Rising Interest Rates or the Brink of QE4?

My colleague, Wenny Gorman, explained in her recent blog on inflation that as prices rise, consumers are more inclined to make their purchase today as opposed to waiting.  This is because in an inflationary environment, prices are rising which means the same purchase will require more money in the not too distant future.  With deflation, the opposite happens, and consumers hold off on their purchases until they really need the item, as the price is likely to be lower in the future than it is today.

Last week the US Consumer Price Index (CPI) fell below 1% to .8%.  It is quite uncommon to have the CPI below 1% in a growing economy.  It will be interesting to see how the Federal Reserve (Fed), and more specifically Janet Yellen, respond if such low CPI numbers persist.  Right now, our economy is growing, while much of the rest of the developed world, Japan and Europe in particular, are struggling to stay out of both a recession (decline in economic activity), and more importantly a deflationary environment (prices decline).

Headed into 2015, there was a strong consensus between most market pundits and investors that the Fed would begin to raise rates later this year.  Should future CPI data begin to depict a landscape in which a deflationary spiral seems probable, we would be hard pressed to see a Federal Reserve that would tighten, i.e. begin raising rates.  In fact, such a scenario could trigger just the opposite.  Instead of the Fed trying to keep economic growth going at a measured pace, they may find themselves once again in a situation where they have to apply techniques to stimulate growth…. QE4.

All comments and questions are welcome.

Denise Farkas, CFA®