O Inflation, Inflation! Wherefore Art Thou Inflation?
A lot of eyes were on Janet Yellen’s testimony in front of the Senate Banking committee last week, as investors wanted to hear more clues about a potential change in the economic and monetary policy of the Federal Reserve. People seemed to be particularly interested in finding out more about the expected rate hike pace and the reduction of the size of the Fed’s balance sheet.
Alas, no new statements were made on these topics (Yellen rarely provides ‘scoops’ in official hearings and testimonies), but she did confirm the inflation expectations remained on track thanks to the ‘strong’ labor market and the rising prices of imported goods (undoubtedly helped by the weakening US Dollar versus the Euro, as you can see on the next image).
Surprisingly, the mainstream media jumped all over this quote to point out why the gold price was going down that day. Morningstar (copied from the Dow Jones newswires) went as far as using as title: ‘Gold Falls After Yellen Says Inflation May Rise‘ . Most news outlets tend to forget a lot of people actually buy gold as a hedge against that very same inflation as it’s one of the best ways to maintain a certain purchase power (it’s a hedge against inflation and economic and geopolitical shocks).
Literally the next day, an updated Consumer Price Index and so-called real earnings report was released by the Bureau of Labor Statistics. Yellen might have to do her homework again, as the CPI data points out the situation remained completely unchanged in June. Not only does this de-rail Yellen’s previous statement, connecting the rate hikes to the inflation rate, it also means there’s a bigger problem.
Whilst everybody was focusing on the CPI data, we compared those with the Real Earnings data. This taught us two different things which are completely contradicting each other. On the short term basis (Month on Month), the average hourly earnings for all employees increased by 0.2%. Is that surprising? Yes, considering the higher (hourly) income did not result in a higher inflation rate.
One potential explanation could be there will be a ‘delayed reaction’ and we will see the inflation rate picking up again in July, but we think the recent weakness of the US Dollar is to blame here. As you could see on the chart we previously used in this article, the US Dollar has lost approximately 10% of its value versus the euro in the past year and this makes it more expensive for the average American to pay for imported products. So whilst this might not lead to an increase in the CPI results, it’s definitely possible people are spending as much money as before as the total dollar index is moving down as well.
A second explanation could be based on the second variable of a monthly or annual income. Whilst a wage per hour is one part of the equation, the total amount of hours worked obviously is as important and even though the wages increased, it’s absolutely not impossible this was connected to a lower amount of hours per employee.
Was Yellen too optimistic? And if she is; gold traders seem to like low inflation rates more than high inflation rates these days!