The latest Consumer Price Index (CPI) numbers were released on February 19, 2016 for January. While the CPI is flat, the year-over-year change is now 1.4%.
The more stable median CPI ticked up, as the 12-month change is 2.4%. You can view the numbers here.
Energy prices have had a big impact on the numbers. It is the primary reason for such a low CPI reading. For example, while the 12-month change in the CPI is 1.4%, it is 2.2% when you remove food and energy. This is actually above the Fed’s supposed target of 2%.
I continue to stress that although the CPI is a government statistic that is far from perfect, it is still useful for a couple of reasons.
First, the CPI can show us trends. As long as the weightings are the same, it does give us a picture of whether consumer prices are trending up or down.
Second, we have to believe that the Federal Reserve uses the CPI statistics in its decision making. I believe that the numbers are probably understated, especially when it comes to health insurance premiums. The weighting and methodology for including health insurance premiums is complicated to say the least. We all know that premiums have skyrocketed while the actual health plans cover far less.
But to the Fed, consumer prices look tame. In most things, prices are relatively tame in our fiat currency era. Prices are going up, but nothing compared to the 1970s.
For this reason, I think it is more likely that the Fed will not be afraid to lower its target rate again, or start another round of so-called quantitative easing.
I know we hear about negative interest rates now, but the Fed is currently paying banks 0.5% on reserves. This is to support its targeted federal funds rate. So before the Fed imposes a negative interest rate, it would first have to actually stop paying the banks to not lend.
The Fed is sitting in a sweet spot right now in terms of lower unemployment and relatively low price inflation. Therefore, the Fed will probably sit tight until the stock market falls a lot more, or until it is more evident that we are in, or heading into, a recession.
Things can happen quickly as we saw in the fall of 2008. You could wake up on Monday morning and see the Dow futures down by 1,000 points. If we see a few days in a row of plunging stocks, the discussion can change quickly. It won’t be talk of whether the Fed will raise interest rates again, but whether the Fed will lower them or start more money creation.
The Fed has had a tight monetary policy since October 2014 when it ended QE3. It has not been expanding the monetary base since that time. Due to the tight money, I believe the misallocated resources built up from the easy money of 2008-2014 will be exposed shortly. As stocks fall and long-term yields fall, a recession is looking more and more likely.
If the CPI were running at 3 or 4 percent, then I might think the Fed would sit still in the face of plunging stocks. But since consumer prices are relatively low, the Fed may not hesitate as much to inflate. We should consider this going forward. It looks as though gold investors are already considering this, as the price has risen in the face of falling stocks and falling yields.