Brief Summary:
- The U.S. Federal Open Market Committee and the Reserve Bank of New Zealand will hold their respective monetary policy meetings tomorrow morning. Expectations are for the Fed to end its quantitative easing program and for the RBNZ to keep rates on hold.
- On Friday, Eurostat will release its monthly Consumer Price Index estimate for the Euro area. The European Central Bank have been criticised for not doing more to combat very low inflation, edging towards deflation. Falling commodity prices, namely the sharp fall in the oil price, have been a major short term contributor to stagnant prices. The risk remains that 1990s Japan style deflation takes hold in the region.
The Fed and inflation
Tomorrow morning at 04:00 AEST, the U.S. Federal Open Market Committee will hold its October monetary policy meeting. The meeting will almost certainly see the final tapering of the quantitative easing program that began in late 2012. After three asset purchase programs since 2009, the Fed’s balance sheet has grown to almost $4.5 trillion. The Fed have deemed the program as a success and say that it will remain part of their monetary policy toolbox for future economic crises.
The focus of markets now turns to the timing of the first ‘post-GFC’ interest rate rise in the U.S.. Markets currently see this occurring in the second half of 2015; as implied by pricing of securities linked to interest rates. Economic growth and the labour market have continued to recover, however, another factor is coming under increasing scrutiny; inflation (or lack thereof).
Very low inflation or more serious deflation continuing for a prolonged period has become a potential pitfall for the developed world. Particularly in the Eurozone, inflation has been running dangerously low for much of the past twelve months. Falling energy prices have been a major short term driver among other post-crisis symptoms. Fed member James Bullard even stated that the Fed should consider continuing quantitative easing to prevent low inflation in the U.S.; although he did not receive support from his peers.
The problem with deflation is that it reaches a tipping point where it becomes self-fulfilling. In a deflationary economy prices fall with time. As such, there is no motivation to buy something today when it will be cheaper tomorrow. This stagnates consumption which means wages and prices fall further. Simultaneously, debts grow in real terms rather than being eroded by inflation. This dampens consumption further as they spend more to pay down debts, compounding the deflationary spiral.
The Fed has voiced an increased concern for inflation recently and may again step up this rhetoric. In July it stated, “Inflation has moved somewhat closer to the Committee’s longer-run objective”, however in September this changed to “Inflation has been running below the Committee’s longer-run objective. Longer-term inflation expectations have remained stable.” Inflation expectations have continued to decline worldwide and this month may warrant further comment.
Signalling the fight against low inflation will most likely be a USD negative as it suggests interest rates will stay lower for longer. As such, we will probably see a recovery in the AUD and NZD should the Fed shift to a more dovish stance. The AUD has risen against the USD ahead of the meeting probably due to some market participants preparing for such a change.
Chris Chandler