US: More evidence of pricing power - ING

James Knightley, Chief International Economist at ING, suggests that the market continues to doubt that the Fed will hike rates meaningfully over the next couple of years, but analysts at ING think the data is increasingly pointing to the likelihood of the Fed taking a more aggressive route.

Key Quotes

“The Federal Reserve has been suggesting that recent weakness in growth and inflation was likely to be transitory, but the market remains sceptical. This hasn’t been helped by the fact inflation and wage pressures have softened and there has been no real progress on President Trump’s tax reforms, which would likely have provided a significant boost to growth.”

“However, there is growing evidence to suggest that inflation is likely to soon return to target while the underlying health of the US economy seems to be improving, supporting the “transitory” assessment of the Fed. Last Friday’s labour report showed job creation remains strong while wage growth picked-up with a 0.3% MoM increase.”

“There was more evidence of labour market strength yesterday with the National Federation of Independent Businesses reporting a rise in its headline sentiment index on small business optimism. Meanwhile, the hiring plans of small businesses and the proportion of small businesses reporting hiring difficulties hit new cycle highs (the former is the strongest the index has been since December 2003). This strong labour demand weak labour supply story points to more wage pressures in the future while strong demand for workers was also reported in yesterday’s JOLTs report.”

“Job openings surged to a new record high of 6.16m, up 461,000 on May. The fact that these were not all filled suggests intensifying tightness in the jobs market that again points to rising wage pressures in the future.”

“However, it isn’t just wage pressures that are showing tentative signs of rising. Last week’s PMI reports showed strong increases in their prices paid components. This points to pipeline price pressures and was also backed up by the NFIB survey, which stated that the percentage of businesses raising their selling prices hit the highest number in two years.”

“Tomorrow sees the release of producer price inflation, which we expect to accelerate to 2.3% YoY from 2% with core (ex food and energy) set to rise to 2.1% from 1.9%. This reflects rising commodity prices (oil is up 14%), the weaker dollar (down 10%), which is contributing to higher import prices and the strength of underlying demand, which is helping to support profit margins. Then on Friday we will be focusing on the CPI report, which we expect to show headline inflation rising to 1.8% from 1.6%.”

“With inflation looking set to return to target quite soon, the economy adding jobs in significant number, the economy growing relatively healthily and wage risks skewed more to the upside than the downside, we continue to think the market is underplaying the risks of higher interest rates. We continue to expect a December rate hike followed by two further 25bp moves higher next year.”