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Alex Cho

Will Inflation Readings Drive Additional Rate Hikes?

In a sharp twist of events, the inflation readings are starting to pick up some momentum in the first half of 2016. Nonetheless, many are skeptical that the Federal Reserve will raise rates more than once over the course of 2016, so what will it be?

Source: Bank of America

As it currently stands, the Core CPI measure has pushed back above 2%. Most of this is driven by increases in specific sectors, which implies that the broad measure of inflation is being impacted by a very narrow subset of the basket weightings for inflation. Furthermore, the Fed Chair Janet Yellen also mentioned “I see some of that as having to do with unusually high inflation readings in categories that tend to be quite volatile without very much significance for inflation over time.”

Perhaps the recent momentum is driven by medical inflation and apparel price inflation. Medical inflation increased 3.9% y-o-y and apparels inflated by 0.6% and 1.6% in the months of January and February, according to Bank of America research. So, it’s no surprise that the Fed isn’t reacting to the data points or using it as a basis to signal for additional rate hikes in the upcoming year.

Furthermore, there’s no denying the backdrop of volatile F/X which may cause the dollar to in the upcoming year thus imports could cause another wave of deflationary readings. After all, many of the foreign central banks are eyeing Japan’s efforts with negative interest rate policy and whether the policy shift below the zero lower bound (ZLB) will drive inflation measures in developed economies. Therefore, we shouldn’t be panicking over rate hikes quite yet over here in the United States. But, it’s worth noting that interest rate hikes tend to negatively impact equity market returns over the long run with cyclical names performing better in the later innings of an economic cycle.

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