This One Chart Explains Why People Are Still Optimistic About Fed Action In September

Economic data in the U.S. has surprised to the upside lately, endangering economist predictions for a September round of quantitative easing.

Quantitative easing essentially puts money right in the pockets of banks, giving them more cash to spend and forcing investors into riskier investments. The last two rounds of QE and a third easing measure—”Operation Twist”—have led to big market rallies that last months.

That said, QE is also seen as an inflationary last resort against mounting financial tensions, and so data that is too positive would dissuade the Fed from taking action.

While real U.S. economic data may be looking up, however, prices are not.

The Fed targets an inflation rate of about 2 per cent, and generally prefers a little more inflation to a little less. With Japan’s Lost Decade never far out of sight, economic policymakers are more concerned about controlling deflation than they are inflation, because they feel they can fix rising prices by swiftly raising interest rates to tighten credit.

Right now, both of the inflation indicators policymakers use—the media’s preferred CPI (blue) and the Fed’s favourite, core PCE (red)—are screaming that prices are not rising quickly enough. Both measures come in below the crucial 2 per cent.

And that could spur the Fed into action, regardless of employment data.

Sluggishness in the U.S. housing market and hiring certainly isn’t helping the economy get fired up, however concerns about rising deflation risk likely have more to do with slowdowns in Europe and China than from the U.S. alone. This could inform the kind of action that the Fed takes next month.

Photo: FRED

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