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Should the Fed be worried about inflation? Or is deflation the real enemy?
The Top Economic Risks To The US Economy
The Federal Reserve Board, aka the Fed, has been hinting at raising short term interest rates sometime in 2015.
However, are we in a position yet to handle the economic risks associated with a rising interest rate environment?
Even the Fed has recently lowered its GDP forecast for 2014-2016.
Below, I have highlighted some important key economic charts you should be watching throughout the rest of this year
The Unemployment Controversy
The unemployment rate continues to drop. However, this has become a controversial data point. Many are quick to point out (including myself) that the drop in the overall participation rate is the reason the unemployment rate is falling.
The unemployment rate is calculated by using individuals who are unemployed, but looking for a job.
source: Business Insider
While the labor force includes those who could potentially be part of the work force:
Labor Force Participation Rate = (Labor Force / Total Population over Age 16) * 100
It is important to note that the labor force does not include people under the age of 16, nor students, retirees, the disabled, homemakers, and the voluntarily idle.
The voluntary idle component is where the controversy lies. The question economists are asking is “Why is the labor force shrinking?”.
Many believe that a large population of the work force has given up looking for work until economic conditions improve.
If this group is added back into the unemployment calculations, then the overall unemployment rate is higher than it is currently stated.
Quit Rates: What Janet Yellen Is Most Likely Looking At
To get an idea of what Fed Chair, Janet Yellen, thinks about the current state of the economy, we should look at “quit rates”.
Quit rates track how many people are voluntarily quitting their job. The concept is that when the economy is strong, individuals will be more likely to quit a job in order to find a better one.
A low quit rate indicates that individuals are worried about finding a replacement job, and therefore do not quit their current job.
Yellen has been a fan of quit rates for some time and has referenced it in past speeches as an indicator she looks at.
“I am likely to supplement the data on employment and unemployment with measures of gross job flows, such as job loss and hiring, which describe the underlying dynamics of the labor market. For instance, layoffs and discharges as a share of total employment have already returned to their pre-recession level, while the hiring rate remains depressed.
Therefore, going forward, I would look for an increase in the rate of hiring. Similarly, a pickup in the quit rate, which also remains at a low level, would signal that workers perceive that their chances to be rehired are good–in other words, that labor demand has strengthened”
Quit rates have not risen at the same pace as hires and job openings, indicating that the job recovery may still be in its early stages:
Source: Bureau of Labor Statistics
Should The Fed Be Worried About Inflation?
One of the key missions of the Fed is to fight inflation.
Inflation is still not a threat in my opinion. In fact, the Fed should be more concerned that its actions could cause a deflationary cycle similar to what happened in 1937 — when fiscal stimulus began to slow before the economy had fully recovered.
Already, the consumer price index (CPI) continues to fall:
The CPI measures the weighted average of prices in a basket of consumer goods and services, such as transportation, food and medical care. Changes in the CPI are used to assess price changes associated with the cost of living.
As a result, the CPI is commonly referred to as “headline inflation”.
source: dshort/Advisor Perspectives
Commodity Prices Not Confirming Growth Numbers
Another data set I find interesting are commodity prices.
During periods of inflation and strong demand, commodity prices tend to rise. Higher commodity prices lead to higher costs of living, which typically leads to higher inflation.
Instead of seeing rising commodity prices, we are starting to see a breakdown of the upward trend that has been in place for the past 13 years:
source: Kimble Charting Solutions
Additionally gas prices continue to drop:
Lower fuel prices may indicate that people are traveling less, packages are being delivered less, and construction is slowing down. Again – this does not support inflation.
That’s the mystery. Like the current economic data, the Fed seems to be mixed on what it needs to do next.
Hopefully, for investors, the mixed economic data will keep the Fed on its toes and a bit hesitant to raise interest rates too quickly.
Keep an eye on the above indicators to see if current trends strengthen or weaken. Either way 2015 is going to be a tough year for the Fed.
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