Article / 16 September 2016 at 0:33 GMT

Inflation update the last chance for a Fed hike next week

Managing Director / Technical Research Limited
New Zealand
  • The widely publicised CPI figure is the missing piece of the puzzle for the Fed
  • Surveys of US inflation expectations are “anchored” around 2%
  • A CPI surprise would be required for the Fed to step up to the plate next week
By Max McKegg

Yesterday’s retail sales and industrial production numbers out of the US came in below expectations, further dampening the prospects of a rate hike by the Federal Reserve next week. But the most important piece of data comes out today: the Consumer Price Index.

Inflation is the missing piece of the jigsaw as far as the Fed is concerned and for months they have been telling us that’s because of the “transitory” effect of earlier declines in energy prices. That argument is starting to wear a bit thin and analysts will be looking for evidence in today’s numbers that the Fed isn’t engaged in wishful thinking.

A CPI surprise would be required for the Federal Reserve to step up to the plate next week. Photo: iStock

After yesterday’s data December Fed funds futures suggest the chance of a rate hike by year end has moved back under 50% (Click to enlarge)

Fed funds chart
Source: Metastock. Create your own charts with SaxoTrader; click here to learn more.

The chart below shows headline CPI is currently running at 0.8% year-on-year and the core rate at 2.2%. Analysts expect both will have increased by 0.1% after today’s update.

On the face of it, a core CPI number holding above 2% for the last few months should be sufficient for the Fed to declare “Mission Accomplished” on inflation.

CPI 2000-2016 chart

But while most countries use the CPI as their inflation benchmark, the Fed in its wisdom decided a few years ago that “inflation at a rate of 2%, as measured by the annual change in the price index for personal consumption expenditures (PCE) is the most consistent over the long run with the Federal Reserve’s statutory mandate”.

That shouldn’t have been a problem because historically the CPI and PCE  have tracked each other closely. But, as the following chart shows, shortly after the Fed adopted the PCE as its benchmark, the indices began to diverge and a large gap has opened up (mainly because items such as housing and medical costs have different weightings).

Fortunately for the Fed, the CPI measure is the most widely publicised and this explains why surveys of inflation expectations are “anchored” around 2%.

CPI-PCE 2000-2016 chart

A further complication is that, while the core numbers might be the best guide to inflation over the medium term, they exclude “volatile” items such as food and energy prices, and the Fed’s mandate is to achieve 2% inflation in “overall consumer prices”. This all-items measure is referred to as the “headline rate”. In the twelve months to July headline inflation as measured by both the CPI and PCE was about 0.8%, well under the core rates because of the impact of oil price falls earlier in the period. The Fed thinks this is a “transitory” effect and that the headline rate and core rates will merge as those oil price declines drop out of the annual calculation.

We won’t get the PCE inflation numbers until the end of the month but today’s CPI update will be a leading indicator for the FOMC as they ponder the prospects for inflation on Wednesday.

In addition the the FOMC, the Bank of Japan and Reserve Bank of New Zealand will issue monetary policy statements next week. The chart shown below shows forward rate curves based on futures pricing and the Overnight Index Swap (OIS) market. Japan’s is not shown but it closely matches that of the European Union.

The US curve has been flattening out all year but is still the only one with an upward slope. In contrast rate cuts in the next few months are built into the others. These forward curves, rather than current rate differentials, will be the major influence on USD crosses leading up to the new year.

Source: Bank of New Zealand

It’s not often we get surprises in CPI updates these days but that’s what would be required for the Fed to step up to the plate next week. A surprise in today’s numbers would be the monthly headline and core rates increasing by 0.2% or more. Unlikely, but stranger things have happened.

– Edited by Robert Ryan

Max McKegg is managing director of Technical Research Limited. Follow Max here or post your comment below to engage with Saxo Bank's social trading platform.


The Saxo Bank Group entities each provide execution-only service and access to permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on or as a result of the use of the Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. When trading through your contracting Saxo Bank Group entity will be the counterparty to any trading entered into by you. does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of ourtrading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws. Please read our disclaimers:
- Notification on Non-Independent Invetment Research
- Full disclaimer

Check your inbox for a mail from us to fully activate your profile. No mail? Have us re-send your verification mail