US Preview: Final Pieces To Fall Into Place Week Before Fed Meets

Here's what's on the US market menu this week. What do you think — will the final pieces fall into place a week ahead of the next Fed meeting?

Via wbponline.com

by Vladimir Amrich
WBP Online correspondent in Washington

Concerns over the inflation outlook are on the forefront for policymakers at the Federal Reserve (Fed), judging by remarks of a top official last week.

One of the key gauges of expected price growth, the so-called five-year forward inflation expectation rate slipped to around 230 basis points in late September and early October, after holding above the 240 basis points mark during the previous 14 months.

In fact, the gauge has been that low or lower only four times during the recovery: in the summer of 2010, before the start of QE2, in the wake of the debt ceiling crisis and the US debt downgrade in the second half of 2011, in May 2012 just before QE3 was launched, and early last summer when Ben Bernanke breached the topic of tapering QE.

Next week's data will be among the last major fundamentals Fed officials will have at their disposal at their upcoming gathering on October 28-29, together with September durable goods, a day before the meeting starts.

Consumer inflation

Although the Consumer Price Index (CPI) is the most commonly reported measure of inflation, the Fed actually considers a different gauge - the price index for Personal Consumption Expenditures - to be the benchmark.

While describing the same phenomenon, there are differences in the ways the indices are calculated, and the weight assigned to various components. However, over time the CPI and the PCE deflator both correlate closely, with the former outpacing the latter by about 30 basis points, on average, over the past three and a half years.

Also, economists prefer to look at the so-called core measures of inflation, which exclude food and energy prices, which, though relevant, tend to have large fluctuations from month to month, which obscures the underlying trend.

Analysts are expecting to see an increase of 0.2% in the core CPI index from a month earlier in the upcoming September release. That would put the change in the core CPI over the previous 12 months at 1.8%, matching the reading in August.

As recently as May, core inflation had been at 2%, matching the reading in February 2013, for the highest pace since the beginning of the third round of Fed's purchases. So far this year, core inflation has shown no progress on the 1.8% average seen last year.

The year began with a three-month-long streak of 1.6% on core inflation lasting until March, which also represents of the bottom of the range of inflation readings over the past three and a half years - should the September report undershoot the 1.6% mark, it would be the first time since June 2011.

For now, there appears to be little goods disinflation in the pipeline, economists at Deutsche Bank said in a recent note.

"If goods prices were going to deflate further, which is what the financial markets currently fear, then we should see both crude and intermediate prices trend lower, as they did in 2008 and 2010. In each case, their movement led the change CPI goods prices," researchers said.

Still, lower energy costs should be palpable in the broader headline CPI, with forecasters penciling in no change from a month earlier and a slip to 1.6% year-over-year in September. This would be the first time that the core measure outpaces the headline since March.

The Department of Labor in Washington will release the September issue of the CPI report on Wednesday at 8:30am local time.

Housing

The second important data set will track sales of homes.

Both the National Association of Realtors (NAR) and the Department of Commerce (DoC) are due to deliver their reports on housing demand at 10:00am on Tuesday and Friday, respectively.

The NAR's tally of existing home sales, which are finalized contracts to buy a home, should climb to 5.09 million in September, after a mild setback to 5.05 million in August caused by fewer purchases from investors.

The DoC's report on sales of new single-family homes is expected to decline to 473,000 units, as payback for a previous outsized surge.

Last week, housing numbers came in stronger with starts and permits in September reversing a good part of the previous slump.

The upcoming sales figures should reflect lower mortgage rates as well as more accessible loans, although credit data still showed the level of outstanding loans declining through June.

Fed response

There has been substantial talk about the near-term trajectory of the US economy, mostly after the surprisingly soft September retail sales numbers.

However, gross domestic product (GDP) growth is still expected to come in at no less than 3% in the third quarter, which is substantially above the post-recession trend, and strong enough to keep unemployment trending down. The strengthening of the jobs market is being signaled by jobless claims data, which only last week hit 14-year lows.

So, while concerns over US growth momentum appear exaggerated for now, inflation may take longer to accelerate than the Fed anticipates. Since monetary policy is data dependent, the logical course of action would be for the central bank to postpone the timing of the rate hike, while at the same time touting progress achieved at every opportunity.

This is what the future for the fed funds rate have been signaling last week, when the expected timing of the first rate hike slipped toward the end of 2015.

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