to begin unwinding this fear-driven trade at some point, suggesting that speculative positioning could shift sharply over the coming days.

Bottom Line: F. Scott Fitzgerald said, “The test of a first-rate intelligence is the ability to hold two opposed ideas in the mind at the same time, and still retain the ability to function”. Markets are currently functioning comfortably within a contradiction – but at some point soon, falling jobless numbers and low inflation rates will come into conflict with one another. It may seem a remote possibility now, but further strength in the employment market could contribute to a modest rise in inflationary pressures before the end of the year – and we look forward to the IQ test.

Karl Schamotta

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