Core Inflation And Payrolls Still Support A Rate-Hike Forecast

Earlier this week Fed Vice Chairman Stanley Fischer laid out the conditions for raising interest rates. “The tightening of US policy,” he said in prepared remarks for a speech in Tel Aviv, “will begin only when the U.S. expansion has advanced far enough–when we have seen further improvement in the labor market and when we are reasonably confident that the inflation rate will rise to our 2 percent goal.”

The economic news of late raises doubts about whether those goals will be reached any time soon, although it’s premature to put a fork in the idea just yet. Payrolls are still rising at a robust pace, albeit after a stumble in March. But April’s respectable gain of 223,000 for total nonfarm payrolls is in line with the moderately faster pace we’ve seen in recent history. In year-over-year terms, job creation continues to rise above the 2% mark, which represents a substantial improvement vs. the below-2% rate of growth that prevailed in the years prior to mid-2014.

As for inflation, the April report on consumer prices still looks weak. Headline CPI is more or less flat these days, although that’s largely due to soft commodity prices, energy in particular. Core CPI (excluding food and energy), by contrast, continues to rise at a pace of just below 2%. In fact, core inflation inched higher in April, advancing 1.8% on a year-over-year basis before seasonal adjustment—the most since last October. Given that core inflation tends to be a more reliable measure of the trend, it’s fair to say that pricing pressures are still on track to meet the Fed’s goal in the foreseeable future.

“While inflation is not a major concern, the pattern of prices is changing,” Joel Naroff, president of Naroff Economic Advisors, told The Wall Street Journal last week. “It used to be hard to find any category where costs were going up but now the opposite is true: Most categories are posting increases.” Chris Rupkey, chief financial economist at MUFG Union Bank, advised via Reuters that the latest uptick in core inflation “will give the Fed greater confidence that inflation will indeed make it to its target in the next couple of years [and] it increases the odds of faster Fed action.”

In sum, the employment and inflation numbers are still moving in a direction that supports the expectation that the Fed may start raising interest rates at some point in the near future. In fact, the Treasury market seems to agree, based on the recent rise in the 2-year yield, which is considered the most sensitive spot on the yield curve when it comes to rate expectations. In the last three trading sessions, the 2-year rate has been holding at 0.64%–the highest level since May 6, according to the government’s constant maturity rate data.

The question is whether payrolls and inflation will continue to support the case for a Fed rate hike in the upcoming reports? The next clue arrives later this morning, with the weekly update on jobless claims—a leading indicator, by the way, that’s been looking quite strong lately.

“We continue to see some pretty broad improvement in the labor market and indications that job growth is still pretty strong,” notes Sarah House, an economist at Wells Fargo Securities, via Bloomberg. “We’re seeing some tightening that should help boost wage growth.”

That’s also the message in the preliminary data for the services sector by way of Markit’ Economic’s purchasing managers’ index. Although the headline number reflected a lesser but still-strong rate of growth in May, Markit reports that that “service providers indicate the sharpest upturn in payroll numbers since June 2014” and “input cost inflation edges up to a nine-month high.”

The case for a second-quarter rebound remains shaky, but it’s not dead yet.