Economic Preview: Economy keeps pumping, but now the Fed wants to let out some air

Economic Preview: Economy keeps pumping, but now the Fed wants to let out some air

Inflation is rising and putting pressure on the Federal Reserve to raise interest rates.

The cost of borrowing money in the U.S. is going up this week thanks to the Federal Reserve — and
a pumped-up economy.

The central bank on Wednesday is all but certain to lift a key short-term interest rate to a range of 2% to 2.25%, putting it at the highest level in a decade. Many loans for things such as mortgages and autos are tied to the so-called fed funds rate.

The Fed has been steadily raising rates to keep the U.S. from growing so fast that inflation gets out of hand. There’s more of a danger of that now, even if just a small one, with the economy expanding at a rapid pace and inflation hitting the highest level in six years.

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The news on the economy has been so good, in fact, that the Dow Jones Industrial Average DJIA, +0.32% and the S&P 500 SPX, -0.04% both busted through to fresh all-time highs last week. Investors have decided to ignore an escalating trade fight between the U.S. and China because corporate earnings are so strong.

“Markets care more about profits than politics,” strategists at the investment firm Voya Global Perspectives told clients.

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A barrage of reports this week on the health of the economy are likely to underscore precisely why the Fed is taking out some insurance, so to speak. Chief among them are business investment, consumer spending and inflation.

Taking advantage of the first corporate tax cuts in 31 years and a Trump administration push to roll back regulations, businesses have opened the spigots on investment.

A proxy for how much companies are investing, known as core capital-goods orders, has climbed almost 9% in the past year. By contrast, these orders were mostly low or outright negative from 2012 to 2016.

The latest read on investment included in August orders for durable goods is expected to be weak, but it might just be a blip. Investment surged over the summer and is due for a breather.

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Consumer spending, meanwhile, is forecast to show a solid gain in August. Ditto for incomes.

Want to know why the economy has strengthened considerably? That’s why. More people are working than ever and now they’re earning better pay, creating a virtuous cycle that keeps the economy expanding.

“The U.S. economy is in a good place right now,” said Scott Anderson, chief economist of Bank of the West.

It certainly is — except for the small matter of rising inflation.

From being almost virtually zero a few years ago, inflation has climbed to nearly 3% yearly pace based on the consumer price index. The Fed’s preferred PCE index has risen by a somewhat smaller 2.3% in the past year, but that’s still above the central bank’s 2% target.

The PCE inflation index is forecast to rise slightly in August, keeping inflation at or above the 2% trendline.

Though still quite low by historical standards, inflation could rise even further in the months ahead.

The U.S. labor market is so tight companies are being forced to boost pay to attract new workers, for one thing. The cost of critical raw materials such lumber have also been inflated by tariffs or strong demand. And just finding enough truckers to transport goods has become a costly headache.

If that happens, the Fed is going to step harder on the gas pedal.

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