13 March 2018

Bob Cunneen, Senior Economist and Portfolio Specialist

US interest rate vs inflation indicators

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Source: US Federal Reserve, St Louis

America’s labour market is in an extraordinary ‘sweet spot’. Strong jobs growth has seen the US unemployment rate fall to a 17 year low of 4.1%. Even US wages growth has been remarkably mild with average hourly earnings only showing 2.6% annual growth in February (black line).

However, this could be only brief bliss for financial markets. Eventual labour demand will see US employees exercise their increased bargaining power to push for higher wages. Combine this with President Trump’s tax cuts and proposed tariffs for steel and aluminium as well as a weak US Dollar  and you have all the key ingredients for inflation pressures.

The US Federal Reserve (Fed) has projected that US inflation should modestly rise to 2% over coming years (green line).The Fed also expects interest rates to “gradually” move higher from their current low target range of 1.25% to 1.50% (red line). However with accelerating inflation, this guidance of “gradual” is not a guarantee. The Fed may need to move more aggressively and rapidly as sweet spots can easily turn sour when inflation ingredients are in the mix.

 

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