With the Federal Open Market Committee beginning day one of the two-day FOMC Meeting, expectations are high for a shift in strategy from the most prominent global central bank. After a decade of rate cuts and low interest-rate policies, the Federal Reserve is expected to signal a pivot in monetary policy just as volatility picks up in financial markets as growing emerging market concerns overshadow the gains in advanced economies. While invariably possible, it is still difficult to imagine the Federal Reserve voting members will use tomorrow’s decision as the launch pad for announcing the implementation of more hawkish interest-rate policies. Growing malaise abroad and the fact that inflation remains unanchored has made it difficult to persuade market participants of the need for higher interest rates despite the window for action shrinking as time passes. The reduced probability of a change in policy tomorrow comes as the latest consumer price index numbers show that inflation risks remain broadly to the downside amid renewed commodity deflation. Today’s CPI numbers showed that headline inflation slipped into deflationary territory for the first time since January, a worrying sign for policymakers despite CPI not being the most important relied-upon indicator by policymakers.
While the preference is to review PCE (personal consumption expenditure) inflation, the fact that energy prices are dragging inflation into negative territory despite the raft of positive inflation drivers such as food, housing, and healthcare means that continued commodity deflation will ultimately drag on the outlook. Regular CPI in August printed at -0.10%, meeting expectations but starkly lower compared to July’s 0.10% print. Annualized figures stayed largely flat, exhibiting no change versus the prior reading, but nevertheless highlighting the challenging decision going forward. While expanding quantitative easing to drive inflation higher might be part of the Federal Reserve playbook, history has shown that expanding easing is not the likely ticket, evidenced further by difficulties experienced by both Japan and the Euro Area. The reaction has been softness in the dollar as precious metals surge on the data. This further reduces the chance that tomorrow will bring news of Fed liftoff with the next possible date being October. Unfortunately for the real economy, the Federal Reserve punting means that interest rates are unlikely to hit 0.75% by end of 2015, and moreover, likely to be cut just as quickly as they were raised.