Fed Interest Rate Cuts on Low Inflation? Not So Fast! Here’s Why

There will be Fed interest rate cuts because inflation is falling, according to the latest mainstream media BS.

And it is BS.

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To prove the point, they show you this chart of core CPI.

Fed Interest Rate Cuts Due To Falling Core Inflation

Yes, it’s true that core CPI has been falling since the middle of last year. But lets note that it is still above the Fed’s 2% inflation target, which is now a threshold.

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Fed watchers and Wall Street types will remind you that the Fed bases its “inflation” readings on the core PCE (Personal Consumption Expenditures index. And core PCE is below the 2% target. Core PCE is the most manipulated and repressed measure of consumer inflation, even more than CPI is. By keeping the rate below 2%, Core PCE allows the market to think that there will be Fed interest rate cuts.

CPI is minimized via the use of a phony substitute for housing prices. I have previously written ad nauseum about this. The bottom line is that if actual housing inflation were included in CPI, instead of the bogus owner’s equivalent rent measure, core CPI would be a percentage point or more, higher than it is.

Yes, housing inflation is coming down, and could soon be negative, which would knock the core CPI down even more, encouraging the Fed to cut interest rates.

But there are a couple of flies in the ointment. There are the noncore items– food and energy. The Fed ignores them because they are volatile. But sometimes that volatility starts to trend in one direction. And then those trends start to push core inflation higher.

Then there’s cost. Rising input costs can push CPI higher. The inflation of consumer goods wholesale prices has been way above the Fed’s target range. Wages are also rising faster than core CPI.

Costs inevitably get passed through to final retail prices, especially when final demand is strong. We already know that final demand in retail sales is strong.

The core finished consumer goods Producer Price Index (PPI) inflation rate has come down since Q3 of last year, but it is still above the lows of the past 16 months. A 6 year uptrend in this PPI inflation rate is intact.

Finished Consumer Goods Producer Prices are Against Fed Interest Rate Cuts

And it’s about to get worse. I’ve been predicting an inflation shock. Why? Because food and energy have been moving sharply higher over the past 3 months. This hasn’t shown up in any of the official inflation measures yet. But it’s coming.

Increasing Food CPI Inflation Don't Suggest Rate Cuts

After going negative briefly in 2016, CPI food inflation has been heating up relentlessly. Yes, there’s volatility, and it’s all upward. The food CPI inflation rate broke out above 1.6% in January, and it has kept going.

This will begin to impact consumers’ inflation expectations. The Fed likes to watch those expectations, as opposed to actually paying attention to the facts. Inflation expectations have been subdued. That’s about to change.

The energy picture is a little misleading because the current CPI data is lagging the reality of the marketplace. It gives economists and the Fed the false impression that inflation is falling. The energy inflation rate fell from the middle of last year, going deeply negative in January. The CPI energy inflation rate is now only back to zero.

Energy Prices CPI Data Lags, Promoting Fed Interest Rate Cuts

But if you drive a car, you know differently. Real time weekly gasoline prices from the US Department of Energy show a starkly different picture.

Gas Price Inflation Argues Against Fed Interest Rate Cuts

Gas prices are the biggest component of the CPI energy inflation rate. But the CPI data lags the weekly Energy Department data by a month. April energy CPI will boost headline CPI. So will food. That will worry the market.

Maybe core CPI can buck that trend a while longer. Maybe it won’t. But headline CPI definitely won’t.That will impact inflation expectations.

And that will prevent the Fed from cutting rates. Stock traders will be disappointed. There will be selling.

That will show up in the stock market charts. Technical analysis can give us a heads up that some savvy traders are exiting out the side door. You can follow the money and find the profits, including SPY options trading recommendations with Lee Adler’s Technical Trader.

 

 

 

 

 

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Lee Adler

I’ve been publishing The Wall Street Examiner and its predecessor since October 2000. I also publish LiquidityTrader.com, and was lead analyst for Sure Money Investor. I developed David Stockman's Contra Corner for Mr. Stockman. I’ve had a wide variety of finance related jobs since 1972, including a stint on Wall Street in both analytical and sales capacities. Prior to starting the Wall Street Examiner I worked as a commercial real estate appraiser in Florida for 15 years. I also worked in the residential mortgage and real estate businesses in parts of the 1970s and 80s. I have been charting stocks and markets and doing analytical work since I was a teenager. My perspective is not of the Ivory Tower. It is from having my boots on the ground and in the trenches of the industries that I analyze and write about today. 

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