Inflation Reports Throw Curve Ball for Fed Rate Hike Ambitions

On a day when the Federal Reserve is expected to hike interest rates, investors, economists and business owners might wonder what lower inflation readings will do to the decision-making of Fed Chair Janet Yellen and her Federal Open Market Committee (FOMC). The news flow out of Washington, D.C., is dominated by the shooting of Republican Representative Steve Scalise and several other people, but the Fed’s rate hike decision remains on the docket this Wednesday.

Inflation is up from a year ago, but it is not quite where the Federal Reserve wants it to be to justify a normalization from the current low-rate environment. We have now seen weaker readings in the Consumer Price Index (CPI) and the Producer Price Index (PPI) for May.

The Department of Labor reported that consumer prices were down by 0.1% on the month-over-month headline reading for May. That is down from a gain of 0.2% in April and is worse than the 0.0% consensus estimate from Bloomberg. The core CPI, excluding food and energy, was up by just 0.1% in May, worse than the 0.2% consensus estimate but matching a 0.1% reading from April.

Where inflation remains closer to the Fed’s 2.0% to 2.5% target range is on the year-over-year readings. The CPI was up 1.9% on the annualized reading for May, under the 2.0% consensus estimate and under the 2.2% reading from April. Core CPI, again without food and energy, was up just 1.7% in May versus the prior year. That is lower than the 1.8% consensus estimate and was under the 1.9% annualized reading from April.

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Overall, costs are weaker than Yellen and the Federal Reserve desire and are just not holding up to the 2.0% to 2.5% target range. Housing prices were up only 0.2%, the cost of medical care was flat, and communication costs remain weak as telecom carriers are doing endless discounting to lure customers away from each other. Apparel costs were down by 0.8% and transportation costs were down 1.4%.  Energy prices were down 2.7%, and the cost of gasoline has chased oil lower with a drop of more than 6% at the pump.

In Tuesday morning’s report, the monthly PPI was flat, rather than the consensus gain of 0.1% that was expected. That was also down from a 0.5% monthly gain in April. The monthly core PPI, which excludes food and energy, was up 0.3%, a tad above the 0.2% called for by Bloomberg but less than the 0.4% gain in April.

Annualized producer price data was up 2.1% in May on the headline and core readings from May of 2016.

Wednesday’s economic data are not so catastrophic as to would block Yellen and the FOMC from doing what they want with a rate hike. That being said, inflation and growth readings had been stronger in the first months of 2017 than they are coming on now, and that makes the normalization of interest rates and an argument about how to unwind the Fed’s $4.6 trillion balance sheet a tad more tricky for the remainder of 2017.

The last look on the CME FedWatch Tool had a 93.5% chance of a federal funds rate hike set for Wednesday, June 14. On June 9 that was closer to a 99% probability.

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