The failure of US inflation to pick up despite strong GDP growth and employment levels are preoccupying policy makers at the US Federal Reserve.
The minutes of the September meeting of the Federal Reserve’s Open Markets Committee (FOMC) which sets interest rates, were released yesterday (11 October) and the committee reiterated its view that rates are likely to increase again in December.
But the US dollar was weak as a result of the tone of the comments, with several members of the committee expressing concern that inflation has not picked up by as much as expected.
Kathleen Brooks, head of research at Forex.com, said the dollar is the weakest performing major currency in 2017.
Although interest rate rises are designed, over the medium term, to act as a peg on inflation, the Federal Reserve will want to see inflation rising towards its target.
If rates are increasing at a pace much faster than inflation is rising, then Ms Brooks said the Federal Reserve will be concerned about the impact on economic growth.
Rebecca O’Keefe, head of investment at Interactive Investor, said the US central bank is pondering whether inflation persisting below the 2 per cent target level is transitory or structural.
She said the stark divergence of opinion on this subject is likely to mean the path of US interest rate rises will be “less aggressive” than expected.
Ms O'Keefe said this slower pace of monetary tightening is likely to boost equity market returns, and keep bond yields lower.
Phillip Smeaton, chief investment officer at Samlan UK, said: “It’s the consensus view that global inflation is likely to stay low for the foreseeable future. We think this makes sense, but holding the consensus view means we must be extra careful not to be caught in a stampede when everyone is changing their mind at the same time. After all, as the graph below reminds us, this isn’t the first time that a benign inflationary environment has changed quickly.”
Jacob De Tusch Lec, who runs the £3.6bn Artemis Global Income fund, said the Federal Reserve’s caution on inflation has led him to increase his exposure to emerging market equities, as those markets are likely to benefit from a weaker dollar.
Emerging markets benefit from a weaker dollar because those economies often have to borrow in dollars, so a weaker dollar reduces financing costs.
Additionally, all commodities are priced in dollars, so a weaker dollar makes the exports of emerging market commodity exporters cheaper.
Ben Preston, who runs the £25m Orbis Global Equity fund, said emerging markets are the cheapest equity market now.
david.thorpe@ft.com
