Hot inflation and strong economic data add turbulence to Fed’s fight

FOMC minutes

Federal Open Mark Committee (FOMC) minutes were released on Wednesday. Details of the Fed officials’ meeting at the beginning of the month showed most officials agreed that slow and moderate rate increases were key to achieving a soft landing. The minutes also unveiled that some officials would have agreed to a half-point increase rather than the quarter-point increase that was unanimously voted upon. As the voting is decided upon by only members of the rate-setting committee, non-voting member James Bullard, the St. Louis Fed President, believed in a steeper hike to reach the estimated peak level at nearly 5.4%. “I don’t see much merit in delaying our approach to that level,” he said. In the wake of last week’s data, some analysts argue in favor of Bullard’s sentiment. Data released showed that in January CPI increased by 0.5% rather than expectations of a 0.4% increase, retail sales increased by 3% instead of expectations of a 1.9% increase, and unemployment reached a 53-year low. Further, data released Thursday by the Labor Department showed a tight labor market as weekly initial jobless claims decreased by 3,000 to a seasonally adjusted 192,000. Yet the biggest blow to the Fed’s fight came on Friday when the personal-consumption expenditures (PCE) price index was shown to rise 5.4% in January from a year prior. The core PCE index was also revealed to exceed expectations at a 4.7% increase. The PCE index is the Fed’s preferred measure of inflation, and the central bank is targeting an annual inflation rate of 2%. Equities fell sharply with the PCE news, marking the worst week of the year, and treasury yields climbed. With strong economic conditions, the challenge to reduce inflation with a soft landing could last longer than expected.

Following these headlines, the market is now pricing in a 41.7% chance of a 50-basis-point increase at the next FOMC meeting according to the CME FedWatch Tool, highlighting the belief that current interest rates are not high enough to have a cooling effect on either consumer spending or the labor market and more rate hikes are in our future. This shift in expectations provides an opportunity with an inverted yield curve to fix floating rate debt at a rate lower than equivalent debt with a shorter maturity. As market expectations change, corporate treasury teams should evaluate both the financial risks and market opportunities presented.

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Although it seems that the expected effects of higher interest rates have not yet materialized when looking at consumer spending or the labor marker, effects have been seen in the level of consumer savings which is now lower than pre-pandemic levels. This could be reason for concern in the event of widespread layoffs brought on by further rate hikes, as consumer debt levels have risen and their financial cushion has been eroded.

Oil floats and natural gas deflates

Attention has recently shifted to oil prices as the war in Ukraine reaches the one-year mark. In retaliation to the European Union’s sanctions on all Russian oil products as well as the implementation of a price cap, Russia announced a 5% reduction in oil production in March (0.5% of global supply). This news is paired with rising uncertainty around the pace of China’s reopening and the additional oil demand that would follow.

Prices for natural gas have reached their lowest levels since COVID lockdowns went into effect. After pipelines critical for delivering gas into Europe were damaged last year, prices surged, but have fallen nearly 66% since December. This is largely because U.S. and EU gas demand has been soft in a warmer than average winter. Several natural gas producers, like Chesapeake Energy Corp, recently stated production will begin to slow down as consumers draw upon the surplus of inventory.

The week ahead

This week, be on the lookout for headlines relating to Core Durable Goods Orders and Pending Home Sales today and the release of the Conference Board Consumer Confidence on Tuesday to gain insight into the consumer. On Thursday, the European Central Bank releases February’s CPI data as well as a policy statement. The ISM Manufacturing PMI and the ISM Non-Manufacturing PMI also get released on Wednesday and Friday, respectively.