November 16, 2018
Growth is Solid, Inflation is Benign, Why Worry?
It was another volatile week in financial markets as fears around slowing global growth were exacerbated by worries over Brexit. This, as the cabinet minister in charge of negotiating a Brexit deal with the European Union resigned over the direction of the proposed deal. The S&P 500 finished the week down 2.1% as of writing.
Financial market jitters are not a reflection of any newfound weakness in U.S. economic data, which continues to point to solid growth and limited inflation. This week, consumer price index (CPI) data for October showed headline inflation rise to 2.5%, mainly due to rising energy prices. Core inflation, on the other hand, edged down to 2.1% (from 2.2%). Over the past three months, core prices have risen an average of just 1.6% (annualized), suggesting little cause for alarm on the price front. What’s more, the recent pullback in the price of oil is likely to push headline inflation lower in the months ahead, with the Fed’s preferred metric – the personal consumption expenditure price index – likely to drift back below the 2% mark.
A relatively soft inflation environment is giving support to the more dovish voices on the FOMC. In comments made this week, Chair Powell struck a balanced tone, but gave a nod to some of these more dovish elements. In particular, he noted the conditions that could lead the Federal Reserve to slow its pace of rate hikes over the next year. Slowing global economic growth, fading fiscal stimulus, and the lagged impact of past rate hikes are three factors that the Fed is monitoring. Despite these risks, the Chairman also noted the relative strength in the American economy, and notably that with press conferences scheduled after every Fed announcement in 2019 (instead of just once a quarter), every meeting is “live” – that is, has the potential for a change in policy.
Other economic data confirmed the solid economic growth narrative. Retail sales rose a robust 0.8% in October, reversing a downwardly revised pullback in sales in September. The drop in September and rebound in October reflected hurricane-related disruptions. Overall, the retail sales data are consistent with real consumer spending advancing by around 2.5% in the fourth quarter. For all intents and purposes, this is a great number. Nonetheless, it does represent a deceleration from the heady 3.9% pace average over the second and third quarters of the year.
With real consumer spending likely to run in the mid-2% range, the overall economy is likely to follow suit. In this environment, the impact of tariffs is likely to be more noticeable. Already there are signs that businesses are attempting to get ahead of the scheduled increase in Chinese tariffs to 25% (from 10%) by stockpiling imports. This volatility makes reading the economic tea leaves and the job of the Fed in gauging the reaction of the economy to higher interest rates that much more difficult.
James Marple, Senior Economist | 416-944-6318
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