The strongest dollar in more than 11 years is coming soon to stores across the U.S.
The 24 percent surge in the currency since June will take time to gradually ripple through the world’s largest economy, first showing up in lower costs for goods imported by American companies and then in the prices paid by consumers, according to economists at Barclays Plc, Goldman Sachs Group Inc. and JPMorgan Chase & Co. That means the dollar will be the next check on inflation, replacing oil as fuel costs stabilize.
“The energy price pass-through should begin to wane by the end of the first quarter,” said Michael Gapen, the New York-based chief U.S. economist for Barclays. “The peak drag from the dollar will come in the second and third quarters.”
Clothing, electronics and automobiles are among the items that will probably carry smaller price tags as the greenback’s appreciation works its way to store shelves and dealer showrooms. That will give an added boost to household buying power, which is already benefiting from the lowest gasoline prices in six years and larger job gains.
“You can’t expect a better environment for consumers,” said Gregory Daco, lead U.S. economist at Oxford Economics in New York. Combined with cheaper fuel, “the stronger dollar is an additional layer of downward pressure on inflation.”
The cost of imported goods and services has dropped for seven straight months, the longest such stretch during an economic expansion since 1998, mainly caused by the plunge in energy, according to Labor Department data. A report Thursday is projected to show prices for goods made overseas rose 0.2 percent in February as crude oil stabilized.
Import prices excluding fuel fell 0.7 percent in January, the biggest decline outside of a recession in records going back to 2002, as the rising dollar started to trickle through the data. Prices at the consumer level will probably follow suit as retailers mark down merchandise to remain competitive.
While a boon to households, weakening inflation toward mid-year poses a challenge for Federal Reserve policy makers around the time they are projected to begin lifting borrowing costs. Officials will need to decide if the rapidly improving job market warrants raising the benchmark interest rate for the first time since 2006, or should lower prices mean they hold off to allow the economy to accelerate further.
The Fed’s preferred measure of inflation tied to personal consumption expenditures hasn’t been above its 2 percent goal since March 2012. In January, the gauge was up just 0.2 percent from a year earlier, the least since October 2009, reflecting the plunge in fuel costs, according to the Commerce Department.
The downward pressure is showing up elsewhere. The price index that excludes fuel and food, known as the core rate, rose 1.3 percent in the 12 months to January, matching the smallest year-to-year advance since March 2014.
The measure will slide to around 1 percent by mid-year, David Mericle and Chris Mischaikow, economists at Goldman Sachs in New York, project. The data so far capture “at most half” of the eventual downdraft from oil and the dollar, with the largest effect “likely to be seen around mid-2015,” they wrote in a Feb. 20 research note.
“A substantial amount of pass-through is still likely in the pipeline,” the economists wrote. “The aggregate effect would remain sizeable into 2016” should the trade-weighted value of the dollar continue to appreciate.
Barclays’s Gapen and Oxford Economics’ Daco project the greenback will reduce year-over-year inflation by 0.2 percentage point. Economists at JPMorgan Chase forecast the effect will be twice as large. The dollar strengthened against all 31 of its major peers last year and is up about 9 percent so far in 2015.
“We’re in a period where core inflation is starting to surprise to the downside,” said Gapen, a former Fed economist. For now, he projects the central bank will raise the benchmark interest rate in June, although “a continual downside shock from import prices” could make officials more patient, he said.
The currency’s influence on prices has become part of the debate. Fed Chair Janet Yellen, in testimony to the Senate Banking Committee last month, acknowledged that the drop in oil and rising dollar are causing inflation to fall short of the central bank’s objective.
The recent slowdown in prices excluding food and fuel is “in part reflecting declines in the prices of many imported items and perhaps also some pass-through of lower energy costs,” she said.
The lack of inflation around the time some people forecast the Fed will raise the benchmark rate could forestall action by the central bank, said Thomas Costerg, an economist at Standard Chartered Bank in New York.
“It wouldn’t go well with markets if the Fed tries to muscle through with a rate hike when inflation isn’t showing signs of picking up,” Costerg said. “Seeing a bottom in core inflation is important for the Fed. This is not going to happen until mid-2015.”
Others say disinflationary pressures won’t keep the Fed from raising interest rates by mid-year.
“If the inflation numbers were going to be an impediment to the Fed pulling the trigger in June, they would have signaled it,” said Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez Inc. in New York.
At their last meeting in January, policy makers said that while price increases will probably decelerate in coming months, “the Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of lower energy prices and other factors dissipate.”
The disinflation stemming from goods made overseas may mean it takes longer for that to happen.
San Francisco Fed researchers Galina Hale and Bart Hobijn found in a 2011 paper that imports account for 13.9 percent of U.S. consumer spending on goods and services.
A 1 percent drop in the price of foreign-made clothing, for instance, would reduce its cost on store shelves by 0.4 percent, according to Mericle and Mischaikow at Goldman. Similarly, American consumers would pay 0.2 percent less for new automobiles.
The Labor Department’s consumer price index showed apparel prices declined an annualized 6.9 percent from October through December, matching the biggest decrease since 1952. The overall CPI fell 0.1 percent in the 12 months through January, the first year-to-year drop since October 2009, when the economy was emerging from a recession.
One irony is that the more investors believe the central bank will soon raise rates the more the dollar appreciates, and in turn, the more inflation will fall short of the Fed’s goal. Higher U.S. borrowing costs make investing in dollar-denominated securities more attractive relative to its counterparts that are still loosening monetary policy.
“Appreciation is likely to persist as long as U.S. monetary policy is expected to diverge from that of other major economies,” said Carl Riccadonna, Bloomberg Intelligence chief U.S. economist.
Nariman Behravesh, chief economist at IHS Inc. in Lexington, Massachusetts, said that while the lack of inflation may play a role in whether the Fed will begin to raise rates in June or September, one thing is more certain.
With cheaper energy already depressing prices “the stronger dollar is one more source of good deflation,” which contrasts with a harmful drop in prices generated by slumping demand, he said. “It’s back-to-back good news for the consumer.”