Is the Fed being too complacent about longer-term inflation risks?

By David Absolon, Investment Director at Heartwood Investment Management

There were no surprises when the Federal Reserve announced that it was keeping interest rates on hold following its March policy meeting.

What has surprised markets, though, is the Fed’s more dovish assessment of economic and financial conditions, which was manifested in a meaningful downward revision to policymakers’ median projection of interest rate increases for this year from four to two.

And yet, this assessment comes at a time when, ironically, there appears to be an upward shift in US inflation.

Supportive conditions for US consumers

While disinflationary energy effects continue to contain US headline inflation, core inflation has been drifting higher over recent months, with the latest reading at 2.3% year-on-year in February.

Admittedly, base effects are contributing to stronger numbers on an annualised basis, but nevertheless a number of factors are coming together which potentially create the conditions for stronger consumer spending and, ultimately, inflation.

It is worth noting that the buying power of the US dollar has remained unchanged over the past two years, according to the Bureau of Labour Statistics.

In effect, the cost of living in the US has remained static between 2014 and 2016, despite an environment of moderate economic growth.

This situation appears puzzling to both us and the market and we would question whether it can continue, given moderate wage gains, tighter employment conditions and the benefits of real disposable income gains to US consumers.

Moreover, consumer confidence indicators continue to stand at healthy levels – US consumers have not yet signed up to fears of a US recession.

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