Falling energy prices once again contributed to a decline in the headline Consumer Price Index (CPI) in May. The CPI fell by 0.3% for the month, although the core index rose again by 0.2. Since its recent peak in September at 3.9%, headline inflation has been trending lower, easing to just 1.7% in May, but the year-over-year core number remains stuck at 2.3%.
Slower global growth and an easing in tensions in the Middle East have chipped away at energy prices in recent months, and was again the primary driver for disinflation in May. Prices at the pump have also edged down in recent months, easing household budget pressures and leaving a bit more in consumer wallets. That hasn’t necessarily translated to higher spending in other areas, however, as yesterday’s disappointing retail sales report illustrated.
With inflation seemingly in check, the Fed appears well-positioned to revisit discussions of additional policy action next week, as the end of Operation Twist quickly approaches. The increasingly apparent slowdown in the already weak expansion should make these conversations more approachable. Moreover, the Fed has historically taken the stance of avoiding policy moves too close to a presidential election to avoid being seen as influencing the outcome. If that is to be the case in this cycle as well, the window for action is quickly closing.
Falling inflation can have positive effects, but the current easing has been driven by a global slowdown in growth which creates an increasing risk to the U.S. economy as well. Optimism that the U.S. was bucking the global trend is waning, as economic data increasingly points to a notable slowdown here as well.
Three broader fat-tail risks still exist today: the growing Eurozone crisis, the increasingly synchronized global slowdown threatening even the high-octane Chinese economy, and the risk surrounding the so-called “fiscal cliff” in federal spending and tax policy if automatic triggers are not addressed before January. We remain cautious in our near-term outlook for the economy, but acknowledge that policy actions are a significant wild card. We anticipate further market volatility as conflicting economic data and potential policy developments are absorbed by the markets.
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