John M Berry says that strong corporate profits and consumer spending figures will ease fed pressure for a 50-basis-point increase
Inflation figures released by the US Department of Commerce have somewhat soothed market fears that worsening inflation will cause Federal Reserve officials to step up the pace of interest rate increases.
The strong 2004 corporate profits data the department put out at the end of March should be viewed in the same way.
A number of Fed officials, including chairman Alan Greenspan, have said that if solid economic growth leads to increases in labor costs, the pressure at first will probably result in declining profit margins rather than more inflation. The officials are assuming that with fat margins, businesses would generally absorb some of the rising costs rather than lose market share to competitors.
The commerce department said the Fed's preferred inflation measure, the core personal consumption price index, rose 0.2% in February, following a 0.3% increase in January, and left the 12-month change at 1.6%.
"The core PCE measures did not breach the upper end of the Federal Open Market Committee's (FOMC) 1.5%-1.75% range in February, as some had feared," Morgan Stanley economist David Greenlaw told clients. "This slightly reduced the likelihood of a 50-basis-point tightening at the next FOMC meeting."
Greenlaw said Morgan Stanley's "baseline case" still calls for rate increases of 25 basis points, though he cautioned that another round of CPI and PCE price releases will come before the FOMC's 3 May meeting. If the core readings are high, that could trigger a 50-basis-point increase, he said.
Perhaps. Certainly Fed officials have made it crystal clear that the pace of rate increases will depend on what the data show.
On the other hand, the Fed will be looking at far more than the price indexes, including what is happening to labor markets and costs.
Part of the latter calculation is the high level of corporate profit margins.
One measure reported two days ago was for margins at non-financial corporations last year. Out of each dollar's worth of inflation-adjusted value added in production at such businesses - that is, the difference between sales and input costs - 11.4¢ was profit. That figure was up from 10.5¢ in 2003 and just 7.5¢ in 2000.
For last year's fourth quarter alone, the margin was 12¢, a level approaching that of the boom years of the 1990s and higher than for any year in the 1980s.
"We now forecast (with energy costs remaining at these levels) annualised consumption growth of 2.25%-2.5% over the middle quarters of 2005, reflecting an estimate that higher energy costs will subtract as much as 0.75% from the level of real consumer spending," Levy told his clients.
"While a deceleration in domestic demand in coming months is likely, economic momentum will slow and reduce pressure on the Federal Reserve to accelerate its tightening path. At current levels of crude oil prices, it does not pose a significant risk to the economic expansion," Levy said.
Levy's analysis is consistent with the way in which many Fed officials have assessed the impact of oil price spikes in the past - that is, focusing more on the likely slowing of growth than on the increase in headline inflation numbers.
All this is more grist for the Fed's data mill.
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