Sticky US inflation does not bode well

Inflation is slowly declining, the labor market is running at full speed and Americans are still happily spending money. Behind this favorable picture lies the danger that an unexpected rent rally later this year will trigger a recession in the United States.

Last week, another series of data about the US economy was poured out to the financial world. The common thread is that the US economy is in pretty good shape. The tight labor market underlines that companies are enthusiastically looking for new staff. And you don't do that if you're worried about the turnover development in the rest of the year. In January, no fewer than 517.000 new jobs were added. That is much more than the nearly 200.000 workplaces that economists had counted on. The population also seems to have little concern about the financial future. Retail sales increased by 3% in January.

Inflation under control, or not?
The biggest economic boost of last week is that US inflation seems to be coming under control. In January, the so-called Consumer Price Index (CPI) stood at 6,4%. A month earlier that was still 6,5%. And in the summer even a level of 9% was reached. That is good news, because a drop in inflation will ease the pressure on the US central bank to slow down the economy by raising interest rates. The expectation was that this Federal Reserve would raise interest rates to 5% this spring, before lowering them gradually. Due to recent developments, it is not necessary to tinker with the first part of those expectations. For the second part, it's a different story.

Higher wages, higher prices
Indeed, all of the above patterns indicate that it will take more effort to push US inflation down to a level of 2% than what financial markets and the currency world are now anticipating. A tight labor market translates into higher wages, which companies pass on in their prices. Moreover, the fall in inflation is mainly due to lower energy and food prices. The core inflation on which the Federal Reserve makes policy is still at 5,6%. That is hardly lower than the 5,9% of the summer months. All in all, it seems that inflation is a lot more sticky than many parties secretly hope for.

Counterpunch of the dollar
That expectation is slowly but surely being adjusted. More and more economists are adjusting their expectation for the US interest rate top to 6%. Supporters of the economist John Taylor – who thirty years ago made a nice comparison between inflation and policy rates – even take into account an increase of up to 8%. That doesn't bode well for the US economy. But such a rate surprise would give the dollar a strong boost. A higher interest rate makes it more attractive to hold capital in the relevant currency. In September, the euro made significant gains against the dollar. However, that advance came to a halt in February. If US inflation is as sticky as it seems this week, a fierce dollar counter-punch is looming.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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