US: No precedent for recent inflation surprises - Westpac

Richard Franulovich, Research Analyst at Westpac, suggests that a bevy of stronger activity data in recent days, most notably July US retail sales and the August Fed Empire survey have reaffirmed expectations for a more solid Q3 and taken the spotlight away from what has been an important theme - a persistent inflation shortfall.

Key Quotes

“But, there is no precedent for the recent string of weaker than expected inflation prints and it will remain a major focus for the Fed.”

“US core CPI surprised on the downside for a fifth month in a row in July, rising only 0.1% (0.2% expected) and leaving the annual rate stuck at 1.7% (consensus 1.8%). On the plus side, two major components - medical care and owners' equivalent rent (i.e. housing) - were stronger for a second consecutive month, after several months of weakness. That will be a relief to Yellen. The main areas of softness were autos and wireless telephony services, supposedly “one-offs” according to Yellen. But, in both cases weakness reflects fierce price competition (i.e. structural disinflation).”

“There is no precedent for the scale of the recent core inflation downside surprises, both in magnitude and duration. This is now the fifth softer than expected core CPI in a row. The sum total shortfall relative to consensus (i.e. the consensus forecast error) comes to a shockingly large -0.7ppts over that period. That is the biggest core CPI miss over a five month period going back to at least 1997.”

“The scale of the US core inflation undershoot relative to expectations is equally stark in a global context. Core inflation has surprised to the upside in a range of G10 economies in the last 5 months, notably Europe. Against that both Australia and Japan have both produced small negative inflation surprises this year but the US is the standout, by a very long shot.”

“Interestingly, G10 currency performance has loosely matched relative inflation forecast errors this year – those economies that have produced the largest positive inflation surprises have seen the most currency appreciation in the last 6 months and vice versa.”

“The Fed will be surely trimming their inflation forecasts at their 20 Sep FOMC and probably their long term neutral rate estimates too, even as they probably formally embark on a tapering of reinvestments, so it’s hard to see the Fed delivering a hawkish surprise at that next meeting. That, along with US government shutdown and debt ceiling risks in Sep/Oct leave the USD in an ongoing vulnerable state.”