Inflation- Modest Acceleration

“A gradual uptrend” is how one economist described the behavior of last week’s refreshed Consumer Price Index (CPI). In March the index climbed 0.2 percent, compared to 0.1 percent in February; over the past year, prices rose 1.5 percent. With inflation so low, it is likely the Federal Reserve will maintain its accommodative policy until the labor market “slack” shows noteworthy improvement. In response to a recent question, Fed Chair Yellen acknowledged significant labor market slack but noted that the relationship between the labor market and inflation was not clear. She also specifically noted that deflation was a much greater risk to economic prosperity than inflation. Deflation makes interest payments on debt more “expensive,” decreases the incentive for consumers to spend and increases the incentive to save. When combined, these factors make us believe the Fed will hold down interest rates until at least mid-2015 and continue to steadily turn off its bond-buying program in order to eventually allow economic growth to take hold of interest rates. A slight acceleration in inflation will not prompt immediate Fed action. As inflation approaches the 2% target, however, interest rate markets could whipsaw at even the most modest mention of a Fed rate hike. We maintain a long-term focus by disregarding interim volatility and positioning portfolios to benefit from eventual higher interest rates.