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01 20 2016 | by Victor Xing | Economics

December CPI: inflation amid weakness in yuan and oil

December CPI came in below market expectation on a month-over-month basis, as dis-inflationary effects of weaker yuan and lower oil intensified at the end of 2015, albeit both now appear firmer in retrospect (even though it still feels odd to call 40 handle oil price “firmer”).  Indeed, investors are now bracing for an even bleaker aggregate consumer price index in the coming month, and futures market is now pricing in slightly less than one rate hike for the entire year of 2016.
On a month-over-month basis, major December CPI constituents are as follows:
  • Headline aggregate CPI: -0.111 vs. flat consensus
  • Core (ex-food & energy) CPI: 0.127 vs. 0.2% expectations
  • Medical Care (medical care has a bigger weight in PCE – Federal Reserve’s preferred measure of inflation): 0.087 vs. 0.361 prior
  • Owners’ Equivalent Rent (proxy for rental inflation): 0.233 vs. 0.209 prior
  • Apparel (proxy for dis-inflationary effects from Chinese imports): -0.235 vs. -0.318 prior
  • New vehicles (proxy for dis-inflationary effects from Japanese imports): -0.064 vs. 0.056 prior
December CPI - MoM
December CPI – MoM change
The year-over-year measure looks slightly better, and it is worth noting that the December 2015 YoY change is relative to the soft December 2014 print due to a similar slump in oil prices (WTI fell to 60.48 on Dec 31st 2014 vs. 68.58 on Nov 28th 2014):
  • Headline aggregate CPI: 0.661 vs. 0.5% prior
  • Core: 2.089 vs. 2.0% prior
  • Medical Care: 2.582 vs. 2.948 prior
  • Owners’ Equivalent Rent: 3.145 vs. 3.076 prior
  • Apparel: -0.924 vs. -1.524 prior
  • New Vehicles: 0.201 vs. -0.924 prior
December CPI - YoY change
December CPI – YoY change
30 day federal funds futures, Jan 2017 – the effective rate reflected in price is 60 basis points, which already includes the current effective funds rate of 36 basis points.  The residual is therefore 24 basis points, less than a 25 basis point hike:
December CPI - dovish FED is priced into the market
Dovish FED communication and policy path is priced into the market
WTI crude futures:
December CPI - market is expecting weak oil to push headline inflation even lower in the coming months
A number of investors are now calling for oil going below $20 – a sign of bearish sentiment
A dovish Federal Reserve communication from its January meeting is now largely priced into the interest rates market, and investors are also expressing their rate path expectations based on a largely bearish outlook on China.  It is worth mentioning that the January rout in equities, oil, and yuan mirrors that of 3Q 2015 with similar catalyst, and investors are consistent in their behavior by pricing out rate hikes.
Nevertheless, the lessons from 4Q 2015 (when oil stabilized and China appeared “less bad” as data improved) was the Federal Reserve can be as sentiment driven as investors, and they not immune from revising their outlooks based on changing economic conditions (especially given energy prices’ impact on the real economy).  Referring to recent FED speeches, 4 hikes are not “baked in the cake,” but in my view neither is 1 hike.

Next article01 15 2016 | by Victor Xing | Central Banks

January FOMC communication wrap-up