The Hindu Business Line : Look out for inflation figures in the US

Around this time last year, there were concerns over the impending deflation and how the Federal Reserve may have to resort to unconventional methods to tackle the same. The Federal Reserve had almost used up monetary and fiscal arsenal by that time. The spate of economic data over the last few weeks which include core CPI, PPI, ISM prices paid index, employment cost index have all surprised on the higher side, albeit by a modest proportion.

Most of the economists have been citing the weak employment number as a reason which would hold the Federal Reserve from moving on the interest rates. The non-farm payroll numbers for March were strong and higher than expected at addition of 308K (3.08 lakh) jobs.

One would have to watch for the employment data for the next couple months to figure out if this is part of a trend. Even the first quarter preliminary GDP number announced last week had a higher than expected deflator and PCE (personal consumption expenditures) index even though the GDP growth number at 4.2 per cent was a tad below expectations. What does one make out of these numbers and what could be the likely Federal Reserve response?

The International Monetary Fund has also come out with a report that has implored the Federal Reserve to prepare the financial markets for a shift in policy. The Fund does not want the financial markets to be surprised with the shift in stance, whenever that takes place. The Federal Reserve Monetary Policy Committee members have now in their public speeches started emphasising on the recovery.

The Fed remains cautious for a number of reasons and would rather wait and move only when inevitable.

In the past interest rate cycles the Fed has only moved on the interest rates when there have been a significant job additions from the trough of the cycle. There should be around 2.5 million jobs that should have been added from that point, however the current figures is way below even one million jobs. The unemployment rate is around 5.7 per cent. However, there is a view that the true number would be far in excess of this and close to around 7.2 per cent as a large part of the job seekers would have dropped out from the search given the conditions.

The data for employment for the month of April would be out this week and this would give a stronger indicator of the trend. If this number is strong and above 250K (2.5 lakh) job additions, one would have to review the outlook as this might indicate a trend. In such a case, the Federal Reserve may have to act this year but only with a modest increase.

The Federal Reserve has changed from easing cycle to tightening mode in the past only when the industrial capacity utilisation is above 82 per cent. Currently, we are much below this level and this would also give reason for Federal Reserve to be patient.

Commodity prices and energy prices continue to rule firm, but would be unlikely to start putting pressure as yet. One of the reasons for the surge in the commodity prices have been strong growth in some economies like China.

China has been able to produce goods at pretty low cost base and prices of number of products have fallen sharply. This has generated significant additional demand for these products. Obviously this results in greater demand of commodities from China.

Chinese authorities are worried about the overheating economy and taking unconventional measures to tighten policy. They have restricted the number of firms that can give credit to certain sectors like real estate and energy.

If China slows down a bit, it would bring down the prices of commodities. The news of China using these measures has resulted in drop in silver and gold prices last week.

The strong growth in the housing sector in the US is also a cause of worry. The Fed would not like to break the asset bubble and hurt the economy. The US household remains highly leveraged and has huge debt in the form of mortgages and other loans. In case the interest rates move up it can cause a wealth effect and affect the consumer spending.

The Federal Reserve would hold its monetary policy meeting this week. The financial markets would watch if the Fed removes the phrase `it would be patient' on acting on interest rates from the statement.

(The author is Senior Manager, Corporate Treasury Sales - Western India for HSBC. The views expressed herein are his own and not necessarily those of his employer.)