Inflation Misses Estimates, Giving The Fed A Chance To Pause Rate Hikes

If the Fed stays with its current dot plot, the yield curve will invert soon. The Fed can prolong the expansion, if it lowers its expectations for 2019 hikes from 3 to 2 or 1.

If the Fed lowers its guidance for rate hikes, I wouldn’t be surprised if the futures market starts forecasting 0 hikes next year.

Inflation - Oil Prices Hurt Inflation

Even though energy isn’t part of core inflation, the two are correlated as the chart below shows. That’s likely because both are cyclical.

Whenever oil prices fall, bullish stock investors are quick to blame supply. However, weakening global growth has explained the last two major crashes.

The crash in 2014 forebode the economic weakness in 2015 and 2016. It also caused weakness in countries which export the commodity. I’m not denying the impact supply has on prices. I’m simply recognizing oil’s great track record.

As the chart below and above show, core inflation has fallen in times of economic weakness and risen in times of accelerated growth. Core inflation is made up of cyclical and acylical factors which muddies the picture.

 

As you can see from the chart below, oil and 2 year breakeven inflation have been highly correlated since early September. It’s fair to say oil is driving breakeven inflation lower.

However, it’s not as if the overall economy has been accelerating and stocks have been powering higher in this period. I think oil is an important factor which is causing breakeven inflation to fall, but it’s not the only one. The high correlation with oil shouldn’t imply that nothing else matters to breakeven inflation.

Because some analysts view oil as the only factor, they are starting to question the veracity of breakeven inflation. I still trust the breakeven inflation rate as other commodity prices are falling and global economic growth is slowing. There will be lower inflation in 2019. Oil has been correlated with core PCE and core PCE doesn’t even include energy prices.

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