Part of the reason for this is the fact that headline consumer inflation is set to surge in the next few months as the base effects of oil’s price falls fall out of the system and are replaced by slightly higher prices.
According to Edwards, Societe Generale economists expect headline CPI inflation to soon exceed core CPI (currently 2.2%) by about 50 basis points. On their core projections, headline CPI will hit 2.6% by February next year before moving towards 3% by the end of the year.
This is important because one of the effects of the low oil price and the resultant low headline inflation was that even subdued nominal wage inflation translated into strong real wage growth. This however is set to end as headline inflation jumps, which begs the question: “How will the household sector respond?”
“This question is crucial because the only thing at the moment keeping the US economy overall out of recession is the relatively robust consumer,” Edwards explained. “The surge in headline inflation from zero to 2½-3% in Q1 next year is likely to crush consumption. The expected expansion of the fiscal deficit under Trump will not prevent this happening in 2017 as it will come too late – in 2018/19.”
For Edwards, the key thing is how the Fed and the markets react to the above outlook.
“My own view is that the Fed, having promised to be data dependent, will not be able to shrug off a rapid acceleration in wage inflation in the same way they might shrug off headline CPI rising well above core CPI,” he said.
Adding: “ My own view is that after the December hike they will likely tighten twice more in the early months of next year. To those who retort that the increasingly weak economy in H1 2017 means they should not tighten – would probably agree. But that doesn’t mean the Fed won’t be forced into it by surging wage inflation.”
