Ag AFP
WASHINGTON: Stubbornly hot U.S. inflation is fueling bets that the Federal Reserve will get more aggressive about trying to cool price pressures and even potentially ditch its own forward guidance by delivering a jumbo-sized interest rate hike in coming months.
Fed policymakers had already all but promised half-point interest rate hikes at their meeting next week and again in late July, following May's half-point hike and the start of balance sheet reductions this month. That would be more policy tightening in the space of three months than the Fed did in all of 2018.
President Joe Biden, whose popularity has taken a hit as prices surge just months before November´s midterm elections, has made fighting inflation his top domestic priority but is finding he has few tools to directly affect prices.
"I´m doing everything in my power to blunt Putin´s price hike and bring down the price of gas and food," he said Friday while speaking at the Port of Los Angeles. "We´re better positioned (than) just about any country in the world to overcome the global inflation we´re seeing and to take the next step towards forming a historic recovery."
The president has tried to hammer home his optimistic message about economic progress in the wake of the pandemic, including rapid GDP growth and record job creation, while pressing Congress to take action to lower costs on specific products.
Biden cited releasing 30 million barrels of reserve oil and repeated his call to approve legislation to go after firms such as shipping companies that are taking advantage of limited competition to impose steep price hikes.
But he acknowledged the rising inflation was a severe problem, saying in an earlier statement the United States "must do more -- and quickly -- to get prices down."
The new data dealt a crushing blow to Biden´s efforts.
The Federal Reserve has begun raising interest rates aggressively, with another big hike expected next week, and more ahead in coming months as policymakers attempt to combat inflationary pressures without triggering a recession.
The CPI surge "raises the probability of even more aggressive Fed rate hikes to tamp down on inflationary expectations," said Mickey Levy of Berenberg Capital Markets, adding that a pause in rate hikes in September is "looking increasingly unlikely."
On Friday, traders of futures tied to the Fed policy rate began pricing in an even bolder path after U.S. Labor Department data showed sharply higher food and record gas prices pushed the consumer price index (CPI) up 8.6 percent last month from a year earlier. A separate University of Michigan survey showed longer-term inflation expectations rising to their highest since 2008.
Prices of Fed funds futures contracts now reflect better-than-even odds of a 75-basis-point rate hike by July, with a one-in-four chance of that occurring next week -- up from one-in-20 before the inflation report -- and a policy rate in at least the 3.25 percent-3.5 percent range at year end.
Yields on the two-year Treasury note, seen as a proxy for the Fed's policy rate, topped 3 percent for the first time since 2008.
"We believe that today's inflation data - both the CPI and UMich inflation expectations - are game changers that will force the Fed to switch to a higher gear and front-load policy tightening," wrote Jefferies' Aneta Markowska, who joined economists at Barclays on Friday in forecasting a 75-basis-point rate hike at the Fed's June 14-15 meeting.
Most economists still expect a half-point hike next week, and more of the same at subsequent meetings through at least September if not further.
Core CPI, which strips out volatile energy and food prices, rose 6 percent in May, down slightly from April's 6.2 percent pace but far from the "clear and convincing" sign of cooling price pressures that Fed Chair Jerome Powell has said he needs to see before slowing rate hikes.
"Any hopes that the Fed can ease up on the pace of rate hikes after the June and July meetings now seems to be a long shot," wrote Bankrate chief financial analyst Greg McBride.
Economists at Deutsche Bank concurred, and said they now forecast rates to rise to 4.125% by mid-2023.
Fed policymakers at the close of next week's meeting will release their own best guesses of how high they'll need to lift short-term rates. They'll also provide forecasts of how much unemployment - now at 3.6% - may need to rise before the economy slows enough to reduce inflation.
In recent weeks some had expressed the hope that by September their own rate hikes, along with easing supply chain pressures and an expected shift in household spending away from scarce goods and toward services, would have started to ease price pressures and allowed them to downshift to smaller rate hikes.
Friday's inflation report suggested the opposite.
Used car prices, which had been sinking, reversed course and rose 1.8% from the prior month; airline fares rose by 12.6 percent from the prior month and 37.8 percent from a year earlier. Prices for shelter - where trends tend to be particularly persistent - rose 5.5 percent, the biggest jump in more than 30 years.
The Fed's current policy rate target is now 0.75 percent-1 percent. Fed officials want to get it higher without undermining a historically tight labor market and sending the economy into recession, but accelerating inflation will make that a hard task. "These are ugly numbers. ... I’d say we’ll probably be in a recession in the fourth quarter of this year with confirmation in the second quarter of 2023,” said Peter Cardillo, chief market economist at Spartan Capital Securities.
