Lower Energy Prices Could Be Inflationary
I read a short article Friday morning about when the Federal Reserve might increase interest rates. One money manager interviewed argued that the drop in oil prices means that the Fed will raise rates later than initially thought. This argument is based on the notion that lower oil prices are deflationary and that the Fed won’t raise rates until it sees evidence of inflation.
This kind of thinking makes sense on the surface, but it could be off base. When oil prices were rising, the Fed and a number of economists said we should ignore headline inflation and focus instead on core inflation. For those who don’t know, core inflation is the rate of inflation if you exclude food and energy. The reason economists study core inflation is because food and energy prices are notoriously volatile. As a result, it makes sense to examine both core and headline inflation.
However, if the Fed focuses only on core inflation when energy prices are falling, it could miss inflation in other kinds of goods and services. While the Fed will monitor both inflation figures, it will likely pay more attention to headline inflation in a falling energy price environment. The Fed does not want to fall behind the curve.
Furthermore, lower energy prices could actually be inflationary rather than deflationary. This is because lower energy prices should generate more economic activity. Demand for all kinds of goods and services could rise when energy prices are low. As a result, businesses are more likely to expand and hire more people. This increased economic activity caused by lower energy prices could produce higher, rather than lower, headline inflation. That alone could prompt the Fed to stick to its plan to raise rates. At this point I continue to expect the Fed to increase the fed funds rates during the first half of this year.
Read Vahan’s blog at Janjig.com.
Vahan Janjigian is Chief Investment Officer at Greenwich Wealth Management, LLC, a SEC Registered Investment Adviser, where he manages portfolios for clients in separate accounts. Dr. Janjigian is a former Forbes magazine columnist and former Editor of the Forbes Special Situation Survey. According to Hulbert Interactive, his stock picks returned more than 18% annually during one of the market’s worst 10-year periods.
Dr. Janjigian holds the Chartered Financial Analyst designation and has earned degrees in general sciences and finance from Villanova University and Virginia Polytechnic Institute and State University (Virginia Tech). He previously served on the faculties of several universities, including the University of Delaware, Northeastern University, the American University of Armenia, and Boston College, where he taught courses in corporate finance, financial theory, investments, accounting, and economics; and he currently teaches a seminar on equity investment management to business executives in Singapore through Baruch College’s Zicklin School of Business. Dr. Janjigian has served as an expert witness on matters involving portfolio management, churning, suitability, and hedge fund manager compensation.
Dr. Janjigian has published his research in numerous scholarly and professional journals; and has been quoted in many leading newspapers and magazines, including Barron’s, Forbes, The Wall Street Journal, and USA Today. He appears as a guest commentator on various television and radio networks, including Fox, CNBC, MSNBC, and CBS Radio. Dr. Janjigian is the author of Even Buffett Isn’t Perfect (published by Penguin) and co-author of The Forbes/CFA Institute Investment Course (published by Wiley).