Will inflation push the Fed for a big rate hike?
Markets anticipate another hot inflation reading later today when the U.S. Bureau of Labor Statistics releases the Consumer Price Index (CPI) at 1:30 pm GMT. The question remains how hot would it be and what the Federal Reserve will do about it? That is key to most asset classes following a volatile start in 2022.
Today’s CPI is one of the most critical data releases before the Federal Reserve meets on 15 & 16 March to decide its next move. Chair Jerome Powell and many of his colleagues have already signaled that interest rates will take off in March, but there seem to be lots of arguments on the magnitude and speed of rate hikes.
The strong January employment report already lifted expectations. Fed funds futures are putting the probability of a 50-basis point rate hike at 28.5% in March compared to less than 20% before the jobs report. While Fed policymakers prefer to take gradual steps towards liftoff, they are already behind the curve, and another inflation surprise may force them to hike aggressively.
The CPI is forecasted to rise 7.3% year-over-year in January, a new 40 year high after a 7% increase in December. When excluding volatile items like food and energy, the core inflation is expected to rise 5.9% year-over-year. However, the monthly increase is anticipated to slow from 0.6% in December to 0.5% in January. Still, there’s a high probability for a surprise, given that estimates range widely from 0.2% to 0.7% for the monthly core reading.
Inflation dynamics may begin to change with the shifting trajectory of the pandemic. Biden’s chief medical adviser, Dr. Anthony Fauci, said the U.S. is heading out of the “full-blown” pandemic phase of Covid 19, and he hopes there would be an end to all pandemic-related restrictions in the coming months. That would translate to slower goods inflation in the months ahead with supply bottlenecks easing further, but risks more rising prices in service, especially shelter, which would be a significant concern.
We’re likely to see a volatility spike today following the data release, especially if it deviates from median expectations. A higher inflation figure will increase the bets for a 50-basis points rate hike putting downward pressure on risk assets and providing the USD another boost, while a slower price increase should have the opposite effect. It is definitely another exciting day for traders!