Implications: A surprise to the upside in January, as rising margins for wholesalers offset the continued decline in energy prices. Final demand services rose for a third consecutive month in January, led by machinery and equipment wholesaling. The rising pace of inflation from the service sector, up 1.3% at an annual rate in the past six months and up 4.8% at an annual rate in the past three months, comes in sharp contrast to the goods sector, where energy continues to dominate. Good prices declined 0.7% in January, as an 8.8% decline in gasoline prices pushed energy prices lower for the sixth time in seven months. Exclude just energy, and goods prices rose 0.2% in January. In the past year, goods prices are down 2.6%, but are down a more modest 0.6% excluding energy. The "core" measure of producerprices, which excludes both the volatile food and energy components, rose 0.4% in January and is up 0.6% in the past twelve months. In other words, inflation is extremely low, but the U.S. is not experiencing deflation. Some will argue that low headline readings on inflation are reason for the Fed to hold off further rate hikes, but we think that is a mistake. Oil prices will eventually stabilize, and when they do, inflation will move quickly towards the Feds 2% inflation target. The Fed knows that the impact from energy is temporary - they have made this abundantly clear in Fed statements and in speeches by many of the Governors – and continued strength in employment and earnings should give them confidence to keep further rate hikes on the table for the first half of 2016.
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