Core CPI continues to hover below the Fed’s 2.0% target, while plunging oil prices keep the broad index close to zero. Core CPI is likely to weaken as the beneficial effect of lower energy costs flows through to all sectors of the economy.
We often read of the threat of impending deflation — which may well occur. But one needs to differentiate between deflation caused by a surge in aggregate supply, as in the present situation, and a fall in aggregate demand as in 2008. The former may well act as a stimulus to the global economy, while the latter threatens a negative feedback loop between income and consumption which can lead to substantial falls in output.
Low inflation takes pressure off the Fed to raise interest rates but we can expect the first increment later this year. 10-Year Treasury yields respected the rising trendline and support at 2.10%, suggesting another test of 2.50%.
The higher trough on the Dollar Index indicates buying pressure and breakout above 98 would signal another test of 100. In the longer term, breakout above 100 would signal resumption of the primary up-trend but is likely to meet push-back from the Fed as a higher dollar would hurt both exporters and domestic producers competing against imports.
