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Will the Federal Reserve Shock the World With a Rate Hike?

The United States can't shake off the inflation blues.

The Federal Reserve has repeatedly signaled that it will cut interest rates this year. From Chair Jerome Powell’s comments to the Summary of Economic Projections data, the central bank is all but guaranteed to pull the trigger on the first rate cut in the coming months. Even President Joe Biden has weighed in on the issue and expects a pivot. But there’s just one problem: Inflation is far from reaching the Eccles Building’s 2% target. The treasure trove of recent measurements has ignited rumblings that the Fed may actually raise rates this year instead.

Federal Reserve and Inflation

While Americans watch the consumer price index (CPI) with bated breath every month, the monetary authorities assess a mountain of other metrics to determine if it is on the right path toward its arbitrary 2% objective. Recent CPI movements have not precisely elicited confidence as consumer sentiment surveys have started edging down again. The latest annual inflation reading clocked in at a higher-than-expected 3.2%. The bad news is that the Cleveland Fed Bank’s Inflation Nowcasting model estimates a rise to 3.4% next month.

So, if the headline CPI does not sway the policymaking Federal Open Market Committee (FOMC), what would? Rate-setting committee members monitor several inflation components. One is supercore inflation, which calculates services prices excluding housing and energy. It rose 0.5% monthly and was flat 4.3% year-over-year. In recent months, the White House, economists, and the mainstream media have relied on shorter time frames to depict how inflation has been vanquished, including looking at three- and six-month annualized prints. This might not have been a good idea.

On a three-month annualized basis, supercore inflation soared to 6.9% in February. Using the six-month approach, supercore came in at 5.6%, up from 2.8% in August 2023. Even if market observers see only the overall services inflation, this statistic has barely budged since September, hovering around the 5% mark. Ouch. That’s gotta hurt.

Of course, there are other avenues to explore that the inflationary threat has not been pulverized despite the Federal Reserve raising interest rates to their highest levels in 23 years. Sticky price CPI excluding food and energy, an index that monitors the price of goods and services that change infrequently, has been stuck above 4% for the last six months. By comparison, this was at 1.4% in January 2021.

Is the US economy on the cusp of a second round of inflation? For businesses and consumers, who have contended with cumulative 20% inflation, it never really vanished from their lives.

History Repeating Itself?

Heading into 2024, the financial markets priced in as many as six rate cuts, although the FOMC conveyed to the world that the central bank would slash the benchmark Fed funds rate three times. However, because of the revival of inflationary pressures and a solid economic environment, monetary policymakers say they have the luxury of being patient before pivoting in the current quantitative tightening cycle.

At the same time, forecasts for the first rate cut have been continually pushed back. According to the CME FedWatch Tool, investors are pricing in an initial rate reduction at the June meeting. Is this a realistic projection or false hope? Torsten Slok, the chief economist at Apollo, surprised the market by becoming one of the first prominent Wall Street figures to abandon rate-cut expectations. Since then, some other experts say the Fed will not cut rates this year.

The futures market is not even considering a rate hike. However, some have entertained the possibility, including former Treasury Secretary Larry Summers, who told Bloomberg last month there is a “meaningful chance” the next Fed move will be an increase in interest rates. This might make sense. Liberty Nation noted last year that inflation trends could emulate the 1970s and 1980s when they ebbed and flowed. Some Fed officials, including Richmond Fed President Thomas Barkin, have alluded to this possibility, stating that they do not want to relive the Paul Volcker era.

Language from the FOMC meeting minutes suggests the central bank is ready to tighten monetary policy if the data warrants it. In other words, the Fed is keeping a rate hike in its back pocket. If inflation continues to venture in a direction that will irk everyone, the futures market will be vital to monitor.

Bedlam in America

It might be too early to anticipate a rate hike, though, as there is still plenty of data to sift through heading into the June FOMC meeting, including a few more inflation reports, a couple of jobs reports, and GDP prints. That said, if history repeats itself, the world’s most powerful institution might shock its counterparts and pull the trigger on a quarter-point jump. Should this happen, expect bedlam on Wall Street and Main Street alike – and expect a perturbed president, be it Joe Biden or Donald Trump.

Read More From Andrew Moran

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