Rate update: Low inflation checks interest rates

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By G. Steven Bray

Interest rates received a nice surprise from inflation data last Fri. Last week, we discussed that several inflation metrics are showing budding inflation, especially at the producer level. We also discussed how producer inflation doesn’t always translate into consumer inflation, and that’s what we saw last week.

The consumer price index, the godfather of inflation measures, showed that core inflation actually rose at half the expected rate and stubbornly remains below the Fed’s target rate of 2%. Maybe just as important, consumer’s expectations for future inflation fell significantly, and this was despite the hurricane-induced increase in gasoline prices.

Well, bond markets liked this news enough to stop their march towards higher interest rates, but it wasn’t enough to ignite a new rally. Economic optimism is fairly pervasive at the moment, and with the White House and Congress singing Kumbaya together around the campfire, I think it would take a surprise event to deflate that optimism.

Short term I still recommend caution. There’s less friction for rates to move higher than lower. In other words, a less significant event, such as progress on tax reform or another hot inflation report, could move rates quickly higher.

Longer term, I think the chances for low rates still are good. The prospects of rising inflation and stronger economic growth helped lift rates off their recent lows, but they’re still only prospects. Most economists are predicting mediocre growth and low inflation for the coming year, and that would support our current low rates.