Sticky inflation persists. The prices of median goods and services have ticked up. This slow change of prices is a headache for the Federal Reserve. They will worry that inflation expectations have anchored to an elevated level.
Inflation is problematic on several fronts. For the stock market, companies will see reductions in profit margins even if prices catch up with cost structures. This will worry market participants.
Sticky inflation can have significant implications for an economy, leading to misallocation of resources, reduced productivity, and lower economic growth. The Fed will manage inflation expectations by adjusting interest rates, to encourage price adjustments and stabilise the economy.
Futures market predicts three more quarter-point hikes in Fed's meetings in March, May, and June. The last increase has 57.5% chance to reach a peak of 5.25% to 5.50% by June, up from less than 4% a month ago and 41.8% last week, per CME Group's FedWatch site.
Two Fed district presidents, Mester and Bullard, thought last week that a half-point hike was more suitable at the last FOMC meeting, which concluded on 1 Feb, before the release of strong economic data. However, neither of them will be voters this year. Meanwhile, the Fed Board's vice chair, Brainard, leaving to head the White House's National Economic Council, means a prominent dove will be lost from the panel.
The US10-year real rate has been surprisingly benign, moving only slightly into its neutral area between its blue bands. However, the Bollinger bands are narrowing (green rectangle). This suggests a proverbial calm before the storm.
Bolinger theory suggests that low volatility cannot persist and given the median inflation, an expansion in the real rate's volatility makes sense. Whilst the theory says little about the direction of the increase in volatility, a movement into the hawkish area between the upper blue and red bands will not be a surprise.
Senior Market Specialist
Russell Shor joined FXCM in October 2017 as a Senior Market Specialist. He is a certified FMVA® and has an Honours Degree in Economics from the University of South Africa. Russell is a full member of the Society of Technical Analysts in the United Kingdom. With over 20 years of financial markets experience, his analysis is of a high standard and quality.