The strongest dollar in over 11 years is coming soon to retailers all over the United States; the 24% surge since June will take some time to spread through the world’s largest economy.
It will first show itself in lower costs for goods imported by American companies and then in consumer prices. Clothing, electronics, and cars are some of the products that will have reduced price tags as the dollar’s appreciation fully ripples through the domestic markets.
This effect will boost household purchasing power, which has already seen the lowest gasoline prices in six years as well as low unemployment. Combined with cheaper fuel, the dollar’s strength will be able to apply downward pressure on inflation.
Prices of imported goods and services have fallen for the past seven months, the longest time a trend like this has gone uninterrupted since 1998. However, as energy prices stabilize, expect this trend to lose momentum.
With Prices Down
Excluding oil, import prices fell 0.7% in January as the rising dollar began to affect costs. Domestic prices at the consumer level will follow suit as retailers mark down wares in order to remain competitive.
Despite helping households, weakened inflation poses a challenge for the Federal Reserve as it is projected to raise borrowing costs.
Policy makers will need to decide to raise the benchmark interest rate for the first time since 2006 or take a hint from the shifting job market and allow the economy to accelerate further.
The Fed’s standard measure of inflation associated with consumption expenditures hasn’t been above its 2% goal since March of 2012.
Your Move, Fed
Downward pressure is manifesting itself elsewhere as well. The core rate which refers to food and fuel rose 1.3% in the preceding 12 months to January, matching the smallest year-to-year advance in a year.
The rate is projected to slide to about 1% by the middle of the year. Approximately half of the anticipated trend from oil and the dollar has been seen, with the largest effect expected around the middle of 2015.
Federal Reserve Chair Janet Yellen acknowledged that the drop in oil and rising dollar are causing inflation to fall short of the Fed’s objective.
The absence of inflation around the time some people predict the Fed will raise the benchmark rate could delay further rate hikes by the central bank.
That might be the best course of action. It wouldn’t go over well with the markets if the Fed attempts to force through a rate increase when inflation isn’t gathering steam.
Until Further Notice
The goal of monetary policy is to keep rates both low enough to foster job growth and high enough to stem inflation. Previously, the Fed has stated that an unemployment rate of about 5.4% would be consistent with holding inflation at the standard rate of 2%.
Both unemployment and the inflation rate are approaching the benchmarks set by the Fed for initiating rate increases.
The Fed pairs rising employment with rising inflation because more hiring generally leads to higher wages and, in turn, leads to an increase in consumer demand for goods and services, which raises prices. However, the Fed should wait until wages are growing in unison with inflation.