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US Inflation Stages Surprising Comeback

Karl Schamotta January 12, 2018

American consumer prices accelerated last month, with shelter and healthcare costs driving a sharper-than-expected gain in the underlying inflation rate – providing additional justification for Federal Reserve hikes in the year ahead. Numbers released by the Bureau of Labor Statistics this morning show a 0.3 percent gain in the less-volatile core consumer price index for December, following a 0.1 percent increase in November. The fastest increase since January is helping to offset concerns that had risen around yesterday’s weaker-than-expected producer price report, helping to put a floor under the dollar on foreign exchange markets.

Inclusive of food and energy costs, prices rose 0.1 percent after posting a 0.4 percent increase in November – with falling gasoline prices limiting the year-on-year increase to 2.1 percent, versus 2.2 percent in the prior month.

Separately, the Census Bureau reported a fourth consecutive increase in retail sales, with a 0.4 percent month-over-month gain narrowly missing expectations that had coalesced around 0.5 percent. November’s number was revised upward, from 0.8 to 0.9 percent, providing further evidence that low unemployment, steady wage increases, and rising confidence levels are intersecting to send consumers on a spending spree unequaled since just before the global financial crisis struck in 2008.

Across the Atlantic, the euro is trading near a three-year high on a trade-weighted basis, rising further after German Chancellor Angela Merkel struck a deal with her Social Democratic rivals to open talks on forming a “grand coalition”. This potentially resolves uncertainty that has constrained Europe’s economic engine since September – but yesterday’s European Central Bank meeting minutes remain the primary driver behind the currency’s ascent.

With economic confidence rocketing higher, and political tensions at a low ebb, investors are increasingly convinced that the euro area’s monetary stimulus programme will come to an end this year. An adjustment in forward guidance is expected to come at the April meeting, with asset purchases winding down in the autumn, and deposit rates rising around the December decision date. The common currency has now clawed back half of its crisis-era losses, but by depressing inflation rates, sustained exchange rate strength could impose self-reinforcing limits on its advance.

Bottom Line: Taken in combination, today’s data releases serve to confirm a growing conviction that the Federal Reserve is on track to hike rates three times in 2018 – bringing market expectations into closer alignment with forecasts issued by policymakers themselves over the past year. Two-year Treasury yields have popped above the 2-percent mark for the first time since 2008 in response, and the dollar looks set to retrace some of its losses as we head into the weekend – but incentives to buy the currencies of countries which export to American consumers remain intact – gains could be limited as funds are redeployed over the coming week.

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