Income and Spending Key to Fed Rate Hike Timing

The surprise rate cut from the People’s Bank of China over the weekend, the second in under four months, is continuing to drive markets higher on Monday, although not overly aggressively in a sign that people remain unconvinced about the PBOC’s ability to shore up the slowing economy.

The decision by the central bank also follows a cut to the Reserve Requirement Ration in February and is extremely unlikely to be the last action it takes this year. Lending rates have risen in China at the same time as we see signs of deflation in the near future. The PBOC had to do something but markets are clearly not that impressed. A more significant slowdown looks inevitable, the only question is if a hard landing can be avoided.

One central bank already battling to drag itself out of a deflationary spiral is the ECB. Data released this morning showed that while minor improvements were seen in January, the outlook remains pretty dire. A third month of deflation was seen, with the CPI flash estimate recording a 0.3% decline in prices. The ECB announced an open ended quantitative easing program in January, which we should get more details of on Thursday with the program due to begin this month.

Whether this will be enough to drag the region out of a deflationary spiral remains to be seen but with unemployment so high and the deflation being so broad based, unlike that expected in the UK, the ECB has a massive job on its hands. I will be very surprised if the ECB doesn’t announce a further stimulus package this year to either work alongside QE, or just increase it.

Focus will now shift to the US, where manufacturing, construction, income, spending and inflation data will be released. The first week of the month is generally a very busy and volatile one, particularly the US, where the sheer volume of data releases, including arguably the most important of all, the US jobs report, tends to create a lot of market volatility. We also get a very good picture of how the world’s largest economy is performing which helps in forecasting the Fed’s first rate cut which I believe will come in the third quarter of the year.

While not generally viewed as the most important of the data releases this afternoon, the numbers I’m most interested in are personal income and spending figures. ISM and official manufacturing data may draw the most attention usually but at a time when the Fed is concerned about inflation, or the lack of it, and require evidence that inflationary pressures are present, we can’t look any further than income and spending figures as this is where it’s going to come from.

With unemployment so low now and slack in the economy appearing to be disappearing, wage growth is inevitable and this brings inflationary pressure with it, as long as this extra income is going back into the economy. If we can get evidence of this, I believe the FOMC will feel comfortable raising rates even if current inflation rates are more subdued.

The S&P is expected to open 2 points higher, the Dow 24 points higher and the Nasdaq 7 points higher.

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