U.S. gets Christmas present from OPEC: Inflation?

December 16, 2014 07:31 AM

Do lower crude oil prices dampen inflation or threaten greater inflation?

The recent collapse of energy costs presents an interesting theoretical economic question. What does it mean for Fed policy and inflation?

Some analysts see this as a win win because lower prices are good for consumers and the price dip may put downward pressure on inflation readings, which means the Fed can maintain stimulative low rates longer.

Analysts would certainly debate whether or not that is truly a good thing—six years is a long time for zero interest rates— but more important is the fact that the actual effect on inflation may be different than anticipated. In fact the opposite might be true.

 First off, remember how the Fed looks at inflation readings. The look at the core reading stripped of food and energy. Books can be written questioning the wisdom and propriety of this but let’s focus on what it means. The lower crude oil prices and downstream lower gasoline prices are not figured in the core Consumer Price Index. However, the low gas prices put more disposable income in the pockets of consumers during the busiest shopping season of the year. This money will be spent on things that are measured by inflation figures and could cause an increase in the core measure and push the Fed to act earlier.

In a soon to be published Futures interview Gibson Smith, Janus Capital Group’s Chief Investment Officer fixed income, makes that point. Smith says, “The markets are forgetting the importance of energy as a tax or as a stimulant to disposable income.”

Perhaps that is partially responsible for the post-Thanksgiving market correction that has seen the S&P 500 lose nearly a hundred points. Traders may fear the economic boost from low energy costs will speed up the time the Fed begins to tighten in 2015.

 It seems a stretch as most analysts belive the Federal Reserve's Federal Open Markets Committee (FOMC) will be cautious and rasie rates incrementally. Would raising the Fed Funds rates to 50 basis points (or between 25-50, as many analsysts suspect will happen) in June instead of September with the likelihood of two instead of one additional 25 bps increases occurring in 2015 warrant such a move? 

I don't think so 


About the Author

Editor-in-Chief of Modern Trader, Daniel Collins is a 25-year veteran of the futures industry having worked on the trading floors of both the Chicago Board of Trade and Chicago Mercantile Exchange.