This week’s October US CPI data will give the Federal Open Market Committee (FOMC) the final bit of comfort required to press ahead with monetary policy normalisation and deliver its third rate hike for the year at its December meeting.
The monthly headline increase of 0.1% didn't look too flash, but that captured the unwinding of prior hurricane related price increases (petrol) which saw the September number print at an elevated 0.5% month-on-month (m/m). The October core increase of 0.2% m/m and the tick higher in the annual rate to 1.8% is the comforting bit. This will give the Committee reassurance that the weak patch in core inflation earlier in the year was indeed transitory.
The latest three-month annualised rate is consistent with 2% inflation. The weakest period occurred in the three months to May this year where inflation was running at close to zero. The annual rate of increase will benefit from the base effect of these low numbers dropping out of the annual calculation next year.
US Core Inflation
In the meantime, the broader economic environment supports further rate hikes. Third quarter GDP growth came in at an above trend annualised rate of 3.0%. Early fourth quarter data suggests that rate of growth could be exceeded in the current quarter.
Furthermore, the labour market continues to tighten. Payrolls growth is averaging around 160k per month, well ahead of the 100k per month required to stabilise the unemployment rate. Job openings remain at a cyclical high and the unemployment rate at 4.1% is below consensus estimates of the non-accelerating inflation rate of unemployment (NAIRU).
Yet wage growth, after trending gradually higher over the past couple of years, appears stuck at around 2.5%. There have been many reasons postulated for that. The most compelling of these is that while the unemployment rate is now below NAIRU, broader measures of labour market slack remain elevated.
One such measure is the U6 unemployment rate. This is the official unemployment rate (U3) plus people who are ‘marginally attached’ to the work force. That means people who would look for a job if they thought one was out there. U6 also includes people who work part-time but would be keen to work more.
US under-employment gap
U6 is now coming down quite rapidly. Indeed, the gap between this and the official unemployment rate (what we call the ‘underemployment gap’) is now down to 3.8%, just short of its pre-GFC average of 3.7%. That suggests to us that wage growth may well begin to accelerate in the period ahead.
Not only does that make the December rate hike a done deal, but also the three hikes the FOMC has already signalled for 2018. In fact, if the politicians can get their act together and deliver on tax reform, the risk for next year is more than three. And with the broadening trend towards monetary policy normalisation in the UK, Canada and Europe, we expect a continued gradual rise in bond yields.
For more on the outlook for inflation, monetary policy and markets, keep an eye out for the latest edition of Quarterly Strategic Outlook which will be hitting your inbox in the next few days.
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