Forex Investment and Currency Trading

Despite rising energy costs, a second consecutive subdued core consumer inflation reading in March indicates that the slowing economy is reducing business pricing power and helping to keep inflation in check. While the Fed remains concerned about inflation developments, the recent trend gives it somewhat more flexibility to ease policy as necessary to support the weak economy amid continued difficult credit conditions.

The overall consumer price index rose 0.3% (0.343% to 3 decimal places) in March, matching the median of analysts’ forecasts (according to Bloomberg). Year-over-year headline inflation remained at 4.0% for a second consecutive month, ensuring that inflation pressures remain an issue of concern for the Federal Reserve. Energy costs rose 1.9%, as fuel oil prices jumped 7.9%, natural gas 1.9% and gasoline 1.3%. Note that non-seasonally adjusted gasoline prices rose a hefty 7.2% in March, but seasonal factors allow for a substantial spring rise in gasoline prices. This factor will also hold down seasonally adjusted gasoline prices in April.

The core consumer price index, which excludes food and energy costs, rose 0.2% (0.152% to 3 decimal places) in March, also matching the median of analysts’ forecasts. It was a second consecutive relatively subdued core inflation reading. Year-over-year core CPI inflation nudged up to 2.4% in March, but remained well below the highs of late 2006.

The report showed signs of diminishing business pricing power amid the slowing economy. Apparel prices fell 1.3%, a second consecutive decline and the largest contributor to a subdued core reading last month. A second consecutive drop in the costs of lodging away from home, likely reflecting slack demand for hotel/motel accommodations, suppressed the shelter component of the CPI and also contributed to a soft core reading. Even medical care rose relatively softly in March, while higher public transit and recreation costs were partial offsets.

While Fed rate cuts late this month and beyond are likely to be less aggressive than recent easing, we believe that the FOMC is likely to lower rates beyond the current one to two more 25-basis-point eases priced into Fed funds futures. With housing and employment continuing to decline, we maintain our forecast of a 1.5% funds rate target later this year.