GLD’s Response To New York Fed’s Call For Higher Inflation

By FX Analyst

The current inflation in the United States is at 0% as seen on the chart below after months of steady decline. This is reflective of the steady decline of oil prices since June 2014, which moderated the price increase of most goods and services across the economy. During this period of disinflation, there are fears that there will be deflation (prices of goods and services going down which is expected to damage the economy like Japan in the 1990s). The US flirted with deflation briefly in January before it emerged from it and the future direction of inflation is up for debate.

It would be rather difficult to convince people that there will be higher inflation going forward in this environment. Indeed, there are several high profile individuals such as Chicago Fed President Charles Evans who would urge for easier monetary policy to encourage inflation to the Fed’s 2% target.

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New York Fed President William Dudley begs to differ. In his opinion, we are going to see higher inflation soon as seen in his recent speech before the Business Partners Roundtable in New Jersey on 06 April 2015. There are 2 main thrusts of his speech that the economy will see inflation gradually towards the inflation target over the next 2 years. Hence, there is a need to lift rates this year given the monetary policy lag.

Pressures of the Improving Economy

His first thrust is that the economy is improving and it will strain the existing set of resources. People will have to pay more for the available goods and services. Employers are the first to feel the brunt of his economic improvement as seen in the wage increase as reported by the Bureau of Labor Statistics (BLS) recently.

The average hourly earnings went up by 0.3% over market expectations of 0.2% in March 2015 and this is 3 times the February increase. He encouraged us to look past the dismal March 2015 labor market report where we see only 126,000 new jobs being created over market expectations of 246,000. In addition, February numbers were revised from 259,000 to 264,000. This is because the overall growth momentum is still strong as seen in the chart below.

According to his research staff, this weakness can be attributed to the temporary effect of a harsh winter and it will pass soon.

“Overall, I view these downside surprises as reflecting temporary factors to a significant degree. For example, some of the recent softness is likely due to yet another harsh winter in the Northeast and the Midwest. My staff’s analysis of a measure of both the amount of snow and the population affected indicates that January and February weather was 20 to 25 percent more severe than the five-year average. Such large deviations appear to have meaningful negative impacts on a number of economic indicators.”

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In addition, Dudley blamed the strong USD to the weak inflation numbers as import prices went down when the USD appreciated 15% from mid June 2014. Dudley sees that with the pending improvement in the economy pushing the existing boundaries of production, we will see higher import price due to increased demand from both consumers and government.

In my opinion, we will have to see the upcoming economic results of the retail sales on April 14, building permit on April 16 and consumer confidence on April 28 to gauge the recovery of the economy. I would give him the benefit of the doubt given that we had the same issue on Q1 2014 and the economy recovered swiftly after that especially an 11-year high of 5% for Q3 2014.

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Higher Oil Prices Ahead

The second thrust of his argument is that low energy prices are about to end soon. His view is that the decline in oil prices since mid 2014 has a direct impact on the investment decisions of the oil and gas industry. This reduction in supply when the economy improves will have a positive impact on oil prices. Source: