Brexit Throws A Wrench In The Fed’s Inflation Plan

The US Federal Reserve has been vocal in the past about how the devaluation of the Chinese Yuan against the dollar changed the effectiveness of the US currency in markets abroad. 

Just as it was believed that things would be improving, the Brexit has thrown a wobble into the expected forecasts. 

Anxieties have risen accordingly.

As can be seen in the graph below, excluding energy and food commodities, inflation has been on a steady upward trajectory:

Although the Federal Reserve predicted a CPI (Consumer Price Index) increase of 2%, the reports for May are showing that prices were up to just 1.6%. 

This is an improvement on the 1.3% that was posted last year, however. 

The decline in the prices of raw materials, a lowering of oil price, and a drop in the strength of the dollar, have all contributed.

The Consumer Price Index is the best measure of how the consumer purchasing power reflects statistically on a variety of goods and services, but excludes the food mentioned above and energy.

With the results of the Brexit and its economic consequences being felt on all global economies, the USD has experienced a strengthening. 

This will lead to the US exports market becoming less desirable as more favorable currencies are sought out. 

Until the shock of the Brexit results is ridden out, the prices of imports will stay low, and this will further impact consumer prices in the US.

As can be seen in the below graph, the dollar has gained in strength against most other currencies:

There are a few worries in the Federal Reserve that, even after the Brexit waves diminish, it could still impact and cause a long term problem.

With the snappy title of the graph below, the subject of the graph leaves no doubt as to what it attempts to signify here. 

 It is a good reflection, in the principal, about how the Federal Reserve tracks inflation and adjusts its rates accordingly. 

It continually tests the mood of the markets and consumer and reacts in what it is agreed to be the appropriate manner:

It is seen in the graph above that the Federal Reserve rates have always been intertwined with the CPI in an ever tightening embrace. 

The concerns about the current strong dollar and low inflation are that it becomes entrenched in the mindset of the consumer population and the public business sector.

The expectations of a continued low inflation rate, once ingrained in the consciousness of the public, is difficult to shake off. 

Even if the job market became tighter, it might not result in annual salary rises. 

Politically, inflation has far reaching ramifications too.

The Federal Reserve must have ammunition to raise or lower rates. 

Without a depressed market, it does not have the criteria it needs to be able to raise the central bank rates.

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Expected Inflation Did Not Rise To The Occasion 

The markets have measured the current inflation trends and expect it to remain quiet. 

Analysts expect it to remain so for the next five-years. 

The graph below tracks the CPI percentage change in the Northeast region of the US, and it reflects the country fully.

The CPI tends to portray the price measure a bit warmer than that which the Federal bank does.  

The market is showing up more credit positive than in past years. 

When there have been market scares in the past, the yields of the Treasury fell below those of the TIPS (Treasury Inflation Protected Securities).

TIPS related inflation is based on the margin of difference between the TIPS and the yields reported by the Treasury.

In an environment that is showing all these factors, including the Brexit ripples, prognosticators probably believe that domestic currency risks are down. 

This will drive inflation predictions to stay quiet. 

The inflation implications may just show a forecast that the Federal Bank will struggle to get to the expected targets. 

All the surveys that are continually undertaken to gauge the atmosphere in the financial markets report that inflation slid back a bit this year – and the Federal Reserve Bank need a rise in the rate of inflation before it can utilize the opportunity to raise the bank rate higher. 

The rates are expected to stay low, at least until the markets stabilize from the Brexit results.