KEY DATA: Imports: -0.3%; Nonfuel: -0.4%; Exports: +0.1%; Farm: -1.7%
IN A NUTSHELL: “Declining import prices provide fuel to the argument that the Fed doesn’t have to worry about inflation, at least for now.”
WHAT IT MEANS: The debate over when the Fed should or will raise rates continues to rage as the hawks and doves weigh in on an almost daily basis. If you believe the Fed members, rates should either be increased in June or next year. I guess that is a tight shot pattern when it comes to Fed policy. Just kidding. In any event, since the Fed claims to be data driven, what do the numbers tell us about potential Fed actions? Well, on the inflation front, there doesn’t seem to be much to worry about. Import prices fell in March and once again, fuel was not the driving factor. Indeed, for the seventh month in a row, nonfuel import costs declined. Every major category, included food, was down. Nonfuel import prices are of by 1.9% over the year, a clear restraint to any attempt by U.S. firms to raise prices. As for our exports, the farm sector continues to be battered by lower prices – they are down 13.5% since March 2014. Only fish prices are up.
MARKETS AND FED POLICY IMPLICATIONS: Controlling inflation while keeping growth solid is the Fed’s dual mandate. With the dollar strong, import prices are likely to be well contained, limiting to an extent domestic inflation. That can allow the Fed to focus more on growth, at lest that is the argument that the doves are making. The hawks simply say that the stronger dollar and low energy prices are transitory factors keeping prices low. Continued trend or above trend growth, coupled with a tightening labor market, improving worker incomes and the eventual turnaround in the dollar and energy prices imply that rising inflation is not that far off. Who will win the debate? My view is the data will firm sharply over the next two months. That may come too late for a June increase, but not for a July or September one. What worries me about the public discussion, especially by non-Fed commentators, is the apparent broadening of the perceived Fed mandate. Those that worry about the dollar argue the Fed cannot raise rates because it would further increase the dollar, lowering exports and restraining inflation and growth. Those that are focused on the equity markets argue that a rate hike would shock the markets, causing a correction so the Fed has to make equity prices a concern. The bond market gurus say that negative interest rates around the world make it impossible for the Fed to raise rates or limit its capacity to do so, implying that the bond market should control Fed actions. So now the Fed seems to actually have a quintuple mandate: Control inflation while keeping the economy solid, equity prices high, the dollar from getting too strong and limiting the impact on bond markets. Huh? People, we are approaching the six-year mark for this expansion. The post-World War II average is 5 years. The last three expansions averaged almost 8 years, with the longest being 10 years. In other words, one other thing the Fed has to consider is that the next recession could occur within a few years and if rates are not up by then, it will be forced to resort, once again, to non-traditional policies. The Fed has to raise rates back to more normal levels and the longer it waits, the faster it will have to act.