Bad news: It looks like inflation is stubborn, and the Fed will have to react
Zachary Halaschak
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Inflation isn’t cooling as fast as observers had hoped and may even be rising again, meaning that the Federal Reserve is expected to keep hiking interest rates.
Annual inflation slowed to 6.4% in January according to the consumer price index, the Bureau of Labor Statistics reported Tuesday. That came as a bit of a disappointment for the central bank, given more aggressive declines in the preceding months. Most economists had thought the headline number would decline to 6.2%.
More significant, perhaps, is that prices rose by half of a percentage point between December and January alone. That was the biggest month-to-month increase since June 2022.
“The January consumer price index release showed that the Federal Reserve still has work to do to tame inflation,” said Sam Millette, a fixed income strategist for Commonwealth Financial Network. “This report, combined with the much stronger than anticipated January employment report, indicates that the Fed may have to hike rates this year by more than what markets anticipate.”
The news was not welcome for investors who fear that stickier inflation will hurt the markets as the Fed keeps hiking rates.
BIDEN SAYS ‘MORE WORK TO DO’ AMID SHAKY INFLATION REPORT
Stocks immediately took a bit of a hit upon the news breaking. The Dow Jones Industrial Average was down some 200 points after the report’s release. The S&P 500 was off by about 0.3%, and the tech-heavy Nasdaq composite fell by 0.2%.
It is worth noting that the January CPI report was shaped in part by methodological changes, including updated seasonal adjustments. It also included new weights for 2023, which were expected to add somewhat to measured inflation, according to a note by Goldman Sachs researchers prior to the Tuesday morning release.
After a series of December inflation reports that showed prices meaningfully falling, some economists were starting to think that Fed Chairman Jerome Powell might actually be able to pull off an elusive “soft landing,” wherein inflation is tamed while a recession is avoided.
After raising interest rates by a quarter of a percentage point at its last meeting earlier this month, some thought the Fed would even forgo a rate hike at its next meeting. Those hopes have now been thrown out the door.
Investors are now pegging the odds of a quarter-point hike at about 90%, according to CME Group’s FedWatch tool, which calculates the probability using futures contract prices for rates in the short-term market targeted by the Fed. More than 9% now think that the Fed will hike rates at an even more aggressive pace, given the recent reports.
The favorable inflation reports that preceded this latest one also gave President Joe Biden a bit of ammunition for his annual State of the Union address. In it, Biden touted cooling price growth and lauded the positive spots in the economy, such as the tight labor market. But on Tuesday, Biden released a statement acknowledging what will likely be a long road ahead.
“There is still more work to do as we make this transition to more steady, stable growth, and there could be setbacks along the way,” Biden said. “That is why my unwavering focus is on continuing to lower costs for families, rebuild our supply chains, and invest in America.”
Republicans have used the country’s searing inflation as a cudgel against the president and Democrats in Congress. Top GOP lawmakers immediately reacted to the hotter-than-expected inflation report by pinning the blame on Biden’s agenda.
“Working Americans need relief from President Biden’s ongoing inflation crisis,” said House Ways and Means Committee Chairman Jason Smith (R-MO). “President Biden is in denial and has no plan to stop the inflation he started. In his State of the Union address to the nation, the President promised more of the same reckless spending, welfare for the wealthy, and Green New Deal handouts that have made everything from gas to groceries unaffordable for working Americans.”
Federal Reserve Bank of Richmond President Thomas Barkin warned on Tuesday that the central bank might “have to do more” if inflation remains sticky and doesn’t show meaningful progress in falling back to the Fed’s preferred 2% level.
“Inflation is normalizing, but it’s coming down slowly,” Barkin told Bloomberg. “We may or may not choose to take rates up further if inflation continues to persist, but we’ll have to see what happens.”
The Fed’s situation is even further complicated by the red-hot labor market.
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The economy notched another 517,000 jobs in January, the Bureau of Labor Statistics reported — a very strong performance that shows commerce is holding up despite the headwinds. The unemployment rate fell to 3.4%, the lowest rate since 1969.
Rate hikes have the natural effect of dampening the economy. So if the strong jobs report causes the Fed to raise rates by even more or hold its tightened stance longer, it could end up causing harm to the economy down the road, potentially causing a recession. Many economists foresee a recession coming.