Streetwise for Sunday, March 24, 2019
The Federal Reserve continues to indicate an expectation of and tolerance for an over shoot their 2 percent inflation goal. So, what happens if inflation moves down instead of up? Suddenly, the game plan becomes a bit ambiguous.
Core inflation, excluding energy and food prices, is currently just shy of the Fed’s 2 percent target and could potentially remain at that level. In addition, inflation expectations, a key influence, have been on the low side.
If a movement towards higher inflation does not materialize, it could put the Fed’s credibility in question. Recognizing a possible error in their projections, interest-rate increases have been put on hold, due to both muted price pressures as well as looming global risks. And that pause is likely to continue until the inflation picture become clearer.
The stakes are high. The Fed has not seen 2 percent inflation on a sustained basis since formally adopting that number in 2012. Officials had been hopeful that this would be the year in which that objective is achieved.
Specifically, the Fed expected a 2 percent core inflation rate by the fourth quarter, per their last set of economic forecasts published in December. They also saw unemployment falling to 3.5 percent. Together with above-trend output growth, that laid the groundwork for a projection of two rate increases this year.
However, there is a rising probability that price gains will come in below 2 percent in 2019, making it less likely that the Fed will achieve its inflation goal on a sustained basis this economic cycle.
The median estimate in a Bloomberg survey showed core inflation coming in at 1.9 percent for the year, and estimates range as low as 1.6 percent. And the consensus, as surveyed by Bloomberg, favors one rate increase this year, in September, at which point the tightening cycle will have peaked.
Inflation expectations, which the Fed views and studies have shown to be a strong determinant of future price increases, remain muted. In fact, expectations of higher inflation declined in a survey conducted by the New York Fed and tied a record-low in the University of Michigan survey in February. Expectations did regain some ground in preliminary March data.
Despite the recent economic news not being particularly upbeat, the Fed will likely continue to stress patience and not sound overly pessimistic in their assessment of the economy.
Nonetheless, according to the Federal Reserve Bank of Atlanta’s GDPNow tracking forecast, the economy will expand at just a 0.4 percent annual rate in the three months through March.
In addition, industrial production for February increased 0.1 percent, falling behind the consensus estimate of 0.4 percent. Capacity utilization for February was 78.2 percent, as compared to a consensus estimate of 78.5 percent.
The New York Fed’s Empire State index declined to 3.7 in March from 8.8 in February. This marked a near two-year low. The Labor Department reported that job openings in the United States hit 7.58 million in January, its third-highest level ever recorded.
However, the University of Michigan reported that its consumer sentiment index rose to 97.8 in March from 93.8 in February, meaning the window of opportunity for the Fed to shift the tone of its outlook is minimal at best.
Should the economy should weaken sharply, the logical answer is to cut rates. And the financial markets are already pricing in future easing as both industrial production and housing data continue to weaken.
Yes, the uncertainty over the direction and health of the economy will reign supreme in the months ahead, resulting in bargains as earnings are scrutinized with the inescapable consequences of less than stellar earnings forecasts.
Therefore, as we begin the second quarter you want to be able to invest in those companies that show up on your radar screen as bargains despite Wall Street’s animosities.
Unfortunately, many investors have moved to the sidelines, convinced that the future could hold a replay of the Great Recession. Yet, there is no evidence of such a possibility.
Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com. Phone calls accepted between 9 AM and 3 PM at (941) 706-3449. For back columns please go to www.RuddReport.com.