While it’s a quiet period for the Federal Reserve (Fed) this week ahead of next week’s first Federal Open Market Committee (FOMC) meeting of 2017, many market participants are trying to gauge the Fed’s view on inflation, especially core inflation, early in 2017. Markets are also concerned about core inflation—and its impact on central banks—globally given the key role we expect currencies to play in financial market returns in 2017. But first let’s look at how we got here on inflation.
West Texas Intermediate oil prices peaked at nearly $110/barrel in mid-2014, and finally bottomed out 18 months later at just over $26/barrel in February 2016, a 77% decline. Over that time, the headline Consumer Price Index (CPI) in the U.S. moved from 2.1% year over year in mid-2014 into negative (i.e., deflationary) territory in the first half of 2015, as the initial drop in oil had the biggest impact during the first 12 months of the oil price collapse (see figure below). Since then, oil prices have moved higher, and are currently near $53/barrel, roughly doubling from a year ago. Over the 12-month period ending in December 2016, the headline CPI posted a 2.1% increase, putting inflation ahead of the Fed’s 2% target. For reference, energy accounts for around 7% of the CPI. The last time the 12-month change in the CPI was higher was in early 2012.
When oil prices were on the way down in 2014, 2015, and early 2016, and CPI was decelerating, many Fed officials noted that the move lower in inflation was “transitory,” and tried to focus the market’s attention on “core” inflation, measured by the CPI excluding food and energy. So where are we on those metrics today in the U.S. and overseas?
In the U.S., core CPI bottomed out at 1.6% year over year in late 2014. Led by a noticeable acceleration in prices of services (education, healthcare, housing, etc.), core CPI accelerated throughout 2015 and 2016, posting a 2.2% year-over-year gain in December 2016, just 0.1% below the highest reading in nine years. Overseas, core inflation has also accelerated in recent years in many large developed market economies, but remains below core inflation in the U.S. For example, in the Eurozone, core CPI bottomed out at 0.6% year over year in early 2015, but by late 2016 had moved to +0.9% year over year. In the U.K., the pace of core CPI inflation has more than doubled recently, moving from 0.6% in mid-2015 to 1.3% in late 2016.
In emerging markets, the story is similar. In China, for example, core inflation has also moved higher from 1.4% in May 2016 to 2% by December 2016. Acceleration in core CPI is also evident among other large emerging market economies, such as India (4.1% in early 2015 to 4.9% in December 2016), Mexico (2.3% in early 2015 to 3.4% in late 2016), and Poland. On balance, core inflation is accelerating in more than 60% of the global economy (U.S., Eurozone, China, India, U.K., Mexico, and Poland), but only India and Mexico’s core inflation is accelerating and running above the U.S.’s core inflation (see figure below).
However, in Japan (the world’s fifth-largest economy), core inflation is still decelerating and is close to zero. In large developed economies like Korea, Canada, and Australia, core inflation is also still decelerating and running below the U.S. rate of 2.1%. However, in large emerging market economies like Russia, Brazil, Indonesia, and Turkey, core inflation is generally running above the U.S. rate of 2.1%, but is still decelerating.
We continue to expect overall inflation in the U.S.—as well as core inflation—to accelerate in the first half of 2017, as oil prices stabilize near 100% above year-ago levels and as the labor market tightens further. Overseas, core inflation is also likely to nudge higher but generally remain below U.S. inflation rates in developed markets and continue to run above the U.S. in most emerging market economies.