Inflation Flatlines With QE in the Spotlight
If the Bureau of Labor Statistics is to be believed, the prices paid by consumers for everyday goods are going nowhere fast. The headline consumer price index for all urban consumers, a highly cited measure of inflation, was flat in November compared to October, indicating that overall price levels for common goods were unchanged. This flatline follows a 0.1 percent contraction in the headline index between September and October and leaves the index up just 1.2 percent on the year.
Headline inflation has been particularly soft this year, mostly thanks to low price pressure in the pipeline (such as price increases for crude, semi-finished, and wholesale goods) and declining energy prices. The energy component of the CPI contracted 1 percent in November and is down 2.4 percent on the year. Within the component, gasoline has led much of the decline, falling 5.8 percent on the year. Prices for utility energy services such as electricity and gas are up, climbing 2.5 percent and 2.9 percent on the year, respectively.
Changes in the price of food have generally kept pace with the headline index. The food price index is up 1.2 percent on the year, with food at home up 0.6 percent and food away from home increasing 2.1 percent.
Because food and energy prices are subject to cyclical factors such as seasonal demand and can be unpredictably impacted by weather and geopolitical events, they are often factored out of the core CPI. The core CPI attempts to peer beyond the veil of volatility and look at underlying trends.
Without the energy component weighing it down, the core CPI climbed 0.2 percent on the month in November and is up 1.7 percent on the year, indicating a level of inflation that is at least in the same ballpark as the U.S. Federal Reserve’s 2 percent target.
The Fed, which prefers the similar but separate personal consumption expenditures price index, targeted a 2 percent longer-run inflation target when it rolled out the current iteration of quantitative easing. Quantitative easing — the name given to the Fed’s ongoing purchases of agency mortgage-backed securities and longer-term Treasury securities — has four primary effects on the economy: higher inflation expectations, currency depreciation, higher equity valuations, and lower real interest rates.
The intended consequence is to spur spending in interest rate-sensitive sectors, which, as Fed Vice Chair Janet Yellen articulated in her recent testimony before the Senate Banking Committee, should “stimulate a favorable dynamic in which jobs are created, incomes rise, more spending takes place.”
Along with its impact on interest rates, quantitative easing drives down currency valuations, which impacts imports and exports; increases inflation expectations; and increases equity valuations. Quantitative easing impacts pretty much every corner of the financial market, which means that any changes to the program will also impact pretty much every part of the financial market.
Most of these effects have manifested in the U.S. to some degree, but inflation data released over the past few months have struggled to remain positive. James Bullard, president of the Federal Reserve Bank of St. Louis, said in a recent presentation to the CFA Society in St. Louis that inflation “continues to surprise to the downside,” continually running below the Fed’s 2 percent inflation target and foiling the central bank’s expectations that inflation is trending toward the 2 percent level.
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