How Will US Fed React To Low Oil Prices.
Falling oil prices are the newest wrench in the Fed’s decision making, but the effect might seem counter-intuitive.
Since the Fed’s last meeting in October, oil prices have fallen 25%. With a meeting scheduled for this week, markets have two major questions about the Federal Open Market Committee’s (FOMC) decision: how long will rates stay at zero, and will oil prices change that? There is a growing belief among market participants that the FOMC’s first rate hike will be delayed by the glut of oil.
That sentiment is misplaced. If anything, the fall in oil prices will cause the Fed to raise rates earlier. Inexpensive oil has had a stimulative effect on the US economy and will have no effect on the more relevant measure of inflation: core inflation.
Two kinds of inflation
The Federal Reserve prints two different inflation numbers: personal consumption expenditures (PCE) inflation and core PCE inflation. Both are calculated in the same way, but core PCE inflation excludes food and fuel prices.
Related: Could Falling Oil Prices Spark A Financial Crisis?
While it may seem like a mistake – after all, food and fuel are the second and third largest spending categories for US consumers – the point is to strip out the most volatile prices and give a clearer image of systematic inflation in the economy.
