MNI ANALYSIS: Soft Dlr Infl Impact Could Disappoint Fed, Mkts

--Dollar Drop Insufficient For Inflation Boost Anytime Soon

By Jean Yung

     WASHINGTON (MNI) - The wait for dollar depreciation to feed through into

import price inflation could be of slower, more limited impact than markets are

expecting, and the Federal Reserve -- already frustrated by the resistance of

inflation to falling unemployment -- could be disappointed again by muted

import-price inflation pressures in the coming months.

     The Fed expects a rebound in core inflation next year as the transitory

factors that have weighed on inflation drop out of calculations and as wages

rise in response to a tightening labor market. Fed Vice Chairman William Dudley

also remarked last week that a slide in the dollar exchange rate should boost

the price of imported goods.

     Economic theory supports that story, but it may not play out that way in

the real world. Since the start of the year, investors have been selling the

dollar amid shifting views on European Central Bank policy and a reassessment of

whether Trump can deliver a big boost to U.S. growth. The U.S. currency hit a

2-1/2-year low against the euro on July 31, and the Chinese yuan has gained

about 3% against the dollar this year. 

     There is no comparative episode of dollar depreciation in the past decade.

When the U.S. currency sank in 2009, its economy was reeling from the financial

crisis. But when the dollar surged a few years ago, it dragged down prices of

energy and consumer products in the United States and kept inflation in check --

and the Fed on hold. 

     That the reverse could happen now looks doubtful. The magnitude of dollar

depreciation thus far has been less than a third of the 2014-2015 appreciation

episode. The DXY dollar index rose more than 25% in 2014 and 2015. This year it

has declined about 10% from the January peak. But compared to exactly a year

ago, the index is down just 2%. 

     In 2015, the large run-up in the dollar prompted Fed Vice Chair Stanley

Fischer to remark that the stronger dollar had played "a material role" in

holding inflation below the Fed's target, citing an internal model that

estimated the appreciation probably depressed core PCE inflation between a

quarter and a half percentage point that year through the import price channel. 

     The size of the dollar's fall this year is much smaller. The decline since

January has helped support non-petroleum import prices, which have been drifting

steadily higher for more than a year. Still, imported price pressures on the

whole are weak. The Labor Department said Tuesday non-petroleum import prices

were flat in July and up just 0.9% from a year ago. 

     The Institute for Supply Management's most recent survey of purchasing

managers at factories around the country saw a large uptick in the survey's

prices paid index to 62.0 in July from 55.0 a month earlier. But ISM Survey

Chief Tim Fiore in an exclusive interview with MNI stated that the increase was

driven by a broad-based demand for commodities, especially steel and aluminum,

as manufacturers geared up to meet new order demands. 

     "It's fundamental demand and it's increasing," Fiore said. 

     Currently at $1.18 to the euro, the dollar is "still pretty attractive," he

said. The majority of multinational firms have currency hedges in place, so

"unless it swings dramatically, I don't know if it will impact import prices

very much." 

     Movements in exchange rates also take time to feed into consumer prices.

Most of the goods purchased by U.S. consumers are still produced domestically

and not directly influenced by exchange rate fluctuations. Services imports are

only a small portion of consumption expenditures. 

     Finally, import prices are not a big factor in the current inflation

outlook. The one-off shocks from cheaper cell phone service plans and

prescription drug prices that weighed down inflation this spring are expected to

persist in the year-over-year inflation figures until they drop out of

calculations early next year. 

     Still, Dudley of the New York Fed on Thursday reassured investors the

impact of the current dollar slide will be felt in import prices and is one of

two key trends supporting a return of inflation to the Fed's 2% target. 

     "Goods prices in general which had been more depressed when the dollar was

appreciating should show a little bit more upward pressure now that the dollar

has been depreciating," he said. 

     That, plus a tightening labor market which is expected to generate wage

growth, "should combine to push inflation up," he said. "The story's not a

complex one." 

     But barring another leg down in the dollar, economic fundamentals may not

allow for a return to the Fed's 2% inflation target anytime soon.

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

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