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Oct 29 2015

Key "Surprises" to Consensus View

Last month, seven years after the Lehman Brothers collapse, the Fed again postponed its long-awaited rate hike. In justifying that decision, Fed Chairman Janet Yellen so surprised observers by citing “global financial and economic developments” — in particular, inflation undershooting the Fed’s 2% target due to “declines in energy and import prices” — that some labeled these factors a new, third mandate, going beyond full employment and price stability.

At the beginning of the year, ECRI had already flagged this issue of global overcapacity — especially in China — resulting in “double-digit percentage declines in export prices for both the advanced and the emerging economies” (ICO Essentials, January 2015). We followed up by showing the flip side, i.e., that import price deflation in both advanced and emerging economies was plunging to the worst readings since 2009 (ICO Essentials, May 2015). Then, before the latest FOMC meeting, we explained why “the price of imports [had] increasingly becom[e] a critical driver of overall inflation” (USCO Focus, August 2015).

Two weeks after the September Fed meeting, the weak jobs report made it difficult to deny that something was amiss, yet this was eight months after we had correctly predicted “easing growth” (USCO Essentials, January 2015). At that time, we wrote that, “Given half a chance, the Fed would like to raise rates this year — and sooner rather than later. … The sixty-four thousand dollar question is whether they will get that opportunity.”

While Ms. Yellen and Fed Vice Chairman Stanley Fischer remain on record as favoring a rate hike this year, two Fed governors have broken ranks. One of them, Lael Brainard, called into question the validity of the Phillips curve, echoing our earlier conclusion that “Those dependent upon the Phillips Curve for insights into inflation are likely to be led astray, as the jobless rate and inflation do not have a consistent relationship” (USCO Focus, January 2015).

Essentially, the key “surprises” sprung on observers over the past month or so — the critical role of import prices, the economic slowdown, and the broken Phillips curve — had been flagged by ECRI. Our more recent analysis highlights new factors that will impact economic growth in the months ahead, and are likely to eventually impact Fed policy.

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